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We have 1 story, take 20 minutes to read and you will understand how to buy a stock.
This story will offer a complete, concise and easy-to-understand A-to-Z process of “how to buy a stock.”
I-What is the stock?
– Emily was a smart girl and she came up with the idea of opening a bakery shop called Jacob & Sarah, which was the name of Emily’s father and mother. The advantage of this type was that each packaged cake would be good for 3 years. To open this store, Emily estimated she needed $100,000, but Emily only had $50,000, she called for capital investment from Michael and Hannah, Michael has $10,000, Hannah has $40,000.
After some consideration, Emily decided she would divide her bakery into 1,000 pieces of equal value, each worth $100.
So Emily would need 1,000 sheets of paper worth $100 each. Emily gave Michael 100 sheets, Hannah would have 400 sheets and Emily kept 500 sheets for herself.
They set up the EHM company from the first three letters of each name, the $100,000 EHM company owned Jacob & Sarah Bakery.
So Emily, Hannah, and Michael were the three owners of the bakery, and they kept the sheets of paper lawfully recognized and it’s called stock.
In other words, the stock is a certificate of the amount that the investor contributed to the issuer. The stockholder is a shareholder or, in other words, the owner of the company.
II- Read Financial Report:
1. Balance sheet:
With $100,000 of initial capital, Emily divided into three parts: $70,000, $20,000 and $10,000:
– $70,000 to buy glass cabinets, furniture, kitchen equipment for baking.
– $20,000 used to buy raw materials for baking bread, eggs, sugar, chocolate, strawberry … then made into 1,000 strawberry taste cakes, 1,000 chocolate taste cakes. The cost of these 2,000 cakes was $20,000, each of which would cost initial capital $10.
– $10,000 left: Emily used to pay staff for a year and now it is in the form of cash in the cabinet.
So Emily’s company had a total initial capital of $100,000 by three shareholders, Emily $50,000, $40,000 by Hannah, and $10,000 by Michael.
This amount was redeemed by Emily with the following assets:
– $70,000 to buy glass cabinets, tables, chairs, kitchen equipment for cake making is called long-term assets. Long-term assets are assets that has long usage, circular and payback period (more than one year or multiple business cycles) and are of great value.
– The remaining $30,000 including 2,000 cakes and $10,000 in cash is called short-term assets. Of which 2,000 are cakes and $10,000 cash is cash and cash equivalents. Short-term assets are assets that have a short period of usage, circular, and payback (within one business cycle or a year)
In a company the total capital always equals the total assets.
The initial capital: $50,000 of Emily, $40,000 of Hannah, and $10,000 of Michael ($100,000 in total) will equal the sum of $70,000 long-term assets (glass cabinets, furniture, kitchen equipment) and $30,000 short-term assets. (2,000 cakes sold at a cost of goods sold of $20,000 and $10,000 in cash).
The balance sheet of the EHM company that owns Jacob & Sarah Bakery will be:
Total assets of $100,000
Short-term assets: $30,000
Of which: Money: $10,000
Long-term assets: $70,000
Total capital: $100,000
Of which: Equity: $100,000
The balance sheet tells us how much the company’s total assets; its short-term, long-term asset structure; and how much money, inventory, and short-term assets, etc. are.
The balance sheet also tells us how much the company’s capital is, in which how much debt and how much equity is.
2- Report on business results:
Return to the story:
After 1 year, Emily sold 2,000 pieces of cakes, each for $25. So Emily earned $50,000.
Emily’s long-term assets including glass cabinets, tables and chairs and kitchen equipment have purchase price of $70,000. After 1 year of usage, creating 2,000 cakes, they were old and worth only 90% of the value, having lost 10%. If selling them, Emily would lose $7,000. This $7,000 is called depreciation.
And the cost of materials of 2,000 cakes was $20,000.
The cost of paying Emily’s employees for the past year was $10,000.
