The rule is to invest in items you are familiar with and in a market you have the knowledge in. The mindset of this article is to write about the stock market and what a share is; the mindset is also to write how the price is set on the market.
What is the stock market?
A stock market is a market where traders buy shares; the market consists of those who wants to sell and those who wants to buy; the price is set by demand and supply; some buy shares in a company because they have a connection to the company; others buy shares due to the analyses they have made about the trend in the market. A well-known example of a share bought as an emotional connection is the Facebook share.
What is a share?
The price of a share is set by the value a company has; an example; the value is set to 10.000 euro and the share price is set to 10 euro; the number of shares on the stock market is 100 shares; the calculation is 10. 000 euro divided with 10 euro. If the traders find the price is set too high they will wait to buy until the price is at the level they value the company.
An example of a company where the value was considered too high is the Facebook share; it was set at around 38 dollars at the time it was introduced on the stock market but fall to around 18 dollars shortly after; the price has since been between 20 and 30 dollars.
What are the earnings on each share?
Investing in the stock market is the hope of gaining a profit in the future; a measure is the price earnings ratio; the price earnings ratio is also written as P/E: the P/E equation is;
P / E = market price / EPS
EPS is the expected earnings; the EPS equation is;
EPS = net income / number of shares
If the net income in the example under the section "What is a share?" is set to 200 euro the price earnings ratio is 5; the equation is;
P / E = market price / EPS = 10 / (200 / 100) = 5
In the example is the price earnings ratio or the P/E ratio 5; it means for every 5 euro investing in this share the expected profit in the future will be 1 euro.
More
information about the P/E ratio is on this link.
