Stock Bubbles

[Sage_Rat]

I am fairly sold on the idea that the stock market is nothing more than a bubble machine.

Say that I loan $1000 to someone at 5% interest for 5 years. For this, each month, I receive $18.87, until the 5 years are up. (At least according to this calculator here.) In end result I, the loaner, am richer by $132.27. If I sell the loan over to someone else, at most I can really only sell it for as much as is remaining to be paid off, probably less. The longer I wait to sell the loan, the less I can sell it for.

Your average stock, at least for the Dow Jones, pays about 2.74% rate of dividends. If I buy $1000 worth of stock, I have to hold that stock for 36.5 years to make my money back, let alone make a profit. I doubt most companies last more than one or two years, let alone expanding into multiple decades. The only way I can make a profit by holding stock is to sell it to someone else. The buyer’s only way to make profit is to sell it again.

Stocks simply become a game of chicken, with each person trying to wait the longest before selling to someone else before it plummets and they can’t sell above where they bought it. And all of this has very little to do with the actual health of a company. I suspect that at least 80% of the direction a stock takes on any given day has nothing to do with what the specific company did.

While not so much a factor for boring stocks, which just sort of track with the market average until the company is actually going under, anything that grabs the headlines can bring down the entire market, even for businesses that have no relationship.

I’m not sure there’s a particular solution for the issue of the disconnect between stock and company, but it seems like there should be some sort of way to buffer industries from one another. If the housing market collapses, that shouldn’t make my Microsoft stock fall, for example.

Does anyone have any particular ideas for either of these?

[Freddy_the_Pig]

@Sage_Rat

Your average stock, at least for the Dow Jones, pays about 2.74% rate of dividends. If I buy $1000 worth of stock, I have to hold that stock for 36.5 years to make my money back, let alone make a profit.

As should be blindingly obvious, the dividends paid by a corporation often grow over time, unlike repayments on a loan. Hence the lower yield.

@Sage Rat

I doubt most companies last more than one or two years, let alone expanding into multiple decades.

Please tell me this is a whoosh. The average publicly traded corporation lasts one or two years? Corporations last for decades, and when they cease to exist, they often merge into another entity in which the shareholders receive an equity stake. A stock is closer in concept to a perpetuity than to a term loan.

[Sage_Rat]

@Freddy_the_Pig

As should be blindingly obvious, the dividends paid by a corporation often grow over time, unlike repayments on a loan. Hence the lower yield.

That may be so, but the average is still only 2.74%.

Please tell me this is a whoosh. The average publicly traded corporation lasts one or two years? Corporations last for decades, and when they cease to exist, they often merge into another entity in which the shareholders receive an equity stake. A stock is closer in concept to a perpetuity than to a term loan.

True, I was thinking of all business, not just public companies. The point remains that people don’t hold on to stocks for periods of 30+ years. And they certainly have no intent of making a profit only following that much time waited.

[Bill_Door]

Those profits not paid out to investors are what drive the stock price up. It’s not like the value of the company is static and the price is driven by demand. Corporations reinvest their money in ways that increase the value of the company.

If you had a share of say, a gold ingot, whose value was solely based in whatever the price of gold is on the open market, sure, that’s a bubble stock. But if your stock is in a corporation whose assets and income are growing because of business decisions, that’s real growth, and real value.

I’ve got some stock I acquired 20 years ago when I quit working for a corporation. I was starting another job that day, and didn’t need my last paycheck so I had them throw it into company stock. I checked the divident reinvestment box on the form, threw the stock into a drawer, and forgot about it, except for once a year when I had to pay taxes on the dividends.

Today, after two 2:1 and one 3:1 split, and 20 years of dividend reinvestment, that stock is worth 30 times what I paid for it. I figure that’s 12% annual growth, and that’s at the end of a pretty rocky decade for the market.

[msmith537]

@Sage_Rat

Your average stock, at least for the Dow Jones, pays about 2.74% rate of dividends. If I buy $1000 worth of stock, I have to hold that stock for 36.5 years to make my money back, let alone make a profit.

Actually, if you invested in the S&P index, over a 30 year period, you would have made about 5x your intial investment, adusted for inflation.

S&P 500: Total and Inflation-Adjusted Historical Returns

@Sage_Rat

True, I was thinking of all business, not just public companies.

Publically traded companies (the only ones you can buy stocks in) tend to have very stringent requirements for demonstrating their viability as a going concern before they can issue an IPO.

@Sage_Rat

The point remains that people don’t hold on to stocks for periods of 30+ years. And they certainly have no intent of making a profit only following that much time waited.

