I’m not a corporate accountant or anything, but my guess is when a company buys its own shares it retires them, and when it sells shares it issues them. They’re not like inventory.
That’s a confused article. It reads like it was written by two people, with diametrically opposed ideas.
It’s not a great article. It does point out that shares can be retired which is probably what happens to most of them, and that a company can’t own itself or pay itself dividends.
Thanks. I think I get it better now. I think this is one reason I have trouble with economics - so much of it is applied psychology. Fruit flies are easier to understand.
Excellent point. You don’t need shares of stock to decide who will run a company. Partnerships managed to do that centuries ago, just ask the people at Lloyds of London.
Equities, aside from the limited liability aspect, primarily serve the goal of providing an access road into the capital markets. However a company can just as easily sell a bond as it can a share of stock.. It can also make that bond callable so that it can buy it back whenever it pleases.
The critical difference is that a bond represents a binding legal obligation to pay a fixed amount per year based on the bonds face or par value. Default on your bond payments and you are technically insolvent.
So getting capital from floating stock gives you more “net” capital in a certain sense since you can live a little closer to the edge - for better or worse.
There is something very basic here that might not be obvious without prompting. In theory it should be very easy to decide how valuable a company is, or at least establish a lower bound, using the accounting identity equity=assets-liabilities. If your company has $100 in cash(assets) in the bank and owes $20(liabilities) on a loan, then the equity of the owner is $80. So if tomorrow the company is liquidated, then the bank gets its $20 back first and the owner gets the $80. If there are 80 shares of the company outstanding then the value of each share must be at least $1, supposing that the legal reporting requirements of the stock exchange are met and all of these things are true.
Of course you as an investor are free to pay $2 for a share of above company if you like, but the extra $1 you’re putting in is just speculation.
There’s also the difficulty in valuing intangible assets. For instance, all other things being equal, a company with thousands of satisfied loyal repeat customers should be worth more than a company with no satisfied loyal repeat customers.
Good points.
The CEO and other execs are usually paid bonuses in “share options” - the right to buy shares in Y days for $X per share. Obviously, the better the share price, the more they make - and the happier shareholders are too.
The original theory was that shares were owned for the dividends, back when stability was key and a 4% return was considdered very good. Nowadays, it seems to have degenerated into a game of hot poato - who can flip shares when they make more money, who loses?
A massive amount of shares are owned by funds - your IRA, your pension, etc. Mutual funds buy and sell a lot (or else they don’t look like they’re doing anything).
A company that builds up too much cash makes themselves ripe for a takeover. If Widgets Inc is “worth” $100M, but $50M is cash, then someone will try to buy a majority of shares and vote for a massive cash dividend. A CEO sitting on a pile of cash is likely ignoring opportunitis to expand or diversify. (Read *Barbariians at the Gate[ /I])
Valuations of large companies are often done with hand-waving; what is a factory worth? How much inventory does the company have? Often annual statements are short on details of what the numbers rally mean. The trickiest is “good will”. Apple is worth a lot because people will line up to buy the next iPad or iPhone no matter if it’s fantastic, or mediocre. (At least for a while). If Apple made a camcorder or a food processor, odds are it would garner decent sales just on the name. That’s “good will” and it has a value, the question is how much?
IIRC, shares owned by the company cannot be voted. Obviously dividends just go back in the bank account. So if the company holds 10% of the stock, the other 90% get more dividends, and have more voting power. A company will buy back stock to meet it’s stock option obligations; or because it thinks the stock is undervalued - meaning that they can buy now and sell it later for more money. Buying back stock can also create a shortage and demand, and so raise the price. (Careful, don’t be manipulating the stock).
I am confused by your question.
This part makes it sound as if Smegco and the shareholders are two different things. (“Why does the company care?”)
They are the same thing when an equity is publicly held. There isn’t “Smegco” and “the shareholders.”
If a stock price goes down, the value of the company goes down, with the amount of loss proportionate to share ownership.
Companies do have hard assets, as well as liabilities, so one way to do a valuation (i.e., to decide how much a company is “worth”) is to tally those two things up. But a third factor–the prospects of the company–is a relative intangible that is just as important. That includes things like where the company is positioned against its market, the potential size of that market, its intellectual property, its talent, and so on. It’s actually mostly this third factor that causes daily fluctuations for a stock.
Company leadership cares about their stock valuation because it can hurt the company if it’s too high or if it’s too low, even though a fluctuation does not directly change hard assets. In some ways, a stock price reflects a vote of sentiment about a company’s general potential, so if that’s high , perhaps capital costs will be lower since it will be easier to find capital if your prospects for paying back the money are good.
To some extent, the responsibility of company leadership is to maximize stock price because the whole point of owning a share is the hope that the stock price will increase. Because of that, many incentive programs for executives include stock-price related incentives. At the same time, executives are always moaning that short-term stock prices are not a good index, and short term stock incentives might be bad long term (since you could do some things to artificially pump up a stock price that might not be the right long-term strategy).
