Question: If my company’s stock is currently $10 and then in a month goes to $20, how does this doubling show up on a company’s balance sheet? And if it does not show up on a firm’s balance sheet, exactly how does trading create any jobs?
Paul Solman: It does not show up on the balance sheet, which is a snapshot of the company’s financial position at a moment in time, listing its claims on others (its assets) and others’ claims on it (its liabilities). The two must balance. Add up all the assets: cash, for example, and/or marketable securities, plant, equipment and inventory you could sell. Add up all the liabilities: loans you’ve taken out, taxes you owe, leases you’ve entered into. As you might imagine, there will likely be a difference between the two columns. That is your “net worth,” a liability against which your shareholders have a claim.
But that little lesson dispensed with, the state of your balance sheet generally has little relevance to what investors will pay for your stock. When your stock price doubles — or multiplies a thousand-fold — it means investors are suddenly far more impressed with your potential for making money, which shows up (eventually) on your “income statement.”
Financial professionals work the phones on the floor of the New York Stock Exchange in New York City. Photo by Chris Hondros/Getty Images.
But what good does a rise in the stock price do the company itself, you ask? The answer is that you can now raise money more cheaply.
A friend’s son starts a company with an educational iPhone app. Looking for investors at $10 a share, he raises a million dollars. He uses the money to create new apps, which start selling briskly. New investors take note and think he may have The Next Big Thing. Rival companies also take note and adjust their apps accordingly to compete.
The young man needs to counter by creating even more, even better, apps, which means hiring new employees. Fortunately, with more revenue and more apps, his company is now thought to be worth more. The new investors will pay $20 a share. He can hire twice as many people as he could at $10. There’s your answer.