You don’t have a 401k where you work?

@Sage_Rat

I’m not sure there’s a particular solution for the issue of the disconnect between stock and company, but it seems like there should be some sort of way to buffer industries from one another. If the housing market collapses, that shouldn’t make my Microsoft stock fall, for example.

What issue? Some would assert that all known information about a company can be found in the price of its stock. The problem is that companies don’t stay static.

[middleman]

Most people think they can pick a winner. Welcome to America. Where everyone is above average!

[Voyager]

@Sage_Rat

I am fairly sold on the idea that the stock market is nothing more than a bubble machine.

Say that I loan $1000 to someone at 5% interest for 5 years. For this, each month, I receive $18.87, until the 5 years are up. (At least according to this calculator here.) In end result I, the loaner, am richer by $132.27. If I sell the loan over to someone else, at most I can really only sell it for as much as is remaining to be paid off, probably less. The longer I wait to sell the loan, the less I can sell it for.

Your average stock, at least for the Dow Jones, pays about 2.74% rate of dividends. If I buy $1000 worth of stock, I have to hold that stock for 36.5 years to make my money back, let alone make a profit. I doubt most companies last more than one or two years, let alone expanding into multiple decades. The only way I can make a profit by holding stock is to sell it to someone else. The buyer’s only way to make profit is to sell it again.

That is a particularly bad metric. Many stocks, especially tech stocks, don’t pay dividends, since they feel they can improve stockholder value more by investing that money into the business. Microsoft and Intel didn’t pay dividends for years (I’m not sure if Intel does even now) yet I think you’d be pretty happy with their 30 year returns. There are types of stock which pay quite good dividends.

As for bubbles - in practice, investors in stock are quite subject to faddish behavior so there can be bubbles in particular over-valued stocks or in the market as a whole. You can do quite well if you realize this. While fundamentals affect stock prices, they sure don’t determine them. Anyone who thinks that no stock goes IPO unless there are very good fundamentals must not of been of reading age during the tech bubble.

[The_Truculent_Gentleman]

@Sage_Rat

I’m not sure there’s a particular solution for the issue of the disconnect between stock and company, but it seems like there should be some sort of way to buffer industries from one another. If the housing market collapses, that shouldn’t make my Microsoft stock fall, for example.

Actually, it absolutely SHOULD cause your MSFT stock to fall.

Is it really a stretch to see the connection?

1. Housing market implodes.
2. People get laid off work / small businesses close.
3. Personal and small business demand for PCs and Windows software declines.
4. This reduction in sales/profits is reflected in MSFT’s stock price.

[Sandwich]

@Sage_Rat

…Say that I loan $1000 to someone at 5% interest for 5 years. For this, each month, I receive $18.87, until the 5 years are up. (At least according to this calculator here.) In end result I, the loaner, am richer by $132.27. …

You should have a browse in a good bookshop for some introductory texts. You won’t learn much useful in this sort of discussion. In the UK the broadsheet newspapers sponsor good general practical introductions, dunno about in the US. Otherwise academic texts are much better than anything in the ‘popular business fads’ section, if you are motivated enough.

The bad news is… it’s all quite complicated. Finance and economics aren’t as easy to have an enjoyable internet discussion about as politics, religion, or more interesting science. For instance, taking your example quoted above: at the end you, the lender, are in exactly the same net financial position as you were at the beginning, neither richer nor poorer.(*)

Sandwich

• yes, yes, I know I’m making the assumption that the discount rate to reflect the time value of money is 5%, but I don’t think Sage Rat is ready for that yet.

PS on reflection, the calculator screwed up since $132.27 is not the correct answer anyway.

[Simplicio]

@Voyager

Microsoft and Intel didn’t pay dividends for years (I’m not sure if Intel does even now) yet I think you’d be pretty happy with their 30 year returns.

I don’t think that Sage Rat is debating that people don’t make money off the Stock Market, obviously they do. Rather, the question is, how do they do it, given that dividends don’t pay out very much?

Obviously they do it by re-selling their stock at a higher price, since the company in question will (hopefully) have grown. But why is, say, 1% of a big company worth more then 1% of a smaller company. If I buy 1% of intel when it has a net-worth of a billion dollars, and then 30 years later its worth 3 billion dollars, you might say I received a three times return on my investment. But how do I actually realize that return? I can’t go knock on Intel corporate headquarters and ask for 1% of their semi-conductor factory so I can break it down for spare parts to sell. All I can do is sell it to someone else, who in turn is buying it so they in the future can sell it to someone else for more money and so on down the line.