So we have a report on the business results of EHM, owner of the bakery Jacob & Sarah:
Business result report:
Sales of 2,000 cakes, $25 each: $50,000
The cost of the 2000 cakes is $10 per unit: $20,000
Depreciation is $7,000
The cost of employee salaries is: $10,000
Pre-tax income is: Revenue minus expenses and asset depreciation: $50,000 – $20,000 – $7,000 – $10,000 = $13,000
Assuming tax of 17.7% = pre-tax income * 17.7% = $2,300
After-tax income is: $13,000 – $2,300 = $10,700
So with $100,000 of initially capital, Emily and two friends after one year generated $10,700 in after-tax profits.
Emily and two friends decided to divide the profits among EHM owners with $5,000 in $10,700 of net profit, the company had 1,000 shares so each share would receive: $5,000/1,000 = $5/1 share.
$5 per share is called dividends. Dividends are a portion of net profits distributed to shareholders of a joint stock company. Dividends can be paid in cash or in shares.
Emily and two friends decided to keep the remaining $5,700 to buy more long-term assets and short-term assets, thereby increasing the annual production output, and revenue is expected to grow. When sales increase, if the production cost still accounts for the same portion as before, net profit will increase accordingly.
Emily and two friends decided to put the company on the stock market and the company was granted the code of 3 letters: EHM.
III- Price determination:
Among Jacob & Sarah bakery’s customers, there was one named Alex.
Alex was convinced by the cakes that Emily made. He also had some idle money without need to use them in the future.
Alex thought the Jacob & Sarah bakery would generate $10,700 in net profit a year. If he bought Jacob & Sarah bakery for $107,000; the annual interest of his investment would be: $10,700/$107,000= 10%.
EHM owned Jacob & Sarah bakery with a total of 1,000 shares, so Alex would buy each share at: $107,000/1,000 shares = $107.
IV- Buying and selling stocks:
After having done some research, Alex found that to buy shares of a company he needed to open an account at a stock company and put money in it to buy and sell shares.
Alex sought reputable and long-established stock companies. He saw that each time buying or selling shares, a stock company charges a fee called brokerage fee. Alex found the company with the lowest brokerage fee among the prestigious and long established companies to open accounts there.
EHM currently owned 400 shares, and Hannah was selling 60 shares for $110 per share.
Alex patiently waited until the price of one share fell to $107 per share to buy.
Hannah, after selling 30 shares at $110 per share, found that there was no longer demand, so she dropped the price to $107 per share for the remaining 30 shares.
Alex now saw 30 shares sold on the stock market at $107 per share as he expected and bought 30 shares for $107 per share.
Alex’s investment amount was $3,210 for 30 shares with brokerage fee of $3.21, so Alex’s total investment was: $3,210 + $3.21 = $3213.21
Back to Hannah, she sold 30 shares for $110 and $30 for $107. Hannah then sold 60 shares for $6,510.
Hannah contributed $100 per share initially for these 60 shares, so the initial investment was $6,000. Hannah earned: $6,510 – $6,000 = $510.
When there is interest in the investment, the tax rate is 15% and Hannah had to pay a tax of: $76.5 plus: $6.51 brokerage fee for the sale of 60 shares.
Hannah’s actual earnings after one year of investment were:
$6,510 – $6,000 – $76.5 – $6.51 = $427, which was equivalent to a return on initial investment of: $427/$6,000 = 7.1%.
V- In summary
how to buy a stock
So we now have a comprehensive understanding of the investment process of buying and selling 1 share.
First we study the company through the information, in which the financial statements are most important. Then calculate a price that we can buy a stock and wait to buy if the current market price is higher than the price we calculated.
When buying and selling, there is brokerage fee. If there is an interest compared with initial capital, then there will be an income tax.
We make money in the stock market in 2 ways: the first way is to receive annual dividends from companies. The second way is to sell stock with a higher price than the purchase price.