Is the Stock Market a Positive-Sum Game or a Ponzi Scheme?

[enosis_]

You seem to be saying the stock prices drops because the company has disbursed cash. That isn't why the price drops.

There are many variables that impact stock prices. A few of those variables include earnings, growth, competition, return ratios, contract negotiations, legislation, litigation, regulation, and audit results.

 

[nitsuj]

There are many variables that impact stock prices. A few of those variables include earnings, growth, competition, return ratios, contract negotiations, legislation, litigation, regulation, and audit results.

exactly!

 

[BWV]

You seem to be saying the stock prices drops because the company has disbursed cash. That isn't why the price drops.

in the case of ex-dividend dates the cash payout is precisely why the price drops.

an important concept in securities pricing that has not been directly addressed here is arbitrage. If stock prices did not react to going ex-dividend, then one could build a strategy of purchasing stocks right before the ex-date and then selling them, pocketing a quarter's dividend with only one day of exposure to the stock price. This is an arbitrage that should not exist in a competitive market, and indeed, it does not exist.

 

[russ_watters]

What is the issue of stock value?

The issue is if the assets of the company have a direct impact on stock price. The example is a clear demonstration of the fact that they do.

You seem to be saying the stock prices drops because the company has disbursed cash. That isn't why the price drops.

Well don't keep us in suspense! Tell us what you think the correct answer is (and prove it, of course).

 

[enosis_]

As an example, let's say that in an IPO, an investor X buys all the shares, let's say 10, for $10 each (in the primary market). He spent $100, and those $100 went to the company. Next, there appears a bid of 10 shares (now at the secondary market) at $11. The investor X sells all his 10 shares to that bidder Y. Now the investor X has a profit of $10. Now let's say there's a bid for 10 shares at $12. The investor Y sells his 10 shares and made a profit of $10. For this to continue indefinitely there always need to be more money to be invested. If there weren't any other bidder, the shares wouldn't have any value and the last buyer would lose an amount of money equivalent to what the others won, making it a zero-sum game.

So is the stock market just an elaborate Ponzi scheme? Or it's a positive-sum game (excluding fees)? Excluding dividends of course.

I think it's important to go back to the start with this thread and point out the example of one person owning all of the shares is incorrect. IPO stands for initial public offering. The purpose is to distribute the stock widely. In the example, a single entity owns 100% of the shares and through selection of a board of directors - absolute control of the company. In this scenario, the investor would be able to make decisions and excercise control over the management of the company not normally available to a common shareholder. The description given is not of a public corporation - but of a privately held corporation.

 

[Barakn]

No, it wasn't important to point that out. Simply change the wording to read " an investor X buys some shares, let's say 10, for $10 each" and the question at the end remains relevant.

 

[enosis_]

No, it wasn't important to point that out. Simply change the wording to read " an investor X buys some shares, let's say 10, for $10 each" and the question at the end remains relevant.

The OP clearly describes a scenario where a single entity owns all of the shares.

 

[nitsuj]

The issue is if the assets of the company have a direct impact on stock price. The example is a clear demonstration of the fact that they do. Well don't keep us in suspense! