Episode 21: How to Choose a Stock

GRANT: Hey, Mak.

MAK: What’s up G?

GRANT: Do you know what happens when you start early?

MAK: I do G. You go wealthy.

BOTH: It’s time for Money With Mak And G. Finance for you and your family.

GRANT: We finally made it to a point where we’re starting to really know some great stuff about investing.

MAK: Yep. But we need to know more. I want to hear dad talk about stocks. Alternative investments are cool, but…

GRANT: Yeah, I know. Way too much work. And you need a lot of luck.

MAK: Exactly. But how do you choose the stock? Do you know?

GRANT: I don’t. Maybe you just throw a dart at a dartboard? No, I know you roll dice.

MAK: I don’t think that’s it. Well, I think we both know what we should do.

GRANT: I guess you’re right. Dad!

DAD: What’s up with the children in my dreams who eat all the food in my house, including my favorite oatmeal pies?

GRANT: Funny dad. But the cream filling is awesome.

DAD: I know. I’m a funny guy. So where are you guys yelling? You know, it’s music to my ears.

MAK: We were talking about investing and how to choose a stock. Get this, Grant thought you rolled the dice.

GRANT: Okay, so I was guessing. Maybe you flip a coin?

DAD: Now you’re starting to make me laugh. But some people do choose stocks by chance. It’s true. I knew someone who wanted to buy a stock that started with a Z because their dad’s name was Zack. And so they bought Xerox.

MAK: Doesn’t Xerox, start with an X not a Z?

DAD: Exactly. But she made a lot of money. Even though she didn’t know the difference between the two. Coffee machines were really good at one time.

MAK: That’s very strange. Well, we want to know the right way to choose a stock.

GRANT: Yeah, we want to pick 100% winners.

DAD: Hey, if I had to pick a stock that would absolutely be a winner, I’d be a gazillionaire. Do you remember that chant?

BOTH: Buy low and sell high!

GRANT: That’s right.

MAK: So, where do you start? Is it with dividends?

DAD: Well, let me give you a quick example. Have you ever heard of Amazon or Netflix?

MAK: Come on dad. You know, we love Amazon. I bought my purple bean bag chair on Amazon yesterday. And we watched Coco. The movie was on Netflix last week.

GRANT: Coco was cool. The land of the dead and some wicked guitar music.

DAD: I agree. It was a great movie. But did you know 20 years ago, you could have bought one share of Amazon for $2. And not too long ago, it was close to $2,000. That multiplies the investment by 1000. If you would have invested $100. It’d be worth $100,000 now!

GRANT: What? 1000 times? That’s the perfect stock.

MAK: I can’t think of a more perfect company.

DAD: Well, we’re gonna have to talk a little bit more about that. But Mak, do you know what Amazon has never done?

MAK: Nothing. It must be perfect. I can’t think of a thing. Wait, does it have to do something with dividends? Please say no.

DAD: It has never ever paid a dividend.

MAK: I told you not to say it. I think I want to cry.

DAD: Well, it did make a lot of people a lot of money because…

BOTH: Buy low and sell high.

DAD: Exactly. But if you needed income along the way, that would have been a terrible investment. Because you wouldn’t have gotten anything over 20 years.

GRANT: That makes sense. But what about Netflix? Did it do the same?

DAD: It did have a lot of success too, but not the same as Amazon. It went up 350 times in 16 years or so. But no dividend from them either.

MAK: Wow, they both grew crazy amounts. But I guess it’s not about the dividend then. So what is it?

GRANT: Did Amazon make tons of money?

DAD: Well, that’s strange. Amazon took years to actually make any money at all. But its stock kept going up and up and up. And all of a sudden in one three month period. It made as much money as it did in the prior 14 years.

MAK: What? That doesn’t make any sense. No profit for years and the stock kept going up? Then over 90 days, it made more money than the last 5110 days? Seriously?!

DAD: Yep.

GRANT: So why did it Keep on going up? No dividends, nothing really big for 14 years?

