How does the stock market work?

https://www.straightdope.com/columns/read/2116/how-does-the-stock-market-work/

Interesting during these times when companies are being harshly criticized for paying dividends. There’s only 3 things a company can do with idle cash: save it, reinvest it into the company (including buybacks), or pay it out as dividends. Shareholders are the owners of the company and thus they aren’t likely to be satisfied with keeping large sums of cash around doing nothing in the low interest rate environment which has persisted since December 2008.

Also, many critics need to realize that they may have benefited from dividends as they may indirectly hold the stock in their retirement plans through mutual funds or ETFs.

Here’s what I don’t get about stocks (sorry for the hijack dalej42 but I think we normally only have one thread per cecil answer)

Noob question: How do buyers and sellers get matched up, as it were?

So, what I mean is, say there’s a bicycle on Amazon for $500. That means there’s a seller ready and willing to sell at that price, and as soon as a willing buyer appears, a transaction happens.

But when a stock in Straight Dope Holdings, say, is listed as $50, the implication is both that I could buy the stock for that price, or sell it at that price. But how can there be both a pool of willing buyers and sellers?

No, that isn’t the implication. What you’re seeing reported is the “last” price, i.e. the last price at which a transaction occurred. But there’s no guarantee that you can transact at that price. The actual market is always a bid/ask, with the bid price a little lower than the ask, perhaps something like 49.95 / 50.00

If you enter an order to sell “at market”, i.e. immediately at the best price available, you will sell at the bid price i.e. 49.95. If you enter an order to buy “at market”, you will buy at 50.00, the current ask price, slightly higher than the bid.

You could also enter a “limit” order, at a specified price. That’s where the current market bid and ask prices arise - some people have entered limit buy orders with a limit of 49.95, other people have entered limit sell orders at a limit of 50.00.

Companies are being criticized for paying out dividends when it’s seen as a short-sighted move because an extended recession means that they may soon need the cash to survive. Banks are a prime example - don’t pay out surplus cash as dividends then come running to the government a year later for a bailout when you’re insolvent.

To add to that, there’s only one bicycle for sale and it’s unique. Shares of stock aren’t unique.

There’s also depth of market. When you see a bid-ask quote, it will also represent the actual number of shares available at that price.

Most trades are done by ECNs, electronic communication networks. The Wikipedia article is flawed, but will give you a general idea of how they work https://en.wikipedia.org/wiki/Electronic_communication_network?wprov=sfti1

I simplified some things, but this along with the other explanation, is basically how it works.

Thanks guys.
I guessed it might be something like currency exchange (buy at / sell at) but didn’t know. Or how the actual transactions happen.

Ignorance fought.

True, but there’s always going to pressure from the owners to pay out that dividend, if you don’t, you can be replaced.

Also, large companies have a bit of an advantage in that they’ll always have leverage.

If I owe you $3000 and don’t pay, you can always send your buddy Knuckles over to convince me to pay. If I owe $3 million, well, now it’s more your problem than mine. It’s similar with large companies. Some local coffeehouse goes out of business, it sucks for the employees and the local neighborhood, but no real effect on the economy as a whole.

Large companies shedding jobs and heading for bankruptcy don’t just affect your local neighborhood, they affect the entire USA and world economies. It may not be fair, but it’s usually in government’s best interest to keep them afloat.

Getting a bit more deep into the weeds, there are companies that are called market makers and they buy and sell out of their own inventories of stock, helping to insure liquidity in the market.

I think our Dear Leader, or his assistant, has misled His followers in that column.

Wrong. Yes, early corporations often depended on governments for support and monopolies — as do many shareholder-owned corporations today — but they were not “public corporations owned by the government like the USPS.” One of the earliest share-holder owned corporations was The Dutch East India Company (Vereenigde Oostindische Compagnie) established in 1602. I cannot find a detailed list of its shareholders but

Here’s a look at Stock Ledger One from 1694 for the Bank of England. For example, Thomas Smith, a chemist from Westminster, invested £25 in Bank of England stock.

It’s not dividends that critics have recently objected to, it’s buybacks.

The public rationalization for the corporate tax cuts was that the companies could use the money for R&D, or to build new plants, or increase production, or any of the many uses that would benefit the broader economy.

Instead, the companies have largely spent their billions on buying back stock. This does, admittedly, put the money back into the economy. The difference is that it has a limited multiplier value. The stockholders get richer, driving more wealth into ever-smaller percentages of the population. The workers in the company and the smaller businesses in the supply chains that could have benefited from internal investment get next to none of this effect. Moreover, spending their cash-on-hand leaves the companies vulnerable for emergencies, exactly like the one we are having now. Instead of being able to ride out the slowdown for a few months, the companies are getting bailed out with yet more dollars, dollars that are coming out of lower tax revenues. It’s a lose-lose for the country, the government, and the economy. Well worth criticizing.

Buybacks aren’t really much different than dividends other than the investors have no choice but to get taxed on dividends, whereas they can decide not to sell during a buyback program and only have unrealized gains. Both are the company shedding cash and that cash ending up in the hands of their shareholders.

