I rather think there are ownership certificates for art also, and some people have art that hangs in a museum, not in their living room. If you used an antique car as an example, then you have both title and most of the value coming from perceived values, set by auction, not from Blue Book.
This makes sense to me, but my (very sparse) googling on the value of dividends makes it hard to believe that they will eventually equal a share of the profits equal to the share represented by the stock. The OP claims the average dividend is 2.5% year, which seems to small to account for all profits. Even if you assume that some companies pay 0% out and reinvest it, I’d kind of assume that this would end up being represented in the current average, since companies who did the same thing in the past would be paying out the higer returns due to those past investments now (err…hope that makes sense).
Longhorn suggests that the difference is in the other ways companies pay out their profits (stock by backs, etc). This seems like it might be some of the difference, but it seems like it would be to erriatic and hard to predict for it to account for all of the missing value.
I’m still holding by my theory from post #21, which I think Wack-a-Mole is coming around to now as well:
Actually, most of the people I know who have really made a lot of money in stocks did it this way. The company was bought out, the purchaser paid a lot for the outstanding shares, and the previous shareholders got rich.
It happens more often than you might think.
Well, sure a company’s stock has
#1 a rock bottom value (liquidation value)
#2 a value to a future buyer
But highlighting #2 in some ways is academic don’t you think?
For example, we could apply the same thing to a piece of land.
I buy a piece of land in San Francisco. I think it’s worth something. I could sell it to someone else in the future. Or I could pass it on to my children and they could sell it. There’s always some expectation of “future” events built into the motivation of acquiring that land. But… that’s not ultimately true. Our sun will become a red giant in 5 billion years and boil away the oceans and possibly engulf the entire planet. So that means that owning land is not really “turtles all the way down.” The last “sucker” who bought the land before the red Giant sun, or San Francisco magnitude 8.0 earthquake, or asteroid impact, or nuclear war fallout is left holding the bag. Therefore, we must conclude that owning land is irrational or a scam or both.
What I’m saying is that at some point someone will buy the company not just to later sell the stock to someone else, but in order to actually gain control of the company itself, the assets it owns and the profits it generates, so they can do something with it. Either liquidate it corporate raider style, just own the company privately and pocket the profits, use it to enhance something they already own (“synergy!!”), etc. Analogous in your example to someone who isn’t buying the proerty in San Fran just to pass on or sell, but to build a house on, or use in some other way then just selling it unimproved to another speculator.
So even though I, as a small time investor with a 1% share will never be able to do anything meaningful with the company, It’s increases in value with the net worth of the company not because I can sell it to someone else who wants a 1% share (they won’t be able to do anything with it either), but because I can sell it to someone who is trying to buy a lot of 1% shares and get a controling stake in the company, which is an actual useful thing to have.
Of course in reality, most of the time, I actually do sell it to another small-time investor. But at some point down the line there’s the expectation that someone will actually want the share in order to actually be able to accumulate enough ownership to do something with the company, rather then keep passing it up the chain.
Is the issue that you feel as if you own something you can’t play with? As a 1% owner (or more likely a 0.00001% owner) of Microsoft, you can’t walk into the Redmond campus and sit in on decision-making meetings. Or when you see the year end statement saying they earned $0.10/share and you only received, in cash, $0.02/share, you can’t go to Microsoft’s bank and take out the remaining $0.08?
There does not have to be the expectation that someone will buy the company. There only needs to be the expectation that the value of the company will grow over time, at a rate greater to you can earn in another investment with equivalent risk, to warrant buying stock (ignoring diversification and other factors that go into building a portfolio). That is why investors buy stock, and when the company fails to meet expectations, that is when people lose money on stock.
You really think that the possibility that someone will buy out Exxon or IBM has a meaningful impact in their share prices? A buyout is just a forced sale. There is usually a premium relative to the price when the buyout is announced, but not from other times. I know a lot of people whose company IPOed at 10. They recently were bought around 1, after sitting down there for years. Sometimes the price set at a buyout is a firesale price. I don’t think WaMu stockholders did particularly well.
That’s not to say that this sometimes doesn’t play a role. The model for CAD startups is for them to be bought by a major player after the technology is proven but before they have a major revenue stream, and often before they go public. In that case the prospect of being bought out does to a certain extent control the value of the share prices, even if the company does go public. But this isn’t all that common.
The value to the SELLER is what the buyers pay. If that sale price is high because the buyer didn’t peg the price to some valuation model, there price could be out-of-wack and into bubble territory.
The liquidation value of a company can be a basis for estimating its value, but it works better for companies that can be liquidated (ones with tangible assets that can be sold) rather than service-type companies, which have little liquidation value.
I own some shares of a small privately traded bank – there are too few stockholders to trade publicly, so if you want to sell shares, you call the bank and they’ll let the other stockholders know there are some for sale(!). I don’t think they are expanding much, so I think profits go out as dividends. I think the dividend last year was 4 or 5 % of the stock value.
That’s pretty high, but on the other hand the stock probably won’t appreciate much.
