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Financial Literacy

Financial Literacy

Home Financial Literacy Investing 101 Stocks as Ownership

Stocks as Ownership

Okay, so let’s go back to that 1/330,000,000th of Google you bought. We know you just snagged yourself a tiny slice of the pie, but… what does that mean, exactly? What did you just buy?

In any investment, an investor puts in their hard earned cash, expecting it to be worth more at some point in the future. They are buying future profits, which can come to them in a variety of ways.

Let’s say GOOG declares suddenly an annual dividend (a sum paid back to shareholders) of $10 a share. If the stock stays flat for 5 years, you would have collected $50 in dividends on your $500 investment. At 2% a year, it adds up to 10% (pretax). Nice. But it is nothing to write home about. Unless your parents insist on you writing to them about every single little thing, in which case, don’t forget to let them know about your last five bowel movements.

What IS GOOG financially, anyway? Well, you know it’s the top dawg search engine on the internet. HotBot has seen better days. Google makes most of their money from people clicking on the ads on the far right column of the page. Merchants pay a few cents or more for each click to Google in return for Google sending traffic their way, hoping that clickers will buy stuff, from which the merchant profits. All those eBay ads – money to Google.

Structurally, around the end of 2010, what you were buying in a share of GOOG was the following (and more!):

1. $100 per share in cash – about $33 billion worth. With 330 million slices of pie outstanding, that’s about $100 a share. Just in cash.

2. GOOG earned about $21 a share based on Wall Street accounting standards (called “GAAP,” or generally accepted accounting principles) – it is expected by most Wall Street analysts to earn about $25 in 2011 and about $30 in 2012. And GOOG earns in cash more than the Wall Street numbers indicate – long story. The important takeaway here is that if the stock is selling for $500, you can kinda sorta take away $100 when you are thinking about the equity value of the stock. It’s like if you were paying $1 million for a home. But included in the purchase of the home was a safe, which had $200,000 in it. All in cash. You could tomorrow sell that safe for $200,000. Would you think that the home cost you $1 million? Or $800,000? Humor us for now and think: $800,000.

3. The company is expected to grow - a lot - as search continues to grow and the company goes into other businesses like cell phones, television, music, other software businesses, etc.. We’re pretty sure they’re planning on staying out of the chocolate pretzel biz.

So your $500 bought you $100 in cash and about $30 in cash earnings (aka profits). Good deal? Bad deal? Time will tell. The belief would have to be that GOOG would earn, say, $100 a share in 10 years and trade at 20x that number to be worth $2,000 a share for you to feel really good about making 4x your money over a decade. That’s a compound rate of 35%. Not bad at all.

The financial analysis of these values is what employs an industry of Wall Street folk.

But that’s a stock in a nutshell. It’s a slice of hopefully juicy pie. None of that “pecan” nonsense.

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