I don’t think currently there’s as much pressure on buybacks as there was before the epidemic. The stories I’ve seen are basically about large companies that are shedding workers but still paying out their regular quarterly dividends. This is likely because the executives have stock options and don’t want to tank the price of the stock by signaling that they don’t have faith in the company to pay out its regular dividend and stay solvent through the crisis. On Caterpillar’s web site listing all the dividends it’s paid, it proudly announces that it has paid a dividend every year it has been in business, and a quarterly one every quarter since 1933. Ok, sure, they could keep that streak alive by issuing a 1 cent dividend instead of the $1+ dividend they did declare recently, but that would essentially give the same signal to the market. They (the executives) would rather put on a show that everything’s going to be fine. Credit markets are being flooded with money to lend and interest rates are low. If they need to borrow money, they probably can.

A good reason why they’re cutting jobs is simply that there’s no work for them to do. Why continue to pay people to do nothing when you instead can just let them go and rehire who you need later? Finding people when you need them should be no problem with our nearly 15% unemployment. It’s bad optics to pay dividends instead of workers, but it’s completely rational from the executive’s point of view. The people in the market for buying Caterpillar products probably aren’t going to be swayed in their purchase decisions by these kind of business decisions; more consumer-oriented ones might be though.

Your point is correct. Yet, even setting aside taxation details, there is one conceptual difference: Buybacks are done deliberately to prop up share prices. Companies buying shares back believe — or pretend to believe — that their shares are undervalued.

Have there been studies of insider trading of corporations buying back shares? Are men who pretend that shares are undervalued when wearing their Directors’ hats, themselves selling shares when wearing their Stockholders’ hats?

Companies are being criticized for paying out dividends when it’s seen as a short-sighted move because an extended recession means that they may soon need the cash to survive. Banks are a prime example - don’t pay out surplus cash as dividends then come running to the government a year later for a bailout when you’re insolvent.

Increasing dividends tend to “prop up” share prices, as well.

Do you have a problem with those, as well?

Buybacks explicitly raise the P/E ratios of shares, which dividends do not. The higher P/E ratios then cause share prices to rise as a consequence: so the P/E ratios can be restored to “normal levels.”

:confused: I’m not sure in what context septimus’ own problems are under discussion here. :confused: I do see issues for the long-term stock market health and U.S. economic health. Some corporations, e.g. Big Oil companies, were continuing with highish dividends AND with stock buybacks. They also borrow hugely, but their borrowings are not for exploration, development, or capital expansion —* they’re borrowing to pay the dividends and finance the stock buybacks.*

In other words, they are seeking very high leverage. This is logical and profitable for them given the low interest rates at which they can borrow, but it does weaken their financial health. If a setback cuts their profits or raises their interest rates, then taxpayers will be asked to help out, perhaps assuming some of the pain which “should” fall on stockholders.

Sooner or later, Big American Capital will come back to the public trough, as it did in 2008, saying “Heads we would have won; but Tails YOU lose. Ha ha!” Sooner rather than later, as it turns out, due to the Covid-19 crisis.

HTH.

I got the key sentence inverted in my prior post. :smack: It should have read:

Buybacks explicitly lower the P/E ratios of shares, which dividends do not. The lower P/E ratios then cause share prices to rise as a consequence: so the P/E ratios can be restored to “normal levels.”

By using “Market makers” (“Specialists” in the NYSE). Their job is to match buyers to sellers. If someone wants to buy 100 shares of X Corporation, it goes to its market maker or specialist, who then matches the request up to someone who wants to sell.

If there is no match, the market maker (who keeps a stockpile of shares of the companies they’re making a market in) has to buy or sell the stock out of their own account.

As the OP explained, dividends and buybacks are ways to return excess cash to shareholders. Why are dividends considered acceptable, while some people think buybacks are somehow evil?

First of all — what’s with the “EVIL”?? Has anyone in the thread used the term other than you? What’s the purpose of throwing around inflammatory words? Does it facilitate rational discussion?

Second, your “ways to return excess cash” is wrong. Big oil companies like ExxonMobil or Chevron borrow on the bond market in order to finance their dividends and share buybacks. I’ve highlighted here to encourage you to reread the sentence. "Excess cash"indeed!! (I hardly think that borrowing to pay dividends and fund buybacks is limited to oil companies in today’s world — that’s just a sector I happened to have had reason to examine.)

Finally, as I tried to explain before, buybacks differ from dividends in that the “cash distributed to shareholders” is not distributed equally. As I already said, Directors may be encouraged to pretend the company is doing well, while selling shares at an inflated price.

But the main point, applicable whenever dividends or buybacks are financed by borrowing was already revealed upthread:

Clear? Would it help if I tried to wedge a word like “evil” into the quote? :slight_smile:

A) You are not in a position to explain anything.

B) How is it unequal? 30/share in a buyback vs .30/share in a dividend ARE being distributed equally.