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May 28

The Explainer: Taking stock of stocks

Some time ago, a viewer from Mindanao asked us to explain the stock market. Your wish is our command. I’m Manolo Quezon. The Explainer.

 

I. Buy low sell high

[http://www.londonstockexchange.com/en-gb/about/cooverview/history.htm]

If you look at the history of the London Stock Exchange, it began as a coffee-house where John Castaing began offering a service: he started tracking and publishing the prices of various commodities and stocks. People realized there was money in it –and the combination of serious investors and daring speculators, profiting from both solid information and rumors, has characterized stock markets everywhere ever since.

We hear of people who “play the stock market,” and sometimes, the big players in the market are called “high rollers,” and this leads us to think of the stock exchange as something like this. Take a look at this scene from episode 18 of the current, and last, season of “The Sopranos”:

But Tony Soprano playing roulette and the stock market are very different. We tend to think of the stock market as gambling, but that assumes it’s a game –of chance.

You do take a chance when you invest in the stock market, but not all the time. And not necessarily.

Explainee, we can do some very simple, low-tech demonstrations of how the stock market works. To do this, we need the following:

Some play money.

Some fake stock certificates.

And some role-playing on both our parts.

Let’s pretend, Explainee, that I’m not just me, but that I’m a corporation. The Explainer Corporation. Now I have income and expenses, of course, but let’s say I encounter a problem.

Let’s say the Explainer Corporation needs to invest in clothes to improve its operations. Maybe if the Explainer Corporation had some new suits, it would improve ratings, and thus, profitability. The problem is, The Explainer Corporation’s income isn’t enough to buy new suits.

So what do you do? Well, the first option is, borrow money, at interest, but that might add to the corporation’s debt. Or you could sell assets, to raise cash. For example, the Explainer Corporation could sell a kidney. But if the corporation sold a kidney, it might affect the future performance of the corporation. So is there another way?

Instead of permanently selling a part of me, I could sell virtual parts of me; I could try to get people to invest in the future of the Explainer Corporation.

I could sell shares of stock in The Explainer Corporation. If I’m doing this for the first time, I could call it an IPO: an initial public offering.

The Explainer Corporation could say, we’re issuing, for a limited time only, 10 shares of stock. I’d keep, say, six shares, to make sure nobody could every really control me, or to sell at some other time.

But I’d put up 4 shares for sale, at say, 5,000 pesos each. That’s 20,000 pesos, enough for perhaps two new suits and a pair of shoes. In return, my assurance is every year, shareholders in the corporation will get a share in the annual profits of the The Explainer.

Now you, Explainee, could then buy a share of The Explainer. You could give me 5,000 pesos, and presto, I’d give you this certificate, suitable for framing.

There. You now own 1/10 of The Explainer Corporation. Win or lose, good ratings or bad, you’ve now invested in The Explainer. Now every quarter or every year, I could then add up whatever profits the corporation’s made, and declare what’s called a dividend.

Say, for fiscal year 2007, since cable TV pays peanuts, The Explainer Corporation made a profit of 1,000 pesos. You, as an owner of 1 share, would be entitled to 1/10 of the profits, or 100 pesos. There you go.

At that rate of profitability, you’d make your 5,000 pesos back in 50 years; if the Explainer, as you and I hope, does very much better, you’d get very much more, very much sooner.

Some people invest in stocks in the hope that their money will assure them dividends every year: at a certain point, their investment pays for itself and it’s all gravy after that. But other people will be more inclined to take risks.

When you bought your 1 share in The Explainer Corporation at my declared price –that is, 5,000 pesos a share- I, the Explainer Corporation, made the money I wanted to make. I raised suit money. My obligation to you, or anyone owning a share, is for future profits –which may, or may not, occur. Everything after this, is none of the Explainer’s business.

But what if you noticed that, for the 6 shares of The Explainer stock I’d put up for sale, instead of just you and five others wanting to buy the stock, there were dozens of people who wanted a piece of The Explainer?

Why, you could then sell your share to the highest bidder. Where would you do that? At the stock market. Now it’s inconvenient for you, or even The Explainer Corporation, to take out ads just to say we have stocks for sale. What you and I would do is get a middleman to handle things for us.

As the corporation, I would have gotten someone to handle my IPO. As a buyer, you might have read about the IPO in the business section of the papers, and called up your friendly neighborhood stock broker and said, listen here: I want a piece of him!

Then you could call again and say, hey, have a share in The Explainer and I want to sell it.

People could then bid for your precious Explainer share. In the stock market. You bought it at 5,000 pesos. Someone offers you –through the trader- 6,000. Another offers 10,000. And so on. Say you sold your share to someone offering 10,000 pesos. You made a 100% profit, right here, right now, without having to worry about the ratings of this show. Or whether my buying new suits improves ratings.

Well, actually, you made a 100% profit before commissions. But even after commissions, you probably made a huge profit. And my commitment would then shift to whoever now owned the share you once bought.

So if the stock market’s pretty straight forward, why do people still think it’s a lot like gambling?

