It would be good to have a discussion of what students know about the stock market and what they believe. Do they know how it works? Do any of them currently have a trading account online or with a firm? What have they heard about investing in the stock market?
The goal here is not to convince students that they should or should not invest in the market, but simply to understand how it works to the point where the decision to participate is not based on fear or ignorance.
When a company incorporates, its value is broken into some fixed number of pieces. These are the stocks.If you and a friend are in business together, the corporation consists of 100 stocks, and each person owns half the business, then each partner owns 50 stocks.
How many stocks would you have to buy in order to own half of Coca Cola?
When we say that “her business is worth three million dollars”, what does this mean? Usually we mean that she could sell her business for that amount. This is consistent with the question on the slide. Coca Cola is worth 2.29 billion times $60 on the day when its stock sells for $60.
To put this in perspective, students can check the national debt clock, which is running in the trillions as of this writing. What is the ratio of our total national debt to the worth of Coca Cola?
These are good examples of ratios where, although seeming small, (1/2,290,000,000) actually represent tangibly large ($60) quantities. They are also useful opportunities for students to work with very large numbers, whose magnitudes are often difficult for students to visualize. An actual physical number line would be a useful tool for this discussion. If you want to push it further, plotting these on a log scale might make both the $60 and the current national debt visible.
Ratios of stockholders' investments must be the same as the ratios of stockholders' shares.
It would be good to have the students work another example or make up their own. Each student or group of students could have a business worth a certain amount, a given number of partners with unequal investments, and be given the task of representing the business by some amount of stocks.
Those classes emphasizing spreadsheets could have the students create a spreadsheet that does the arithmetic for them.
For those interested in the mechanics of business, it is important to note that at this point in the example such a business is not available for trading on the stock market. However, a shareholder could still make a private sale of his stock. One partner, for example, could buy out the other one.
Who wishes they owned this business? Is this a good return on investment or not? Have the students compute the APY of this investment for this first year. $2 on an investment of $15 is a pretty good rate!
It might be good to point out that not all stocks pay dividends. Many, if not most, investors depend on the value of the stock (which represents the worth of the business) actually rising, so the profit they make on the stock is only realized when they sell it.
Again, it would be helpful for the students to work through another example. It would also be useful to point out that many businesses lose money in a given year. Which numbers, in that case, are negative? This is also an opportunity to add information to a spreadsheet representing the business, which you may ask students to create.
Here is a charming description of the way the stock market works, dating from the 50's, complete with stereotypical gender roles and jerky editing. It's about 10 minutes long and could be the springboard for a variety of discussions. In particular it provides a fascinating contrast to the eTrade baby commercial at the start of the module. If you watch them in rapid succession, it almost hurts. Students could have a discussion about marketing, assumptions made about the audience, etc.
What are the consequences of being able to trade stock quickly and freely? Students have a lot of experience with social networking sites, where the so-called “stock in trade” is personal information. They have a strong intuition of how the use of personal information has changed via these sites. They would probably have a lot to say about the equivalent phenomenon in markets.
It would be good if all the students had laptops at this point and could look up AT&T. They could also find ticker symbols for some of the other companies they like. Coca Cola, Google, Toyota, are just a few possibilities. This entire lesson should include a paper trading exercise. So to start with, students will need to pick a few stocks in which to invest.
The relevant numbers here are
The dividend is given two ways: as a dollar amount and as a percentage yield. So $1.72 is 5.62% of what? (The share price, but which one? Probably the closing price of $30.61.)
The PE ratio does not have units. Why? (Because the numerator and denominator are both in terms of dollars. There is an implied unit: dollars paid per dollars earned.)
Shares are given by daily low and high--$30.51 and $30.85 respectively. How much variation in this stock happened on this day? ($.34, or slightly over 1%).
This brings up the issue of risk due to volatility. The opportunity to make 1% on your money in a single day (by buying at $30.51 and selling at $30.85) represents a HUGE APR. (What is it?) Alternatively it represents a huge potential loss (just as huge!).
People who attempt to make money by buying low and selling high in a single day are called “day traders”. This approach is generally frowned upon because it is (for most people who have no special information about the stocks) considered a form of betting.
