But you’re completely discounting the idea of dividends. But oil companies regularly pay dividends.
Or consider the guy who owns 100% of the company. As he sells oil and his company makes profits, what does he do with those profits? Pay himself a dividend with that, and use it to fund his lavish lifestyle? Or reinvest the profits into more oil wells and trucks and ships and employees?
If you’re 1% owner of a company that doesn’t pay dividends, the company is reinvesting the profits (if any) into growth. That’s why Microsoft for decades didn’t pay dividends, because rather than the owners taking profit money out of the company for personal use, they used the money to grow the company larger, which is supposed to make the company even more profitable in the future.
You seem to have a pretty good idea why someone would run a sole proprietorship business. Why would it be hard to understand why someone would want to own half, or a quarter, or 1% of a business? If the company is profitable, you either get paid your share of the profits, or the company assets grow.
It is true that the stock price can diverge wildly from the real value of the company, due to all the various reasons discussed. But the bottom line is that you own a part of an organization that generates profits, and that has value.
I’d say you are more likely to lose money on commodities since the Futures market is a zero-sum game. Wealth can be created in the stock market such that both parties could profit on a sale. In Futures someone gains at the expense of someone else.
I’m discounting them because the OP stated they weren’t a major source of return on stock investments (avg 2.5%, apparently, and since we’re doing oil companies in our example, I looked up Exxon and they apparently pay out at 1.6%, assuming I’m reading their website right), and while there was some nit-picking early in the thread, no one seems to have discounted that premise. If indeed, a stock will eventually pay out all of its profits in the form of dividends (even if it spends years or even decades rolling them back over into investing in the company first) , then I agree the problem is solved. But just going on the info in this thread, I have trouble seeing how this could be the case. Companies don’t appear to return very much of their profits to their shareholders in the form of dividends.
If on the other hand, the company just rolls investments back into the company, so that the company (ideally) increases its profits every year, then my question remains: what mechanism couples the share price of a company to the companies actual profits?
Maybe you own the oil. Is it in your backyard and do you own all the land covering it and have clear mineral rights to it? What if your oil is at sea and someone else puts up a rig nearby to exploit the find (IIRC Iraq invaded Kuwait partly because Kuwait was slant drilling into Iraqi oil fields)? What if your workers go on strike and refuse to drill? What if the refinery blows up that buys your oil?
Just saying…
And the problem with owning 100% of your company is your ability to exploit new opportunities. You have been spending lavishly on yourself so when you find a new oil field do you have the billions in capital needed to exploit it? Probably not as sole proprietor.
So, in order to actually get the oil you need a loan. You might get a bank to write you a loan for billions but you will be paying millions in interest payments back to the bank.
So, you sell stocks to raise the cash. You could not have gotten the oil without sharing some of the wealth otherwise so even sharing you are still richer. Other people can benefit buy buying a stake in your company. That is an asset to them. They can show it to a bank to secure a loan for instance. At some future date they can sell it and, hopefully, realize a profit.
Dividends are not meant to fully recoup your investment. It is just your money earning a little more money. This makes the stock more attractive and helps inflate the share price. Remember the underlying value of the stock remains and you can sell that at any time so, at least with the dividends, you got a little extra along the way. Whether the stock would benefit more by rolling all profits back into the company thus raising stock prices or offering some of that in dividends back to its shareholders is a debatable question (dependent on each unique situation).
Profits are used to measure how well a company is doing. If they are making profits then they must be doing something right. As they make money they will expand their operations in one way or another (even if they do not and just leave the money in the bank remember I technically own a percentage of that money). Remember if I bought 10% in your $1000 company and you grew it to $2000 I still own 10% of that. Someone else may figure you are doing well and seek to own a piece of your company. I say I will sell it to him for $200 and he agrees. I made a $100 profit.
The guy who bought from me is speculating that you will continue your good performance and someday he will want out and someone else will want in. That guy will realize the profits at that point.
Actual profits of a company are merely a guideline to give some reasonableness to the prices.
As noted above though there are many things that can affect share prices. In the end it is really supply versus demand.