The combination of fact, and rumor, and the riding high –and sinking low- of the stock market, when we return.

 

II. Hey big spender

 

That was a scene from Alfred Hitchcock’s classic “Rear Window,” where Stella the nurse tells her patient Jeff of how she read the signs indicating the Great Stockmarket Crash of 1929. And their little repartee illustrates the debate that always takes place about the market. Is it all about hunches, or about the iron-clad rules of economics?

After all, the stock market has its ups and downs. When the stock market’s doing really well, it’s called a bull market. Optimism rules the day. Brokers and buyers are bullish. When the market’s doing badly, it’s a bear market. Everyone’s cranky –they’re bearish. The market as a whole, of course, is based on the numbers put together, of representative stocks.

Explainee, let’s go back to our little role-playing game.

You’re the investor, I’m the Explainer Corporation. Now of course, as a publicly-listed corporation, that is, a company that has offered shares on the stock market, and as a corporation in general, I’m under certain obligations.

I have to declare my profits and losses every year, to the government, and inform my shareholders of how things are, every year, in a big blowout we call the annual stockholder’s meeting. To make you, my shareholder, feel special, I could publish it in an annual report.

Now as we mentioned, for 2007, the Explainer could declare a profit of 1,000 pesos. That’s backed by a report. And you could get your dividend and leave it at that. But say you found out, in the middle of the year, that a big ad placement was obtained by this show? Then you’d know the Explainer probably stands to make a big profit next year. You could then decide to do two things:

Wait for your next dividend, or, profit on the news. You could sell your share at the point news started to spread –and make your profit early.

And this brings us to how the market can end up resembling a roller-coaster ride.

Something unpredictable could happen. A studio executive could have a bad hair day, and suddenly cancel this show. Presto, no more Explainer, wailing and gnashing of teeth, and the corporation would have no purpose.

Your stock would then be worthless –or worthless, until and unless a new show goes on the air. No one will want to buy your share, the Explainer can’t give you dividends, and depressed over this sudden turn of events,

And here’s where unscrupulous individuals can make money off your and my misery.

One way is through insider trading. That’s what put Martha Stewart in jail.

It would work like this.

Say you have a friend in the studio’s management. And you knew the studio executive was having a bad hair day, and hated black suits, and that viewing my show first thing in the morning, went nuts and yelled, “cancel that show!”

Your friend could call you; and before anyone know of the cancellation, you could call your stock broker and say, “sell my Explainer stock, now! At whatever price!” Knowing full well whatever you’d get for the stock at 10 am is much more than it would be worth say at 10:30 am when news of the show’s cancellation broke.

Or you could do something else. You could try to manipulate the market.

You could hang on to your stock, even if a cancellation’s announced, watch the price of the stock crash, and buy additional shares, dirt cheap. Then you could float a rumor that The Explainer was coming back –on CNN.

Suddenly, people would want a piece of The Explainer again, and even if you know it won’t happen, others don’t –and you can sell your bigger number of shares at a high price, and get out before people figure out your rumor isn’t true.

You know, the effect of rumors on the stock market can be… Well, a lot like this scene from “My Fair Lady.”

And can end up in one of two ways: laughing it off, as Rex Harrison’s Prof. Higgins laughs off rumors Eliza Doolittle’s of noble blood, or with people stampeding into the market on the basis of a rumor.

To tell us the difference between sheer fiction in the stock market rumor mill, there are professionals called stock analysts  They look at the facts –how a company’s really doing, what it’s really worth, whether it’s prospects are good or bad- and tell their clients their opinions, who can then act accordingly.

When the market does well, of course, everyone wants to take credit for it. Most recently, there was this:

Which was to be expected. But to whom does credit belong, when the market’s doing well?

John Mangun, columnist for The Business Mirror, wrote this. Explainee, would you like to read? 

The credit for stock prices reaching this new level belongs to none of those wanting all the glory. It is not political conditions. It is not merely economic policy. It is not the government fiscal programs. It is not foreign financial institutions praising the investment climate in the country. Although all these play a factor in price movement, the responsibility and, therefore, the glory belongs to the management of the companies listed on the PSE.

 

Now business journalists  like Mangun are in the business of separating fact from fiction, and propaganda from reality. So let’s ask him to tell us what the brisk activity in the stock market means, when we return.

 

My view

 

Tonight we’ve seen how money’s made in the stock market, and what it means when the stock market hits record highs.

But what I’d like to leave you with, tonight, is this thought: when stock market news is good or bad, who should get the blame or the credit?

The companies. Their management. Their ability to make profit or failure to do so. That, ultimately, is what the stock market’s about. When our economy crashed in the mid-1980s,

Jaime Zobel said something we should remember. The economy survived, he said, not because of the government at the time, but because of ordinary men and women who continued to work, and work hard, so that the country’s economy not only survived, but regained value and energy.

Hooray for the companies whose value has boosted the market, I say. And boo to those who are trying to take credit where it isn’t due.

 

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