The whole process seems divorced from the actual company the stock is supposed to represent a share in.

[Voyager]

@Simplicio

I don’t think that Sage Rat is debating that people don’t make money off the Stock Market, obviously they do. Rather, the question is, how do they do it, given that dividends don’t pay out very much?

I was mostly objecting the the use of an average dividend, since stocks have a bimodal distribution of those which are dividend oriented and those which are not. If you are talking about an average dividend, you should compute it using the bucked of dividend oriented stocks. As we near retirement, we’ve moved money from more volatile stocks and funds to some with excellent dividend yields, which don’t move a lot in price.

In an ideal world, the money reinvested is used to increase earnings. Since the stock prices is based on earnings, there is a direct correlation between the reinvestment and the money you can get out of it later. In the real world the price earnings ratio varies over time, sometimes irrationally, which is why I kind of agreed with him about the bubble. I assumed he knew the buy low sell high stuff.

[Simplicio]

@Voyager

I was mostly objecting the the use of an average dividend, since stocks have a bimodal distribution of those which are dividend oriented and those which are not. If you are talking about an average dividend, you should compute it using the bucked of dividend oriented stocks.

I think Sage Rat’s point was that, on average, stocks aren’t dividend oriented, since if they were, the average dividend of all stocks would be higher. So I think the number he gave was the correct one for what he was trying to show. The average dividend of stocks that offer them would also be interesting to know for its own sake, though.

In an ideal world, the money reinvested is used to increase earnings. Since the stock prices is based on earnings, there is a direct correlation between the reinvestment and the money you can get out of it later.

This was my question in the previous post, how is stock price correlated with earnings? The answer is obvious for stocks that offer a dividend proportional to the earning, but since those are not in the majority, there must be another mechanism that couples earnings to a shares value.

[Voyager]

@Simplicio

I think Sage Rat’s point was that, on average, stocks aren’t dividend oriented, since if they were, the average dividend of all stocks would be higher. So I think the number he gave was the correct one for what he was trying to show. The average dividend of stocks that offer them would also be interesting to know for its own sake, though.

Assuming we are talking stocks here, and not index funds or mutual funds, I’d say trying to invest given the average is a terrible idea.

This was my question in the previous post, how is stock price correlated with earnings? The answer is obvious for stocks that offer a dividend proportional to the earning, but since those are not in the majority, there must be another mechanism that couples earnings to a shares value.

The market. Though the market is also driven not by current earnings but by expected earnings, which is why a stock with a good earnings report but a bad forecast will go down.
There are fundamentally different mechanisms at work, since dividends are set by the board and price is set by the market. But I’m sure dissertation after dissertation and book after book have been written about the correlation between earnings a price. I realize that what I just wrote is so simplistic as to be glib.

[Sage_Rat]

@The_Truculent_Gentleman

Actually, it absolutely SHOULD cause your MSFT stock to fall.

Is it really a stretch to see the connection?

1. Housing market implodes.
2. People get laid off work / small businesses close.
3. Personal and small business demand for PCs and Windows software declines.
4. This reduction in sales/profits is reflected in MSFT’s stock price.

At most there were about 1 million people who were in danger of losing their house due to adjustable rate mortgages. Being busy dealing with trying to find a new home, they end up losing their job. A few very small businesses end up having to close down because they’ve lost too many workers. Say, this takes down another 100,000 people.

We assume that there is another say…100,000 people who worked in the housing market that got laid off due to the immediate shrinkage of the market.

So now we’ve got 1.2 million people out of work in the US. This is slightly more than 1/3rd of 1% of the US populace. They aren’t buying Microsoft products. But of course, Microsoft’s market is far large than just the US, so at most their sales fall by say half a percent.

Matching that, MS’s stock falls by half a percent. Which isn’t good, of course, but hardly a horror.

Except, in the modern day world it actually crashes by half or some other extreme value because the entire population pulled out of the market and end up trashing the market, shutting down lots and lots of businesses and forcing all the ones that remain to do layoffs and minimize spending for a while. Where there should only be a small, largely localized impact on the market, instead there’s a massive one because no one wants to be the guy who ends up holding the trout.

Wikipedia: “Stock market crashes are in fact social phenomena where external economic events combine with crowd behavior and psychology in a positive feedback loop where selling by some market participants drives more market participants to sell.”

So, how do you buffer the region between industries? When one crashes, while it should certainly affect the whole market, it should affect it in a more reasonable manner.

