I had been intending to write a post about the misconceptions of stock price, but this morning a friend shared with me a stock he had recently invested into and we had a conversation about it. I thought it was valuable information to share here. I'm not including the actual stock now, but may do so later. I suppose I would call this an explanation with examples of calculating simple return, that is one initial investment held over a period of time with that equity investment sold at a termination price or expiration date, with no withdrawals or deposits or dividends along the way.
He invested $1200 into 150 shares of a biotech stock at $8/share. The stock recently increased to $15 before settling in at $13. He was wondering how much money he would make if the stock rose to $50. He was expecting that would be a pretty big figure, after all an increase from $8/share to $50/share was a large increase. So, let's look at how to exactly calculate his return in this case, how much actual cash profit he will receive.
150 shares purchased at $8/share and sold for $50/share. 150*(50-8) = $6300 Profit
on a $1200 investment, so his total return is (50-8)/8 = 5.25, 525% Return or $6,300
It was surprising to him that it wasn't more money.
Looking at it in a different way - He bought 150 shares at $8 ($1200 cost). If stock doubles to 16, 150*16=$2400, or 2x return. If stock goes to 32, then 150*32=$4800, or 4x return, and all the way to 50, then 150*50=$7,500, less his $1200 investment is $6,300 profit.
There's usually at least 2 different ways to look at any math problem.
Now that's a great return on investment!
**
He had been reading that a teacher made 17,000% return by investing in 1 stock. Not 525%, which was his initial expectation, but 17,000% return. Was this possible with his investment? How can we know? And what stock price does that imply and most importantly, how much moo-lah could he expect to cash in on?!
That return would give him $204,000, and the stock would need to rise to a price of $1,360 per share.
How do we know that?
8*17,000% is 8*17,000/100 or 8*170 or a 170x multiple to the original price of 8.
8*170=1,360. So an increase from $8/share to $1,360 per share. Shown another way, $204,000/150 shares is also 1,360/share.
Is that possible with this company? How large of a company will it be if it grows by 170x over the next several years? That's a pretty large return to be sure, but we need to look at the Market Capitalization, or Market Cap of the company and compare that to others in the pharma and biotech industry in order to really get a how large the company could actually be. That gives as a broad big picture of the company's current size vs peers, what kinds of drugs is management expecting to produce, what stage of development and fda approval are those drugs and if the market cap grows how does it look versus competitors.
Market Cap = (# shares outstanding) * stock price, so this particular company is trading at $13 per share and there are 146 million shares outstanding! That gives the company a 13*146million = 1.9 billion market cap - let's round that to $2 billion.
If 2 billion grows 170x, then the future market cap at 17,000% return is $340 billion ! Thats 50% larger than Pfizer! Now that is an unlikely scenario with an almost impossible probability. And even if that were the case, it would be a multi-year process with more fundings and dilution along the way.
Its important to look at as many different perspectives when analyzing a stock and company, and through some simple calculations of return and performance, as well as taking a broad look at the size of the company measuring market capitalization versus peers in the industry helps to provide some perspective.
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