DAD: Well, it’s the expectation of what Amazon was doing, as well as remember supply and demand. First, it was the expectations of the future. Sounds weird, but people saw what was going on. More customers, more movies, more services, more customers. It just kept going.

GRANT: What? Did you say vacations?

DAD: No. Expectations.

MAK: Okay, not falling at all. Isn’t an expectation what you think will happen?

DAD: Yes, it is. Okay. I know you love movies. So before you choose a movie, you think about it, right?

MAK: Yeah, I guess.

DAD: Okay, what about the last movie you chose?

MAK: Hmm. It was Lion King. We went to that place where they serve food. It was awesome. And you’re right. I did think about what would be best.

GRANT: When Puma farted in the mud, that always makes me laugh.

DAD: Yeah, me too. Anyways, don’t you sometimes think about other movies and who they’re made by? For instance, Lion King was made by Disney. They’ve had a lot of great movies, right Mak?

MAK: Yep. They do. A lot of wood off the hook.

GRANT: Good one Mak. That’s dad’s slang, so he’ll get it.

DAD: Yeah, it was a seriously gnarly baby. Did you expect that Mac?

MAK: No. And what does that mean?

DAD: Well, I think you probably better google it to figure it out.

MAK: Ah, good one, dad.

DAD: So back to expectations. Mac, you expect a movie to be good based on the company, the actors, and you also think about recommendations from your friends or people you trust.

MAK: That sounds about right.

DAD: And do you ever think about whether you want to pay full price the first week it comes out? Or do you wait a little bit and go to the dollar movies?

GRANT: Come on dad, nothing’s $1 anymore.

DAD: Okay, that was in my time. But what about seeing it during a matinee pricing? Or you can wait and watch it or buy it online?

MAK: That makes sense. Maybe it doesn’t have great reviews, and we’re not willing to pay the full price. With an expectation, it might not be as great.

DAD: Exactly. Any guesses how this works with stocks?

GRANT: If it’s about expectations, using your movie example, you pay what you think is worth based on your expectation.

DAD: Great start.

GRANT: And if you expect the stock to be successful, and it isn’t, that could be really bad.

DAD: You’re right on track. What else Mak?

MAK: And if it is better than expected it goes up.

DAD: There you go. Do you remember Pokemon Go? We used our phones. We downloaded an app and we went to different places around town and caught various animals like Charmander, Pidgey and Bulbasaur.

GRANT: Yep, that was awesome when it came out. Never seen anything like it before.

DAD: Well, in early 2016, Nintendo stock wasn’t really doing great. Expectations weren’t high, and it sold for around $15 a share. It was owned by Pokemon. And when Pokemon GO came out in 2016, guess what? It had over 500 million people download it.

MAK: That’s more downloads and every single person in the US. That’s a Ton! It must have been played all over the world.

DAD: It was. Crazy, huh? It was super profitable and nobody expected it. When they heard how many people were using it and how much money was being made, what do you think happened?

GRANT: It took off like a rocket.

DAD: Exactly. And Nintendo only owned the name ‘Pokemon’. The software that made it possible to catch animals in different locations was actually owned by a completely different company.

MAK: That’s crazy. So what happened to Nintendo stock?

DAD: Well, in a week or so, it jumped to over $33. That’s over double. People changed their expectation of how much the company would make going forward and how much it was worth.

MAK: But why was it $33? I mean, in math class, we use a formula to get the right answer. You know, one plus one equals two. Was there a formula used?

DAD: That’s an awesome question Mak. There isn’t a formula.

GRANT: Is it a guess? Could have gone to three, four, or even 40 or 50?

DAD: Absolutely. It’s easy to understand why a stock goes up or goes down in price. It’s not easy to understand why it went up to 30 or down to $10, for instance.

MAK: So how do you choose which company to invest in?

DAD: There’s no recipe like making a cake where you just add eggs and milk and flour and cook it, then you have a delicious cake or in our case a more valuable stock. Just because a company makes money and has a good product doesn’t mean its price will go up.