Take your $1000 company you started that I own 10% in. You sold 1000 shares at $1 each. I own 100. Some other people own the other 900 shares.
You double your company in one year. Someone on the market wants in on that action. Thing is no one is selling at the (now) $2/share baseline of your $2000 company. So, people will offer (say) $2.05 and see if anyone bites. No takers they may go to $2.10 and so on. Eventually someone may sell.
This is what happened in the Dotcom bubble. There are a finite number of shares being chased by a lot of people. Everyone wanted in on the Microsoft dream of becoming millionaires with the next Big Thing. Share prices skyrocketed faaaar beyond anything merited by the underlying company.
This can work in reverse too. Maybe your (now) $2000 company is found to have been gotten to because of massive fraud on your part. People are suing you for $10,000. I probably couldn’t give away my shares under that circumstance even if you have some underlying assets (they will be gobbled up by others suing you first).
Yea I understand why a company would want to sell stock, so that they could raise capital to invest and build oil-derricks and what not. My problem is in understanding is why anyone would want to buy it, since it appears that they’re unlike to see much of the profits.
We seem to be talking past one another though: your next post seems to be just repeating your earlier post. Lets try a thought experiment:
I’m going to start a company called Simplicio Inc. I will sell you and four other suckers 20% of the company for 5$'s each, so my total assets are 25$. I’m also going to say that the company is worth 25$ Doper Dollars (DD’s). Then each morning I’ll roll a dice, if the dice comes up 1 or 2, the company has lost 5 or 10 % of its value in DD’s. If it comes up 3, nothing happend, 4, 5, 6 means we gained 5, 10 or 15% that day. I’ll pay no dividends (cause who wants a dividend of fake money anyways), so all my profits are essentially being “reinvested” in my pool. Obviously, the value of my company in my fake money will grow and shrink depending on the roll of the dice, but on average, its going to grow pretty fast.
So you sell your share, the guy who bought from you is speculating that I will continue my good performance and someday he will want out and someone else will want in. That guy will realize the profits at that point.
You see my point, whether profits are in real money or fake, it doesn’t seem to really make a difference, since ownership of the share is divorced from any meaningful claim on the profits in both cases.
But obviously no one would buy a share in Simplico Inc, and yet people buy shares of real companies. I (unlike the OP, I think) don’t think its a scam, I’m sure there’s something I’m missing. Some mechanism makes a share something more then just an arbitrary betting slip. I just don’t see what (unless its my previous theory from post #25).
The fact that shares represent a part of a company’s underlying assets has already been mentioned. If there are a million shares out there for a company with a billion bucks in the bank, each share has an underlying value of $1,000.
But if the market value of a stock was directly tied to this “actual” value only, then share prices would move towards that price and be stable - and there are some stocks out there with a very stable business model that are like this. They usually pay dividends, and are good things to get into if you are nearing retirement. But the fact that most sticks are volatile show that the price is based on many other things, especially bets on the future. If I own 100 shares of Simplicio, Inc. purchased at $10, and I have reason to believe that the stock will go up to $15, I’ll buy more. If I think it will go down to $5, I’ll sell.
Why do I think either of these things? It might be based on careful analysis, or it might be because I heard some clown on TV talking about the stock, or it might be because I heard a tip from my neighbor, or, worst of all, it might be because everyone else is buying or selling and I want to get in on the action. That is where the volatility and the bubbles come from.
So market valuation might or might not have anything to do with real valuation, as the Internet bubble should have demonstrated to everyone. It is a bet.
One of the things you’re missing is that there’s another investor #6 out there who wants to buy the company. He wants to buy the whole company. To avoid repeating what others have said about “a shareholder just sells shares to another person who then sells it to another person and so on” – think of investor #6’s transaction as buying the company of which the mechanism happens to be stock shares.
Again, investor #6 doesn’t frame his decision in terms of acquiring “shares” – he thinks of it as buying a company. On the other hand, the original 5 investors’ mindset have already divorced the shares from the company. Maybe they had this frame of mind the day the bought the shares. It doesn’t matter.
