Chapter 1 — Understanding the Basics

🍋 Johnny and His Magical Lemons

Your best friend Johnny is an unusual guy. Some might even say he’s a little… eccentric. But that’s part of his charm.

Johnny runs a business selling magical lemons. Yes, you heard that right—magical lemons. These lemons are so good that anyone who buys one swears they can run faster, think sharper, and even sing in perfect pitch (but only for a day).

Johnny buys each magical lemon for $0.50 and sells it for $1.00. His stand is always buzzing with customers. Why? Because Johnny is not only a great salesman, but he’s also got a flair for theatrics—he wears a magician’s hat and calls himself “The Lemon Whisperer.”

• Daily Revenue: $1 × 200 = $200
• Daily Cost: $0.50 × 200 = $100
• Daily Profit: $200 - $100 = $100

Johnny works his magic every day, and after a month, his profits look like this:

• Monthly Profit (Net Income): $100 × 30 days = $3,000
• Annual Profit (Net Income): $3,000 × 12 months = $36,000

💼 Johnny Offers You a Slice of the Magic

One day, Johnny comes to you with his magician’s hat slightly tilted and says, “Hey, best friend! I’ve got an offer you can’t refuse. I’m dividing my magical lemon business into 100,000 shares. Want in?”

Being intrigued, you ask how much a share costs. Johnny, with a dramatic wave of his hand, announces, “Only $72 per share.”

Now, before going ahead, let’s ponder:

• Is this a good deal?
• Why would it be a good deal?

It’s magical lemons—surely it should be a good deal, right? They’re magical, after all. But wait… maybe we should do the math first.

Let’s imagine that you buy 100 shares. Since the company is divided into 100,000 shares, those 100 shares would make you the owner of 1% of the magical lemon company—much the same way as buying a share makes you a part-owner of a company in the stock market.

• Your Total Investment: 100 shares × $72 = $7,200

And since you now own 1% of the company, that means 1% of the earnings are yours!

• Your Share of Annual Profit: $36,000 × 0.01 = $360

Now, let’s calculate your return on investment (ROI). ROI tells you what percentage of your investment you’re getting back in profit. To calculate ROI, we use the formula:

ROI = (Your Profit ÷ Your Investment) × 100

In this case:

• ROI = (360 ÷ 7,200) × 100 = 5%

At this price, your return would be 5%, which honestly isn’t very magical. You politely decline, thinking you’d rather put your money in a 6% bond or another investment. Johnny shrugs and says, “Suit yourself. But remember, you’re turning down magic.”

🤯 The Crazy Market

Johnny’s offers change daily, much like the stock market. One day he offers shares at $100, then $60, $50, $40, and finally $15. You jump in at $15 and buy 100 shares.

Here’s the magical part: even though the price per share is lower, you’re still buying 100 shares, which means you still own 1% of the company. And owning 1% entitles you to 1% of the company’s earnings, just like before.

• Your Total Investment: 100 shares × $15 = $1,500
• Your Share of Annual Profit: $36,000 × 0.01 = $360

Now let’s calculate your return on investment (ROI) again to see how much better this deal is:

ROI = (Your Profit ÷ Your Investment) × 100

• ROI = ($360 ÷ $1,500) × 100 = 24%

This time, your ROI is 24%, which is a fantastic return compared to the earlier offer of 5%. Waiting for the right moment paid off!

Johnny’s pricing behavior reminds us of Benjamin Graham’s famous analogy: “Mr. Market.” Graham, one of the greatest investors of all time, described the market as a wildly unpredictable, schizophrenic business partner who offers to buy or sell shares at a different price every day. Your job? To take advantage of him when the price is right—just like you did with Johnny.

📚 Key Market Terms

Johnny’s example introduces terms commonly used in the market:

🎉 Wrapping Up Chapter 1

Well, I hope you’re having fun with the market right now and that you’re starting to grasp some of the key ideas behind identifying good opportunities. We’ve explored how owning part of a company works, how share prices can affect your return on investment, and how the market can behave like a quirky, unpredictable character.

However, since this is real money we’re talking about, you probably want confidence that the business you’re putting your money into is actually a good business. You’d want one with steady, reliable income—not just a one-year miracle or at the very least, a business that isn’t handled by a schizophrenic dude like Johnny.

Luckily, this is just the first chapter! In the next chapters, we’re going to dive deeper into answering these important questions and learning how to spot truly good businesses.