When there’s profitability but low dividends, you should in general find appreciating stock price. I think historical stock market gains are ~8% (depends on how measured) including dividends. The 2.5% dividend rate is probably current, but if we do the apples/oranges comparison anyway, the avg price appreciation is 5.5% and the dividend 2.5%. Growth companies will have higher appreciation and lower dividend, and stable companies should have higher dividends and lower appreciation.
But this whole dividend model is very simplistic. As presented, it won’t help determine if a stock is reasonably priced or not. I just presented it to show a way of looking at valuations that can show inherent value even when there are no dividends, so a stock usually isn’t a Ponzi scheme.
“Momentum” stocks where price seems to have no link to profitability can be Ponzi-ish.
But you can’t give the stock back to the company and cash in for $1000. You can never directly have the share of the value the stock is worth. So it seems like it may as well be theoretical monopoly money.
Thanks for the explanation, and this makes sense. However, this doesn’t seem to be a large factor in the way people profit from the stock market - as has been discussed in the thread, this is only a few percent of the value of owning stocks.
To demonstrate my confusion, let me create a fake conversation between a business and a prospective investor. For simplicity’s sake, let’s say it’s a non-dividend bearing stock.
“I’m confident our company will grow if we can get more capital to expand our business. I am willing to sell you 5% of our company in exchange for X dollars”
“Okay, so does this mean I get 5% of the company’s profits?”
“Well, no.”
“Can I cash in the stock with the company at some point to get back my money plus a fraction of whatever profit it helped make?”
“No, you can’t cash it in with us”
“Then how is it that I benefit from owning a fraction of the business?”
“If our company does grow successfully, you can sell the stock for more than you bought it for on the open market.”
“But then how is the person I’m selling it to benefitting? He’s not able to get a fraction of the profits or cash it in either, right? So why would he buy it from me?”
“Well, he hopes that some day he can sell it for even more than he bought it from you”
“So then the third guy gets it with the intent to selling it to a 4th guy? We’re just passing money around between us, but no one is able to actually getting money from the company as a return on their investment, right? The only profit comes from being able to convince someone else that holding onto this piece of paper is somehow a good idea, because everyone thinks it’s a good idea, right?”
And that’s where I’m baffled. Essentially that stocks are worth something because you may be able to sell it one day to another guy who has the idea that stocks are worth something, because he in turn intends to try to find a guy who agrees that the stocks are worth something…
The stock market would make perfect sense to me if the percentage of the companies profits were distributed in accordance with the percentage of stock you own. That seems somewhat related to dividends, but as I mentioned earlier, dividends don’t seem to be a big part of the profit relating to the stock market, and at the percentages quoted in the thread it seems you’d be better off putting it in a savings account versus dividends if you didn’t otherwise expect to be able to sell it for more later.
The stock market would also make perfect sense to me if you bought stock for $1000 from a company, and a year later they’d grown by 20%, and you were able to take it to them and cash it in for $1200.
But the actual system, where most of the profit derives from being able to pass the stock off to the next guy who in turn tries to pass it off to the next guy seems like a bizarre game to me.
You’re neglecting to point out any reason for the value of the stock to track with the value of the company, at the same time as attempting to discredit one of the few possible reasons why it should.
At any rate, the point of this thread is much more about what wild-eyed modifications could be made to make stock better track with the value of the company than about how stock works to begin with. The current recession, I think, proves that this is a goal that hasn’t yet been achieved. The market shrank by far more than made any sort of sense for what actual financial losses could be foreseen.
Occasionally, you can sell back to the company, but from your standpoint it’s not unlike another person buying your stock from you.
It might help to think not of buying 5% of a company, but >50%. You’re now the majority owner of a small company. The management recommends that you use the profits to invest in the company rather than give out a dividend.
Now you’ve got a choice – get a dividend, or reinvest. In the first case, you end up with stock worth the same as you bought it for (or around there) plus some cash. In the second case, if the investments pay off, the stock is worth more. Either way your net worth is higher, but one is due to cash, the other higher stock value.
Because there’s always this option of a dividend, there is a basis for stock appreciation. If the company is more profitable, it will have more cash available for a dividend, so the value goes up. If it invests this cash, the future profitability likely goes up, which can be turned into a dividend, so the value goes up.
In this way, it’s a bit like a savings account. When you get interest, you can keep it in the account to grow it, or you can extract it for cash.
Most people aren’t majority shareholders 
so you will only have indirect votes about dividends. Investors looking for cash payments have gravitated over time toward corporate bonds, gov’t bonds, etc., leaving more “growth” investors in the stock market, reducing demand for dividends.
This may lead to what you’re asking. What about a company like pets.com? The investors never got a dividend, so what was the point of owning? I doubt few who bought pets.com thought they’d pay dividends. So for them, where was the value of the stock? Those people weren’t really INVESTORS, but SPECULATORS.
But what percent of stocks are held by speculators rather than investors, and how much does that add (or subtract) from the price of stocks? How much volatility does that add to the market? I don’t know.
Even with speculation, there still is the fundamental idea that profits CAN be distributed. This gives stocks more of a fundamental value than artwork or classic cars, which are purely speculative (unless you are able to profit off of them while owning, like selling tickets to see them).
