Stock Market Muliplier Effect
With the marvelous performance of the
US stock market, I wanted to understand the fundamentals of how it creates
wealth. One very simple little example is shown here.
1) Consider a company that has 100 shares outstanding
at a current price of $10. The market capitalization of that company is
$1000 (100 * $10).
2) I want to buy a share in that company and I'm willing
to pay $11 for that share. Now the market capitalization of that company
is $1100 (100 * $11).
3) The value of all the shares has increased by $100 although
I added only $1.
4) The stock market has a multiplier equal to the number
of shares outstanding!
5) Most companies have more than a million shares outstanding
and a good number have more than a billion shares outstanding.
6) It still stuns me - if I'm willing to pay $1 more for
a share, all the other stockholders feel that the value of each of their
stocks have gone up by $1.
This multiplier effect has an element of a pyramid scheme.