[msmith537]

@Sage_Rat

So, how do you buffer the region between industries? When one crashes, while it should certainly affect the whole market, it should affect it in a more reasonable manner.

There are guys in every investment bank in the world who do nothing but try to hedge risk between different industries.

The entire market does not crash because of one company. It is usually because of a major event that affects the entire economy.

[Sage_Rat]

@msmith537

There are guys in every investment bank in the world who do nothing but try to hedge risk between different industries.

The entire market does not crash because of one company. It is usually because of a major event that affects the entire economy.

Yeah, but are there any wacky ideas being peddled about by wild eyed economists, is my question?

[SenorBeef]

I’ve always had this question myself and no one has ever explained it to me adequately.

I think some of you are misunderstanding his question. Quite simply - how is stock inherently valuable? He mentioned that dividends are a way in which stocks can be inherently valuable - you buy a small part of their company with the expectation that they share their profits with you. A reasonable system, except dividends are not the primary way that shareholders make money with stocks, and many don’t even pay a dividend.

So the issue becomes - stocks only seem to have value because other people are willing to pay you for that stock, in the hopes that one day they can get someone else to pay them for that stock. At no point (excepting dividends) is actual value paid out to the holder of the stock - it’s all one chain where you hope to get the next guy to pay more for it than you did. It’s almost like a weird ponzi scheme.

So yes, stock values increase and decrease - but these aren’t always necesarily tied directly to company success. But even if they were - it’s not as if you can cash your stock in at a company as if it were a bond, so their success or growth (or stock price change irrespective of success) does not inherently make your stock more or less valuable - it only affects the value so far as someone else is willing to pay more for it. But it’s an endless chain of trying to sell it to the next guy for more than you paid - at what point does anyone benefit from owning the stock? Or is it all just a big chain where it has value because everyone agrees it has value even though it can’t pay out actual value in any meaningful way? Is the whole stock market as it exists today essentially an emporer has no clothes situation, where everyone is willing to buy into the game as long as everyone else is?

[Sage_Rat]

@SenorBeef

I think some of you are misunderstanding his question. Quite simply - how is stock inherently valuable? He mentioned that dividends are a way in which stocks can be inherently valuable - you buy a small part of their company with the expectation that they share their profits with you. A reasonable system, except dividends are not the primary way that shareholders make money with stocks, and many don’t even pay a dividend.

So the issue becomes - stocks only seem to have value because other people are willing to pay you for that stock, in the hopes that one day they can get someone else to pay them for that stock. At no point (excepting dividends) is actual value paid out to the holder of the stock - it’s all one chain where you hope to get the next guy to pay more for it than you did. It’s almost like a weird ponzi scheme.

It is related, somewhat, to the value of the company in the sense that people buy and sell based on their expectations of the company. The one given is that you can’t sell the stock if the company closes its doors, so you don’t want to be the guy holding the stock when that time comes. Any bad news is potentially that end point and you want to be the first person out if it is. Hence, minor news scares the most skittish and they pull out, larger news pulls out more, etc. You end up with a stock value that does track–more or less–the health of the company.

By that measurement, if everything actually works properly, it becomes a non-bubble machine.

The problem comes when everyone expects a certain market to be a “sure seller”, and they all buy in and buy in and create a positive feedback system that keeps pumping up the value.

And then with the other problem being that investors pay more attention to the market as a whole than to the individual companies, each company bears an overly strong dependence on public opinion of the whole market.

[Tom_Tildrum]

@Sage_Rat

Say that I loan $1000 to someone at 5% interest for 5 years. For this, each month, I receive $18.87, until the 5 years are up. (At least according to this calculator here.) In end result I, the loaner, am richer by $132.27. If I sell the loan over to someone else, at most I can really only sell it for as much as is remaining to be paid off, probably less. The longer I wait to sell the loan, the less I can sell it for.

I’ll just note that this assumes that the borrower remains solvent and pays back the entire loan. As we’ve seen over the last couple of years, this is by no means certain. It’s stacking the deck a bit to posit lending as a sure thing.

[Lemur866]

But companies are liquidated all the time. Or more usually, bought. So if you’re a shareholder in Tiny Software Company of America, and Microsoft buys the company, the way they buy the company is to purchase your stock. They can purchase your stock by paying cash, or trading you MS stock for TSCA stock.

And so the amount Microsoft pays for purchasing the company depends on the value of the company, which is reflected in the price per share. Of course, companies look all the time for purchases where the value of the company is NOT reflected in the value of the shares–in their opinion. If you think the company is undervalued, then it’s a good idea to buy. But that’s just, like, your opinion, man.