OK, I’ve been trying to figure this out for years. Why does stock have value? On the surface, it’s because other people are willing to give you money for it (and, yes, I know you’re buying a tiny part of the company), but what good is it to them? I can understand that in certain situations (for example, if a company is being bought out by another) the stock is worth money because the company that’s taking over it needs to buy out all the stock, but those situations are few and far between (and if you look at a company like Microsoft or GM, that company would have to drop way in value before it could be considered a takeover target). And dividends aren’t really a consideration; most companies pay low or no dividends, and the ones that pay dividends of any consideration are mostly utility companies whose market cap increases very slowly…
You buy stock with the expectation that it will appreciate and you will be able to sell it for more and make a profit.
Yes, you cannot eat stocks but if you own stocks (like if you own diamonds or paper money) you can get other things you want like food, shelter and pussy. And that is, in summary, why stocks have value.
The value of any stock is the present value (PV) of all future cash flows plus the PV of future growth opportunities (PVGO). Theoretically, anyway, a stock that is trading for 20 means that per share, the PV of all future that company will earn (plus what it will eran by growing) is $20.
This is a nice theory, but how does it work really? You can’t really predict future cash flows beyond a few years (at most) and PVGO is even less tangible. This is kind of circular reasoning as any value left in the stock after calcing the cash flows is assumed to be PVGO.
Some (in fact many) stocks DO pay a dividend. Most big companies do (GM, Ford, Merck, etc). These stocks are then easier to price, as most big companies have fairly stable EBITDA levels. Their market cap does increase (as well as decrease usually) slower because they choose to return proceeds to investors rather than ram it back into the company to fuel growth.
Smaller companies prices are largely or entirely based on PVGO. That is, you are assuming the company will grow considerably and earn real $$ at some point. Penny stocks are little better than lottery ticket bets on some big event happeneing.
Hope this helps somewhat. A note though, I’m only about ½ way through my MBA, so I haven’t hit the REAL advanced finance yet.
The value of any stock is the present value (PV) of all future cash flows plus the PV of future growth opportunities (PVGO). Theoretically, anyway, a stock that is trading for 20 means that per share, the PV of all future that company will earn (plus what it will eran by growing) is $20.
This is a nice theory, but how does it work really? You can’t really predict future cash flows beyond a few years (at most) and PVGO is even less tangible. This is kind of circular reasoning as any value left in the stock after calcing the cash flows is assumed to be PVGO.
Some (in fact many) stocks DO pay a dividend. Most big companies do (GM, Ford, Merck, etc). These stocks are then easier to price, as most big companies have fairly stable EBITDA levels. Their market cap does increase (as well as decrease usually) slower because they choose to return proceeds to investors rather than ram it back into the company to fuel growth.
Smaller companies prices are largely or entirely based on PVGO. That is, you are assuming the company will grow considerably and earn real $$ at some point. Penny stocks are little better than lottery ticket bets on some big event happeneing.
Hope this helps somewhat. A note though, I’m only about ½ way through my MBA, so I haven’t hit the REAL advanced finance yet. I’m sure someone will be by shortly to correct any misstatements.
The value of any stock is the present value (PV) of all future cash flows plus the PV of future growth opportunities (PVGO). Theoretically, anyway, a stock that is trading for 20 means that per share, the PV of all future that company will earn (plus what it will eran by growing) is $20.
This is a nice theory, but how does it work really? You can’t really predict future cash flows beyond a few years (at most) and PVGO is even less tangible. This is kind of circular reasoning as any value left in the stock after calcing the cash flows is assumed to be PVGO.
Some (in fact many) stocks DO pay a dividend. Most big companies do (GM, Ford, Merck, etc). These stocks are then easier to price, as most big companies have fairly stable EBITDA levels. Their market cap does increase (as well as decrease usually) slower because they choose to return proceeds to investors rather than ram it back into the company to fuel growth.
Smaller companies prices are largely or entirely based on PVGO. That is, you are assuming the company will grow considerably and earn real $$ at some point. Penny stocks are little better than lottery ticket bets on some big event happeneing.