I do see that having investors with 2 perspectives on what shares mean makes things more confusing. Some investors only think of shares as abstract items (trend investors, day traders). Others think of shares as administrative paperwork to a larger conceptual picture (the founders of companies and value investors think like this.)
I guess another way to think of it: if people were to keep asking why people buy “titles to automobiles” how would you answer? It doesn’t make any sense! Why would a piece of paper printed up by the state department of motor vehicles have any value? The answer is the that car’s “title” is merely a mechanism of the transaction. It’s a means to an end.
That’s a very meaningful claim on the profits. I will look at Simplicio Inc. and reason that over the long term, this company will be profitable. I will set a horizon for ownership, and will calculate over that horizon what the value of the company will be. Then I will discount the new value to today’s dollars. If the price of the stock is below that number, I will view it as a buying opportunity. If above, I don’t buy (and if I own, then I sell). The possibility of Simplicio throwing 1, 2, or 3 for 15 straight throws is a risk factor that I should account for. I account for this by raising my required rate of return on Simplicio, Inc., which lowers the value I would pay for the stock today.
Now let’s change the assumptions: on a 1 or 2, the losses are now 7% and 13%. Nothing else changes. This will factor into my long term outlook as the stock has become riskier, and I will recalculate what I believe is the current value. Then I will look at the current price. If the current price is above my calculate value, it is time to sell the stock. Simplicio hurts his wrist, affecting the throws - logic tells me that the results will be just as random, but emotion might tell me differently, and again I think the stock is riskier (or maybe safer).
This kind of analysis happens everyday. Not everyone uses the same models nor the same factors when they use the same models. While everyone should have the same access to information, some are better at reading between the lines; analyst A thinks the wrist injury is a positive while analyst B assigns a negative factor to it, and analyst C considers it a non-factor. This is why different people assign different values to the same instrument. Remember, we are not talking about today’s profits when valuing a company. We are talking about expected future profits. The only thing you are ‘betting’ on is the future profitability of a company. Bad decision if you bought GM at $60 - somewhere there was a fault in your analysis (or in the analysis of the analyst you listened to).
Ruminator go read my post #21. I think your saying the same thing, which would make me happy.
People buy titles to automobiles because they can drive them around. No one buys one one-hundreth of an automobile because that would be worthless. But if we had lots of people trading 1% shares in a single car, and a few rich people trying to actually collect 100% of the shares, then it would make sense again, since it would have an intrinsic value to a few people and the many 1% owners could make money trying to sell it to those few, even if they couldn’t use them themselves.
Again, I think that was your point above, I’m just trying to summarize to see if we agree.
I’d say this is really where the argument ends up. You think that control is a fundamental aspect of the valuation. However, while you may give up a say so in the goings on at the company, you gain the liquidity to be able to divest at a moment’s notice. Further, you are really overlooking the fact that monetization events occur with public companies. You won’t know when they will happen like you would with a certificate of deposit, but they do happen all the time. Companies are sold or sell major chunks of assets for large one-time dividends resulting in the realization event that you are looking for. Companies also buy back stock fairly often.
I believe Car-X will appreciate in value. Thing is I cannot afford Car-X. So, I get together with a bunch of people and we chip in and buy Car-X. Each of us now owns a share of the car but not the whole car. If the value of Car-X does appreciate and seems it will continue to do so somebody in the future might want to buy my share of the car and I make a profit.
And so it goes. None of us owns the car, just a part of it. None of us can go drive it. It is an investment and sits in a garage. Just like if you own shares in a company you cannot walk in and take a chair saying you own it.
In this case the value derives from a possible future buyer of the car. That person may never show up but we all know it is a possibility. People rotate in and out of ownership. The asset exists. At some point the owners, by majority vote, could agree to put the car on the market and sell it. If they get a price they like they cash out.
Automobiles, most of which have an easy computed value, is not a good example. Try instead a Picasso. Why is one Picasso worth a million bucks? Not from the canvas, but mostly because that is the price set by the market based on a number of factors. Artists might become unpopular, and the value of their work drops without it changing any. A work of art found to be a forgery drops in value, which shows that the value does not come from the material of the painting itself. And I believe that there have been syndicates that buy paintings.