No, because if a stock is that undervalued, you can buy up all the shares, own and then liquidate the company, and make a tidy profit - or you can sell your stock to the investment group who is going to do the same thing. Such a situation will not be allowed to exist for very long.
That’s not exactly true. Remember, the market is forward looking. So unless companies would quickly go back to pre-2007 earnings (unlikely), the assumptions for pricing needed to change. Also, risk assumptions changed. Traders (finally) realized that the P/E ratios at which the stocks were trading were out of whack, and traders/portfolio managers decided to take on less risk*, driving prices down. You had two drastic changes (decreased future outlook, less risk) exerting downward pressure market-wide. Stocks don’t price on what happened yesterday or is happening today. Stocks price on what is predicted to happen tomorrow, the next quarter, the next year, and the next five years.
*My theory is that after losing so much, many companies decided to give the risk departments some teeth to reign in PM excesses.
I actually was offered a buyback from Fisher Scientific (back when they were still Fisher Scientific and not part of ThermoFisher) in 2004. I didn’t do it and eventually sold the shares on the open market.
I’m hoping to make at least a little money in a single stock with where I work now. They offer a stock purchase plan where you get the lower of the two prices of the offering period (first trading day in January to last day in June or first day in July to last in December) at a 15% discount. So instead of $200 getting 20 shares at $10/share, I’d get 23 shares at $8.50/share (whole shares only in this plan.) Hold on to the shares long enough and you don’t have to report ordinary income from the discount and cap gains but just cap gains. As far as I’m concerned, the stock won’t have to gain much for me to make a decent profit on it, even after taxes, thanks to that built-in discount.
True, people draw their money from stocks at the same time as they, allover, are heading into a time period of savings–which is detrimental to the market.
But the problem is the positive feedback mechanism. People end up hunkering down for such a long winter because they know that other people are going to be doing the same. Their prediction is right, and they are making the right fiscal move based on the future, but that future happened for stupid reasons. Everyone knew that everyone was going to over-react, and hence they had to over-react as well.
What do you think it means to “pocket the profits”? It means paying a dividend with the company profits rather than reinvesting the profits.
If you’re the sole owner of the business, then you make the decision yourself and get all the dividends. If you’re a shareholder in a business, then all shareholders make the decision collectively, and the dividends are shared. For very large corporations, this shareholder decision is delegated to a board of directors that are elected by the shareholders. But the decision still belongs to the shareholders. However, if you only own a tiny fraction of the company your wishes are only going to count for a tiny amount. But if you’re a very big shareholder you can effectively control the company even if you don’t own 50.0001% of the company.
But see above, the dividends that companies pay out per share, on average, appear to be a very small part of their profits per share. Presumably the rest is reinvested in the company. If I were the sole owner of the company, the reason for doing this is obvious, if I grow the company it will pull in more profits later and my reinvestment will end up netting me more money in profits then if I’d just pocketed it earlier. But from the (vaguely) quantitative arguments above, it appears this may never happen if you’re a small stock holder. You (or who ever you sell the stock to), will not see a return on the reinvestment in the form of dividends ever. So why buy the stock in the first place?
Of course, I could be wrong, over the lifetime of a company it may return all its profits in dividends (or stock buybacks or whatever), since the arguments above are pretty hand-wavy, so if you have evidence that that’s the case, I’d certainly be interested.
Perhaps part of the difficulty is people understanding why Person B would want to buy when Person A is selling.
I think (though I could be wrong) that some people are thinking in terms of single stock portfolios. In this case, you are probably probably better off than just going to Vegas and betting black. Most knowledgable investors, both amateur and professional, think in terms of portfolios. They think in terms of overall risk in addition to single holding risk. As the investors needs change, so should his portfolio change.
For example, a 25 year old single investor can afford larger amounts of risk than a 32 year old investor with a mortgage and a kid. The 32 y.o. can afford more risk than a 45 y.o. with kids in college and retirement on the horizon. The 45 y.o. can afford more risk than the 60 y.o. with retirement around the corner. The 32 y.o. will look at his portfolio and pick out potentially high return securities because their risk profile is different than his risk profile. They are no longer good investments for him and he needs to reduce his exposure (either completely or partially), regardless of the securities past performance and projected future performance. This does not mean that it is a bad investment, and it may be perfectly aligned with the 25 y.o.'s investment goals, making it a good buy for him.
Investing in securities is not a zero-sum game. People invest in stock because they reasonably expect, over the investment horizon, to earn a greater return than they would in other investment opportunities with similar characteristics. Because risk and return are reversely correlated, the purchaser of a stock knowingly takes on a greater amount of risk for the opportunity for a greater return. Unlike the sole proprietor, it is easier to take your money out of the company, because the market prices companies (mostly) efficiently and provides a highly liquid forum for cashing out or buying in. That includes not just your portion of profits, but also your portion of the capital assets, goodwill, operating assets, liabilities, et al.
ETA: A company should never, ever return 100% of its profits to the investors, because they would basically that there is no more room for growth and there is no more reason to invest in the company.