GRANT: But you said it’s about expectations and supply and demand.

DAD: It is. Okay, Makenna, say you have five shares of a chocolate cupcake company. There are a total of 100 shares that people can buy, and you expect the company to make $100.

MAK: I love chocolate cupcakes. I’d be very happy with that investment. Would they pay dividends and cupcakes?

DAD: Probably not. But it does sound good, doesn’t it? What if the company actually makes $250 instead of $100? Is that better than your expectation and do you think it’s more valuable?

MAK: That’s easy, it’s more valuable. And he did better than expected. Since I’m the owner, this is much better for me.

DAD: Excellent. 100 shares of stock is the amount available, it’s also called the supply, more people will want your stock that’s called demand. When more people want something, and there are only so many available, the price goes up.

GRANT: Is that kind of like an auction Dad?

DAD: It is. If there was an auction for the last video game on Earth, and 1000s of kids wanted it, the supply would be low, and demand for the game would be 1000s. That would make the price go through the roof.

GRANT: First of all, that’s a nightmare dad, 1000s of kids will go crazy trying to buy it. So the smaller supply and the larger the demand, the more the price goes up?

DAD: I couldn’t have said it better myself, gee, when a company continues to be more and more successful, the demand goes up and up. If the number of shares the supply stays the same, the price goes up too.

MAK: So we look for companies that will continue to make more money or we believe something will change in the future for the better. This will increase the demand and will increase the price.

DAD: Now we’re on a roll. So can you give me an idea of how that might actually happen?

GRANT: How about if a game company releases a new game, and it’s more successful than expected? Like the Nintendo Switch?

DAD: You totally nailed it G. Nintendo plans to sell 2 million switch game consoles the first month released. That was a good number. So that’s the expectation. And guess how many it sold?

GRANT: 3 million?

DAD: Wow. That’s freaky. You’re absolutely right. So their stock went up. And within a year It sold over 14 million, which was more than the Wii U sold for as long as it was being sold.

GRANT: Dad, Wii U have Zelda, Super Smash Brothers, Super Mario Odyssey, Mario Kart 8. They were all great creations!

MAK: I love Mario Kart. You ate a lot in that game.

GRANT: Okay, maybe I did. But you never beat me in Super Smash Bros.

DAD: You’re both amazing. This is a ton of fun.

MAK: I agree. Thanks, Dad.

DAD: You’re welcome. So what’s our investing goal?

BOTH: Buy low and sell high!

DAD: What changes the price?

BOTH: Expectations.

DAD: And how does an expectation change the price?

BOTH: Supply and demand!

DAD: Woohoo. You guys nailed it.

GRANT: It’s my birthday. It’s my birthday, I rock.

MAK: I’m a guru. I got this saying.

DAD: Picking a stock to invest in can be tricky. Our goal is to buy low and sell high. Even though there are many reasons prices move. There are some basics. Companies are valuable because they make money. If you are an owner, then you share in its success. So first and foremost, the company has to have value which is based on its performance. If it never makes money, there is generally no value in the company. Most of the time, it’s said that information on the value of a stock is built into the price. That means that with all of the available information, the stock should be priced appropriately. This is the current expectation. However, if something happens, like a new product is being launched that will change the world, the stock will be more valuable because the company will make more money in the future. Therefore more people want to buy it and the price goes up. That’s where supply and demand come in. So a stock’s price is based on expectations. And when those expectations change, the demand will change with it, which will change the price of the stock. If you ever watch the financial news, you may hear Ford Motor Company beat expectations. That means the company earned more money than what was expected. This is generally seen as a positive and the price of a share will generally rise. So remember, we want to buy low and sell high and expectations will change the demand for a stock which changes its price. We’ve come a long way in a short time. Let’s take a listen to the Preview of next week’s episode, and as always, thanks for being here. Bye!

MAK: G, you know, we learned a ton about investing in some great stuff about stocks.

GRANT: Yeah, I’m super excited to get started. But where do you buy the stock? Do you have any ideas?