Ramu is a manager in a bank. He is a very shrewd kind of person. He has a sharp mind, resourceful in practical matters and is often successful in everything he attempts.

Anu is Ramu’s darling 5 year old daughter. He had always encouraged in her qualities of fearlessness, creativity and willingness to experiment and try new things. Turns out, she is already a champion kid leading every other kid around in most skills. She has a curious sense and has a great enthusiasm for new learnings. Ramu has great dreams for Anu and knows that if he can provide her the opportunities, she has the right kind of potential to excel.

The plan

In his line of work, Ramu meets many business people. Some of them seasoned business persons, some struggling to make the cut and some more just starting up on a new venture.  Ramu understands some of their challenges and, as a banker, also provides solutions to some of them through his bank.

Ramu had a thought to use this knowledge to fulfill his ambitions for Anu. He figured it gives a very good chance to provide the best possible opportunities for her. He prepares a plan to bring his thoughts into action.

Being a fairly successful person in his own life, Ramu has a respectable stature and is quite popular among his peers, friends and his community. So, one day he invites about ten of his close acquaintances for a gathering and pitches his idea to them. Almost all of them know how smart & bright Anu is.

He shows them a few details of his plans for Anu,

-          The school he wants to enroll her into

-          The coaches he wants to hire to train her on specialized skills

-          The opportunities that’ll open up to her through these skills overtime

-          The amount of funds he is planning to raise

-          The potential returns along with projected timelines

His detailed plan impresses most but only three of them were absolutely positive about it.  Paddy, Ramesh & Anand showed great confidence in Ramu and his plan for Anu and shared the same prospects as Ramu has for Anu.  

Few others commended the plan but thought the investment was too risky for them. Abhay & Suresh were very critical of the plan and did not think it will work out.

So, as an outcome of this gathering, Ramu now has funding from three of his friends. He was counting only on a 20% success but was delighted to see 30% agree with him and help him raise funds.

In business terms we can call Paddy, Ramesh  & Anand as “Venture Capitalists”. They are the people who are sold on a business idea (venture) and help provide the capital for it with a goal to reap the benefits of its success.

(to be continued..)

When the path is not clear or when we face obstacles in the path we feel the emotions of fear, anger, frustration & disappointment.

(Don’t worry… this is still a blog on stocks . This point is important here and you will soon appreciate why…)

Human behavior and actions are driven by these emotions at every stage in life. The same applies when people invest in stocks. We put our money into the stock of a company when we see that they have a good product/service, good management running the company and have clear plans which will increase their market share and profits in the future. We expect that more and more people will want to own stocks in this company and that the stock price will go up.

Our moments of decision come when a news item appears in the markets on the company. Every investor thinks differently and perceives the news differently and hence reacts differently. What matters is whether particular news changes the equilibrium of the number of buyers and sellers.

If the number of buyers increases, the stock price will go up following the laws of supply and demand. If number of sellers increase, the stock price will go down.

A prudent investor will have control on his emotions and will assess each news item to see how the reality of the company changed and how the path towards the expectations is impacted.  It has been proven time and again that patience is the number one virtue of a successful investor in stock market. Ask Warren Buffet.

The greater Fool Theory:Observation that any price (no matter how unrealistic) can be justified if a buyer believes that there is another buyer who will pay an even-higher price for the same item. This line of thinking causes and fuels stock market and commodity market booms and manias which, in due course, lead to busts and paranoia’s. (Taken from www.businessdictionary.com)

So, what gives? Why do we buy a stock at a price?  

When I die, I want to die with a satisfaction that I had enjoyed the most delicious meal, had enjoyed living on the beach, had been to the top of the mountains or had met the most beautiful woman. I definitely do not want to die holding shares of GOOG (Google) or any other company. I want to take profit out of this investment and enjoy the benefits within my lifetime. Am sure it is what you would want.

Our expectation on the growth in price of a stock has a time limit. When we buy a stock at a particular price, we expect to find another buyer, within this time limit, who is willing to pay the higher price that we want. Why is he buying when you are selling this stock?

The answer is in expectations, valuations and timelines.

 In my next blog, I’ll introduce you to Jammi’s “Raising a kid” analogy to the stock market and then we’ll get back to answering “Why companies pay dividend”.

Almost every one of us have studied the subject of economics in school and learned the basic concepts of supply & demand and the effects of variations in these measures on the prices. In a competitive market, if the demand for a particular good or service is more than the supply of it, price rises. Similarly if more of that good or service is in supply than there is demand, price goes down.

Applying this understanding to the stock price of Google, we can infer that the rise in the price of a single stock of the company from $250 in 2008/09 to about $620 today is because of high demand among investors to own the stock.

So, what is the reason for this high demand for Google’s stock? Why do more & more people want to be shareholders of this company?

To answer this question, let us first try to understand the world of stock market a little.

Incentives to invest in a stock

When you buy a good or a service, it is because the value of the traded good or service is higher to you than the money you are paying for it. A rational person expects to get a substantial value in return when he thinks of parting with his hard earned money.

When we buy a stock in a company, we expect to sell it at a higher price than we bought it for and profit from the trade. After all, everybody begins with the basic mantra of stock market investing: “Buy low, sell high”.

(In order to sell the stock at a higher price, there needs to be a buyer who is willing to pay the higher price. So, why is he buying when you are selling this stock? Is he rationale in his trade? Are you being rationale in selling it? Look for another blog from me covering this in detail soon…)

The direct potential return from a stock investment is in the form of dividends from the company. However, it is up to decision of the company management to give dividends in a particular quarter. As a stock owner, you are a part owner of the company and dividends are the direct way in which profits are distributed to the shareholders.

So, in summary, the returns from a stock investment can be in the following two forms:

• Appreciation in the stock price and the opportunity to sell it at a higher price
• Dividends (profit sharing) by the company (plus the opportunity to sell at a higher price in case stock price appreciates)

Stay tuned: Some of the upcoming topics…

- Why companies pay dividend?

- How stocks are created

- Why private companies want to go public

- Snapshot of a public company

- Why public companies work to increase shareholder value

http://mashable.com/2010/09/07/future-ad-agencies-social-media/

http://ec.europa.eu/enterprise/policies/international/cooperating-governments/usa/transatlantic-economic-council/index_en.htm

http://news.bbc.co.uk/2/hi/business/8036202.stm

http://www.allbusiness.com/government/government-bodies-offices-legislative/12833435-1.html

http://ca.news.yahoo.com/s/capress/091025/business/cda_eu_trade

http://www.iisd.org/pdf/2009/com_trade_subsidies_undermining.pdf

http://www.allbusiness.com/retail-trade/food-stores/4258177-1.html

(Also check the additional articles in the above link)

http://www.indiana.edu/~gradipe/docs/krasner.pdf

http://www.jstor.org/pss/2009974

http://www.economist.com/specialreports/displayStory.cfm?story_id=14530093

http://www.hindu.com/biz/2009/10/05/stories/2009100551221300.htm

http://www.guardian.co.uk/business/2009/oct/04/g7-g20-economic-policy

http://www.latimes.com/business/la-fi-g20-obama26-2009sep26,0,5752091.story