Hope this helps somewhat. A note though, I’m only about ½ way through my MBA, so I haven’t hit the REAL advanced finance yet. I’m sure someone will be by shortly to correct any misstatements.
Mods, cleanup on aisle 3
Jeeeeez, sorry about the multiposts. My connection is REALLY slow today and looked like it had crashed. A couple o’ “Stop. Resubmit”'s later and you get the mess you see above.
Cripes, I’m going back to bed.
Yes, I know all that (in fact, I’ve worked in the securities industry for 10 years, although in the technology area). But what I’m asking is, what is the intrinsic value of a stock? As an IBM shareholder, what do I (or institutional investors) care what their quarterly revenues were, other than the fact that it makes the value of the shares increase? Why does the value of my shares increase? OK, I can now exchange the shares for more money; it’s not like I can go to Armonk and say “give me my .0000001% of the company”…
The value is entirely in the fact that you own a piece of the company. Since your share of IBM is miniscule as a percentage of the whole, it’s tough to visualize. Think though of a small company that you own 50% of. Then, it is easy to see why your stock is worth money, you own half of business X, and are entitled to half of all the money it makes.
Same with stock, but your share is much smaller. If you own 1 billionth of IBM and IBM is worth $120 Billion, someone will pay you $120 for your share. You also have an interest if IBM suddenly becomes worth $200B, your share is now worth $200 instead of the $120 you paid.
The way the corporation is run, and the decisions it makes contributes to its future worth. That’s why you would also have the opportunity to vote on who runs your company, the Proxy vote, they do it every year.
A great deal of press makes the stock market seem like gambling, and it is for a lot of people. The dot-com rise and fall was from people hoping to get a proportionally big share of a company that would someday become an IBM or Microsoft, and get fabulously wealthy as a result. It didn’t exactly work out perfectly, though.
The biggest crapshoot of stock is that the value of the company is defined by what the free market (other traders) believes it to be. If other traders don’t think the stock is worth diddly, you won’t sell it for much at all, even if you think it’s very valuable. The Present Value of cash flow is the standard way to make the calculation, but estimating the CF and appropriate discount rate is an art, not a science, and there’s lots of variations between people.
Damn, I’m rambling, let me know if this makes sense.
You own a percentage of the company, just as if you’d formed a partnership with people and bought a company together. The value of your stock is based on the value of the assets (less liabilities) that the company owns, plus whatever potential there is for earnings in the future. Obviously, the company isn’t going to liquidate everything and pay you back the value of your percentage ownership (unless it goes out of business), but you still have that value backing your shares, and the potential for such a liquidation, if it was called for, and someone buying your stock will gain that same value. The fact that the earnings aren’t all paid out to the owners just means that it is reinvested in a higher value of fixed assets, inventories, cash and securities, etc., that are again subject to the possibility, unlikely as it is, of conversion to a cash payout to you.
Some stocks do pay a bigger dividend (i.e. utlities). Others would rather put money into growing the company and raise the per-share price.
You are really buying a piece of a company so that has value.
I should add, what’s know as the “book value” of the stock is basically the asset minus liabilities divided by the number of shares outstanding. That’s a very rough definition. In other words, what your share would be worth if the company were liquidated today. Obviously, it won’t be exact, because the assets may be over or under valued on the books, and won’t get as much when they’re sold off. And there are other miscellaneous stuff in the equities section of the balance sheet that throw this off. But basically. And like cheesesteak said, the market value has very little relationship to book value, it’s entirely based on speculation: what’s going to happen in the future to the company regarding earnings, do i consider the assets to be valued fairly on the balance sheet, what are other companies in the industry doing, what other investment opportunities are there, etc.
I hate to nitpick at this, but I’m afraid that somebody might go away thinking this means that you are entitled to half of the companies revenues, or assets, or gross profits, or something. It means only that you’re entitled to half of what’s in the shareholder’s equity account, i.e., the company’s net worth, assuming it’s accurate.