What are day traders betting on? What causes the daily fluctuation in the stock price, so different from the last example of the business with three owners? A short discussion might precede the next slide.
At this point each student should select 4 stocks to research. As the discussion of AT&T proceeds, the behavior of AT&T can be compared to the various companies the students have chosen.
A few of the students' stocks can be chosen for discussion, preferably in different sectors of the economy. One place that lists the sectors is Yahoo's sector browser.
Students can suggest events or news items that might affect the market. Which of the chosen stocks will be affected? How about the sectors? What kind of news might cause a whole sector to rise or fall?
This opens a discussion on diversification, which will be brought up again later.
The next few slides explore variability in a single stock. It would be fun to have each student track the same quantities for their stocks, and keep track of all of them on a spreadsheet. Each student can invest $1000 in each of their stocks, and gains and losses can be averaged over the whole class for the various time durations given in the next few slides.
For this slide, notice that the variation over a week was more than the variation over the single day on slide 9. The stock price for a given day is the closing price at the end of that day.
Here is a case where the variation was reduced by passing from a week to a month of data. The smooth orange curve is the 15-day moving average—the average closing price over the previous 15 days.
This is a good place to have a discussion about what an average is, and what it does to the extreme points of data. One sometimes hears claims that “on the average, the stock market makes 7% per year” or 10% or whatever. The next few slides show the fuzziness of that claim. They also give lots of opportunity for mental calculation of percents and fractions, and comparisons of scale.
Some stock market “experts” advise the investor to “buy and hold”. They don't usually say how long one should hold. Here is a case where holding AT&T for six months would have resulted in about a 10% (have the students estimate this from the graph) rise
.Holding for a year though, results in about a $5 or 16.5% rise. Not two 10% rises! Ask the students to estimate what happened over a five year period (working backwards, of course, from the first slide showing one single day).
Compare this with some of the other stocks the students have been tracking.
The rise here is about $3 over 5 years, less than one percent per year (which the students should calculate or estimate). Ask the students what they think happened over the past 10 years, both for AT&T and their own stock picks.
We see a drop of over $10 (over 33%). On the other hand, there are times (visible in the graph) when buying AT&T was a good investment, as long as one sold it at certain other times (also visible in the graph). Have the students identify some examples.
Here is the punch line. A discussion with the students about what they observed should yield the following observations:
Although the value of a stock is assumed to grow at a certain rate, that rate is actually the average of a fluctuating quantity. These ideas are explored in the books: A Random Walk Down Wall Street and Irrational Exuberance.
How is it possible to pay attention in such a way that you can tell when a stock is relatively undervalued or overvalued? This is exactly what investors try to do.
What causes the PE ratio to change? Discuss with the class that the PE ratio comes from two distinct quantities that are independent of one another.
It would be good to see what the mean and variation are for the PE ratios the class found for their stocks. It is important to realize that the historical willingness of people to pay a certain amount is just a measure of human behavior, rather than a tight measure of “worth”.
The video is of course the famous stock market crash of the twenties. But students should know about other, more recent large drops in the market.
It might be interesting to return to the discussion about the effect of the internet on communication and trading at this point. What effect would these have on sudden rises and falls in stock value?
Buffet suggests two strategies, which can be compared using this spreadsheet and online resources. Discuss the following with your students. What is a mutual fund? What is an index fund?
What are the possibilities for investing $250 per month for 4 years in the stock market? Have groups of students choose two stocks in companies whose products they understand and explore what would have happened had they invested $250 per month in these stocks starting 4 years ago. On the other hand, the spreadsheet simulates an “index fund” made of stocks that mirror the market as a whole. It is possible to compare the results. Conventional wisdom is that about half the class will do better than the index fund and about half will do worse.
In concluding this module it is important to emphasize the relation between risk and reward. Although risky, the stock market yields far better gains than the usual investment made by poor people, the lottery. Students can look up the statistics on this and perhaps be surprised by not only how much is spent on the lottery but also the disproportionate amount spent by low-income families. With the lottery, the chances of winning are so small that the risk amounts to near certainty of loss. Compared to this, the stock market is a much better “bet”. This point is made by eTrade in this commercial.