In the end, it’s not an effort by the company to “keep stock prices high” but an effort by company leadership to create the most valuable company possible. The stock price is a popular vote on how successful those efforts are, and to some extent how good a job leadership is doing.
I have to disagree with this.
First off, the balance sheet is designed for various accounting purposes, but the valuation of stock and companies is not one of them. You’re criticizing a screwdriver because it can’t hammer in a nail. The balance sheet isn’t even a lower bound on value; even if you reduce assets for impairment, you still use the value for the highest and best use of the asset, and you don’t necessarily get that price on liquidation.
Secondly, the valuation of the company and price paid for stock take into account future earnings. You’re right that these are speculation to some degree, but it sounds awfully dismissive the way you say it. If I offer to sell you $100, then you know it’s worth $100. If I offer to sell you $100, plus $10 per year for 20 years, then clearly it is worth more than $100. There are equations to calculate the net present value; we might conclude that this stream of income is worth $150. The extra $50 you pay isn’t “just speculation” - it’s the actual value (presumably weighted for risk, alternative investments, etc.).
A stock can’t usually promise such a clean flow of money, but the thinking of a long-term investor is going to be the same basic calculation.
…which is why I used a very simple example of a company with no assets other than cash. Of course once you start getting into assets that are hard to value, then the exact value of the equity also becomes hard to determine, but it still exists. What I am trying to illustrate is simply that the value of an equity is “real” and represents a real claim on something, it’s not a pure zero-sum-game made up number between a buyer and a seller.
“Risk” and “speculation” are sort of the same thing. If you’re taking a risk then you’re speculating that the future outcome is going to be one thing and not another. All future returns are promises but we’re not in the future yet so we can’t really know.
Assets - liabilities isn’t even the lower bound. For example, Zynga was recently valued at less than it’s cash + real estate because investors believed that management was likely to waste their existing cash on future unprofitable ventures.
But a situation like that leaves open the possibility of a liquidation takeover, doesn’t it? If you could buy up controlling interest in Zynga and replace the management, then sell off the real estate and pool the cash, you’d make a profit. (Of course, this won’t work if there are enough stockholders who won’t sell and would back management.)
The recent trend in tech companies is to offer different classes of shares with different voting rights. For example, Zynga offers Class A, B & C shares with 1, 7 & 70 votes respectively. Marc Pincus is the only person who owns Class C shares which all but completely insulates him from a hostile takeover.
Okay. Personally, I find it a little hard to see why anybody would bother with the other shares in that case. They entitle you to dividends - if Marc Pincus ever decides to pay out dividends. Or they entitle you to a share in the assets of the company - if Marc Pincus ever decides (or is forced by circumstance) to liquidate it. Or you can sell it to somebody else who can hold onto it for the reasons above.
“It’s a tiny piece of control over what this big company will do” is one of the best general reasons I’ve heard for why stock ownership is still valuable in an age of rare and declining dividends. If the company is structured so that the control from your shares is not just tiny, but effectively zero, then that reason should evaporate.
But that’s just my two cent’s worth, as it were.
And - hey, Shalmanese! Was your choice of name connected with ‘Stand on Zanzibar’ at all?
Typically, non-voting shares would be “preferred shares”. the theory is they guarantee a fixed dividend; the voting shared get profit payouts only once the preferred shares have been paid in full the “guarantee” amount.
However, I recall reading many years ago that stock exchanges and many mutual funds were becoming hostile to the idea of classes of shares and would not deal in non-voting shares, for precisely the reasons you mention. By reducing demand, they would make these shares less valuable and discourage their use.
If you’re the CEO, your job is to manage the company for the shareholders, they put their money in the company, and hired you to run it for them. They don’t want the company run into the ground, they want it to grow in value. If you fail to do that, you’re just another worker who’s failed, you get fired, and they put someone in who is actually going to uphold his fiduciary duty. This is also reinforced by offering stock options and other incentives keyed to stock price.
Nobody is going to hire you as CEO before you’ve gotten a track record of driving growth and higher company value. The CEO isn’t going to hire VPs who don’t share that drive. The VPs are going to make sure that this particular brand of shit rolls downhill to their underlings, who are going to be forced to implement policies with staff who likely don’t care either way.
Yes 
Preferred stock is the type that often has no voting control. However, they do usually get some nice benefits, including:
- priority dividends: they’ll get paid dividends before anyone else (often, including the founder).
- deferred dividends: if they expect x% per year and you don’t pay anything out for 5 years, then they’ll want 5x% before anyone gets anything.
- priority on dissolution: if the company goes tilt, they may get their share of dividends and liquidation before any of the other classes.
So it’s entirely possible that the people with control have to pay the preferred shareholders a ton of money before they can get their first cent out of the business. Since they’re motivated to get money for themselves, the preferred shareholders may be content that everything possible is being done to generate those payments.
Not all investments are made equal, and not all investors are made equal either. You may still look at that scenario and decide it’s not for you, but someone else may see it as a tempting offer.