Dear daughter,
A question I had a few years ago is what is the stock market? I’m going to tell you, in my own words, how I see the stock market.
Sometimes we try to answer ourselves with our current knowledge, instead of doing research or studying. I did that and I couldn’t be farther to answer this question on my own.
I won’t give you here technical definitions or use the vocabulary professional investors are using.
The stock market is a shop where you can buy or sell businesses. That’s it. For me, there is not much more to it.
Different people might give you a lot more details, definitions, and technical jargon, but in the end, this is my answer.
Why buy or sell in the stock market?
There are several benefits of using the stock market to buy or sell businesses.
Stock exchanges, as they are also called, are regulated.
If someone (the owner) wants to list his/her company in the stock market, have to follow rules and regulations.
The one I like the most is that they must make publicly available their financial reports. And these reports must be audited by third parties.
This makes them a valuable source of information, and probably the most important one although not the only one.
Another important rule is that every person should have access to the same information. All potential buyers have access to the same information.
If there is information that is important to make a buying or selling decision and is not available to everyone, the company owners and employees involved can be prosecuted.
There are many more rules, but these two, are the most important to me. It means to me that I can make an informed buying or selling decision knowing that there is no hidden information that I should know before making a decision.
Just to put this in perspective for you.
Imagine that your brother-in-law (the bud guy always used negative examples about handling money) tells you he has a business and wants you to invest in it. He asks for a certain amount in exchange for a 15% ownership of his business. He tells you how great his business is doing, he shows you some good numbers and everything looks perfect.
How do you know all he is saying is true?
If he shows you a financial statement, how sure can you be that the numbers are real?
The short answer, is you don’t. You just trust him (hopefully not) because he is your brother-in-law.
As you can see, if this situation happens, you don’t have any certainty about the numbers or the prospects you are seeing.
And that is what the stock exchange guarantees. All the information, at least the important one, is audited and you can trust it.
Investing in the stock market
What I suggest you do, is that you use the stock market to invest.
How to this?
The very first thing you need to do is to be able to understand a business by reading the financial statements.
Warren Buffet, known as the best investor of all time, said that “accounting is the language of business”. Therefore, if you want to understand a business, you need to understand accounting.
You can also say it more informally, if you want to “talk business”, you need to “talk accounting”.
There is no shortcut here. It is a must.
So, here is where you start. Learning accounting and especially learning how to read and interpret financial statements.
Once you learn the basics of accounting, no need to have a master’s on that topic, the book that helped me more is “Warren Buffet and the interpretation of financial statements: The Search for the Company with a Durable Competitive Advantage”.
Later, I will summarize for you what I learned from that awesome book. Yes, I know, you want a short summary because you don’t like to read too much.
Spoiler alert, you will have to read if you want to learn new things.
I hope I’m making this process easier for you. But you still must read all my letters. Get it?
Gambling in the stock market
There is a lot of money in the stock market. And because of that, it also attracts gamblers.
I truly hope you will never “go” to the stock market to gamble.
As opposed to investors, gamblers buy businesses having a “hopeful wishing” that the price of that specific business will go up quickly and they will sell for a profit.
It is called hopeful wishing because there is no strong foundation supporting a rise in the price.
It is not like a great business is creating an exciting new product, with more products will come more sales and therefore, more profit.
In this case, mostly is about feelings. Gamblers have a feeling that the price will go up and they get into a business just for the short term.
Dear daughter, I hope you don’t do gambling, and I truly hope you can start investing your hard-earned money as soon as possible.
Love you, Dad.