Here is a way to explain it that MAY make some sense. It came from an introductory finance class, so take it only for what it’s worth, and I’ll take some liberties in order to explain with less jargon and equasions. Keep in mind the principle of the time value of money. If you are going to reinvest a dollar or pay off debt, you will find that dollar more valuable the sooner you get it.
A model for understanding the valuation of a stock can be thought of as the the steam of dividends the stock will return in perpituity.
This may not make sense as you’ll sell at some point, but when you sell the value will be the future stream of dividends in perpituity from that point. Therefore the value will be the same whichever way you calculate.
This is hardly a magic formula because you have to guess what all dividends in the future will be.
Under this model, there is inherent value in a stock. You are buying the future stream of dividends.
**So, is there still inherent value in a stock if a company chooses to give low or no dividends? **
When a company makes profit, it has to do SOMETHING with that money if not given as a dividend. If it keeps it as cash, that cash will earn interest. That interest will generate money over time, which should boost future dividends. If the company invests, that will hopefully be returned by higher profits, which will boost future dividends, which boosts the value of a stock.
This model works if you assume corporations will eventually give dividends. This assumption gives inherent value to stock even if the stock will not return a dividend within your investing timeframe.
And companies do eventually move to dividends when their profitability outpaces investment. For example, Microsoft.
Companies that fail before distributing dividends strain this model, as do companies that quickly go from expasion to losses (Krispy Kreme) with no “cash cow” period from which to extract dividends. But in these cases investors misvalued the dividend stream.
Using this model to explain the valuation of stocks doesn’t mean there’s not speculation or even a “bubble” in a stock, as price is not the same as valuation. Plus any valuation calculation is full of guesses of future performance. Sometimes stocks get completely unhinged from any inherent value (.com stocks in the 90’s), but that’s pretty rare now.
Voyager and Wack-a-Mole, there isn’t really any question why people want Paintings or Antique Cars though, they’re valuable as collectables to people interested in such things. If a person or a bunch of people buy one purely as an investment, they’re still basing what they pay on expectations related to that one guy at the end of the line that’s going to buy the painting or car for its intrinsic value to himself, and the enjoyment he gets from owning it.
No one “collects” shares of ExxonMobile in the same way, there aren’t any showrooms filled with rich peoples most prized and valued stock certificates. So the question is, who is the collector in the case of stocks? Who is that guy that investors are thinking of when they’re trying to speculate on how much they will pay for the stock, the guy for whom the stock has some value beyond the ability simply to pass it on to someone else.
The reason I used automobiles is that it also has a piece of paper (the title) analogous to stock certificates of companies, whereas works of art such as Picasso do not.
The administrative concept of automobile titles is so unified with the car that you can’t even legally sell the car even if you have physical possession of the car in your garage. This is very similar to company shares. To continue the comparison with company stocks: conceivably, a car’s title could change hands 10 times and the actual physical car never moves from a buyer’s garage to a seller’s garage.
It’s just that most of us have opposite types of interaction with companies vs cars.
For companies & stocks, the average person interacts more with the stock (the piece of paper) rather than the actual company (e.g. exercise voting rights, attend shareholder meetings).
For cars and titles, the average person interacts more with the car (drive it to work every day) rather than the actual title (transfer it to a seller, or get a name changed on it.)
There are people who buy art as an investment, but the more important point is that the value of the painting, even as something to look at, is dependent on immaterial things. After all, a rich person could easily commission an exact duplicate any painting for a lot less money. Does the appeal of looking at a van Gogh really worth tens of millions of bucks? To some extent someone paying this much for a painting thinks that the painting will retain its value, that is be able to be sold for at least as much later, just like stock.
And I should add that during the bubble, when I was theoretically rich, looking at my stock portfolio gave me a lot of pleasure.
You OWN a percentage of the cash in the company’s bank. You own a percent of the company period and that means all that entails.
I guess the value is if the company is ever sold. The company has a value. If a majority of the share owners decide they want to cash out they can put the company up for sale. If they get a price they like they all cash out.