What links a stock to its actual company?

Question

As I understand it, when people buy a share of stock, the price goes up. When people sell it, the price goes down. So what does this have to do with the company itself that this stock represents? For example, if a bunch of people wanted to make Apple’s stock price go down, they could just agree to sell their shares. So what does the actual stock price have to do with the company?

In: 5

Answer 1

So first of all, lets take a regular brick and mortar business that makes 100k a year in profits. You can think of it as a business with just 1 share owned by 1 person. How much would you be willing to buy that business for? If you offered 100k, the owner would probably be like screw it, ill just run it for one more year and then close down and then sell the empty building and make more…. or I’ll hire someone else to run it and maybe make 40k a year. If i take the 100k and try to invest it, I’d probably make less than 40k/ yr in return….

So the general rule of thumb is 10 times net. Someone would normally offer 1 million for that business. They’d make their money back in 10 years. If they thought the business is growing…maybe it’ll make 120k next year and 150k after…. they’ll probably be willing to pay more. Maybe 2 or 3 million today.

Let’s look at it from the other side with a ridiculous corporate situation. Let’s say a business has 1 million shares and 1 million in its bank account. If the shares were selling for $.10, you could buy them all for 100k, empty the bank account, and let the business fail. As long as you have over 50% of the voting shares, you can make unilateral decisions. This extreme of an example would never happen, plus you’d also factor in future profits, but that’s kind of the principle.

People are buying when they think the shares are undervalued and selling when they think they are overvalued. This gets you to converge on a current stock price. If the shares ever get too undervalued, you ( a bank) could always buy out controlling interest. Then they could gut the business or decide no more reinvestment, we’re pocketing all the profits going forward. Over long periods of time, that’s whats keeping the stock price actually tied to the value of the business.