I am late to this particular thread. A few years back, on another message board, someone said "I don't understand the stock market, someone explain it to me like you'd explain it to a third-grader," and me and my MBA wrote this piece, which was very well received. Apologies for length.
Joe owns a coffee shop. He put up a lot of his own money to start it, and now it's very successful. So successful, in fact, that he'd like to open another one across town. However, Joe doesn't have the extra cash to buy and equip a new store, since the money he makes either goes back into the business or pays for his vacation house on St. Lucia.
So he gathers up a group of his friends, and says, "If you give me $100 each, I'll give you a share of my profits down the road." His friends think this is a good idea, but say, "If we're going to put up our money for this, we want some say in what the company does." So they agree that Joe will handle day-to-day operations, but when there's a big decision, they'll get together and vote on it. 90 of his friends pony up $100 each, and Joe puts off buying a Jaguar for a month and puts up $1,000 of his own money. He now has $10,000, and uses it to build the second coffee house. There are 100 shares in the company now.
At the end of the year, Joe totals up the books and finds that the company has made $1,000 profit, or $10 per share. What's more, sales are steadily increasing. So he writes each of the 90 individual shareholders a check for $10, and encloses a letter where he says "I expect our profits to increase 20% per year for the foreseeable future." He also pockets $100 for his own 10 shares.
Joe's shareholders do the math. If profits go up 20% per year, next year they should get a dividend of $12. The year after that, $14.40. By the end of year 6, Joe will have paid them $99.30 total--almost their original $100 back. If the trend continues for 20 years, Joe will have paid them $1,866.88 total, so by putting $100 at the start they'll get back over 18 times that over time! Joe's Coffee is looking like a smart investment.
So smart, in fact, that a man in an Armani suit comes to town and makes it known that he will pay $150 for someone's share in Joe's Coffee. Some shareholders are desparate for cash to buy crystal meth, and figure they'd rather take a $50 profit right now that wait 6 years for all their money to come back. Others think their shares are worth more than that, so they wait until he offers $200 per share. Eventually Mr. Armani buys 51 shares of the company, and now that he has a majority of the votes as to how the company is run, he fires Joe as CEO, and exploits minimum wage workers to greatly increase the company's profit.
As more and more businesses sell little parts of ownership in this fashion, a bunch of guys in suits decide they're going to buy a big building in New York and make it a place where they can all get together and buy and sell these shares all day long. Everybody loved to trade stories about different things that were happening that would affect how much money the different companies would make. As this news came out, people changed how much they were willing to pay for the different stocks. And they all lived happily ever after, until enery prices went through the roof and nobody could afford to deliver coffee beans to Joe's shops anymore, they couldn't sell any coffee, and the stock price went way down. Then they threw themselves off buildings.
The end.
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Topic: Explain the stocks/economics to me like I was a 3rd grader (Read 21067 times)