The Stock Market
From stonks to not stonks
Ah the stock market, something that all of us inevitably end up hearing about nearly every day regardless of our interest in it. You might have had it explained to you by that one guy who has data for the sole purpose of constantly refreshing the Stocks app whenever he’s out. Chances are, however, that his summary was childishly simple. So simple in fact, that you are left wondering why the heck people treat the stock market as this monolithically influential thing.
To understand how the stock market works, it helps to get an idea of its origins. The Dutch East India Company (VOC in Dutch), established in 1602 by the Dutch government, needed a new way to fund their expensive voyages. At the time, these kinds of companies would be funded only for the duration of the trip and then be sold off at the end. VOC, however, took a different approach: rather than telling investors to put all their funds in the company, they allowed them to instead invest in individual ships conducting their respective voyages. In return, these investors would be entitled to a portion of the ship’s profits.
This practice did 2 things: firstly, it allowed for the company to take on lengthier journeys and expand their operations. Secondly, it created competition among individual ships to appear as both safer and more rewarding investments. Although the purpose of this was to generate more funds, the Dutch East India Company unknowingly created the world’s first stock market.
Although the modern stock market is by far more vast and complex than its original manifestation, the gist is similar. A better analogy, however, would be pies. A company can be thought of as one, in that you can divide it up into slices and sell it to people. By owning a slice, you own a part of the pie. Now how much your slice is worth depends on a couple of things:
The size of the pie. If the overall size of the pie increases, so does your slice and vice versa if the pie’s overall size decreases. But the pie’s “size” also depends on whether or not it’s popular - if news spreads that the pie is made from cheap ingredients, chances are people will start liking it less, and so the pie’s “size” will decrease
How many slices there are. Say a pie has 100 cherries on it and has 2 slices available - that means each slice has 50 cherries. But it is then decided, by the pie owners, that they ought to offer more slices to the public. In fact, they’ve just issued 8 more slices effective immediately, totaling to 10 slices. Each slice now has 100 ÷ 10, so 10 cherries on each slice
Now that the foundations have been established, let’s start using some actual financial terms. A pie’s slice is referred to as a share, or equity if you’re feeling fancy. The pie’s decision to start giving slices to people is known as an initial public offering (IPO) - this is when a firm’s stock is first available to the general public. Companies do this for various reasons - raising money, boosting public image, or the financial transparency that comes along with going public, which can go a long way when it comes to working with other companies.
So when a company’s IPO is, say, $1000, this means that lawyers and accountants valued the company as such after going through the financial and legal procedures. This is why whether or not an IPO is successful - in that whether or not the company’s stock is publicly priced higher or lower than its initial valuation - can be such a big deal for companies. Turning back to our example, if the $1000 company’s share price jumps on opening day such that the company is now worth $1500, this would be a successful IPO. On the other hand, if the share price tanks and drags the company’s value to $500, this would be an abysmal IPO.
Point (1) from above refers to a company’s market capitalization (market cap) which is the total market value of all the authorized shares. Do keep in mind, however, that a company’s market cap is not necessarily how much that company is worth. The reason is because shares are often over- or undervalued, meaning people are willing to pay more or less than what each share is intrinsically worth. Point (2) is what’s called issuing shares; creating more of them.
Observe the difference in the stock’s value depending on how many of them there are. If we assume that both companies are worth the same, a share of the company on the right (Company B) is worth significantly less than the one on the left (Company A). Here, however, is when things can get a little confusing. There is a huge difference between selling shares and a company issuing them, even though they both tend to have the same effect.
When a company issues shares, they are creating more of them. So imagine that Company B’s board of directors injects 10 more shares, resulting in a total of 20 available stocks. Assuming other things equal, this would decrease each share’s price. Think of it in terms of simple supply and demand: you have more of something, it becomes less valuable. As absurd as it may initially sound, there are actually reasons, which will shortly be discussed, firms would do this.
Selling shares, on the other hand, doesn’t change much in and of itself. All it does is transfer ownership of said shares to someone else. In the real world, however, selling shares is almost always indicative that the stock is going to decrease, which is why people are getting rid of it. So if a large investing firm dumps their share in a company, other investors begin to think that something is wrong and that they should probably cash out while they still can. And this is the central explanation for the stock market’s volatility: expectations. If a stock’s price shoots up and continues to go up, it’s only because people think that it will continue to do so - the demand for the stock will increase. But if the table turns, and people begin to lose faith in the company, the stock will fall. This is also why a company may want to issue more shares.
If a stock is overvalued, companies would want to issue more of them in order to receive more money for each share - if people are willing to pay more, why not let them? On the other hand, issuing more shares can be for equity financing purposes - the process of raising money through the selling of shares. The main rationale for going this route as opposed to debt financing - taking out loans - is because there exists no obligation to pay back money and thus no additional financial burden. Companies will also typically explain their seeking of supplementary cash. If the plan is to invest in a new product or to acquire a competitor, this will bring about good vibes among shareholders as it pertains to the firm’s future. Once again, it all boils down to expectations.
Curious isn’t it? What can make or break a public company isn’t how great their product is, their marketing, nor is it their profit margins. Rather, it’s the human judgement that does so. It is oftentimes irrational, short-sighted and error-prone, yet it has the power to either propel economies into prosperity or plunge them into financial disaster.
Econ IRL
We all probably understand that the ongoing global pandemic has had a noticeable effect on employment, reducing it by nearly 15% in April of 2020 in the US. But break this impact down by sector and you’ll find that not everyone was hit equally hard, and that in fact plenty were left unscathed. Such disparities can be illustrated by dividing the workforce into just 2 categories: STEM and non-STEM. With that in mind, a team of 4 economists recently published a paper exploring this gap.
As some might have guessed, STEM fields were indeed safer from the COVID-19 recession than non-STEM ones, meaning that they had greater resiliency to economic downturns. This begs the question: why exactly were STEM occupations more secure? After controlling for several variables such as demographics, remote work feasibility and educational requirements, the researchers found that the most important factor determining the occupation’s safety was how important STEM knowledge was for the job. In other words, people who worked jobs where you needed to know your science, tech, engineering, and/or math had better employment outcomes in the second quarter of 2020 (which was when the unemployment spike occurred).
What’s even more intriguing is that this held true for jobs that weren’t even classified as STEM. If you were working a job that for some reason wasn’t formally labelled as a STEM job but still utilized more STEM knowledge than someone working in an actual STEM job, chances are that you had a better employment outcome.
‘Till next time,
SoBasically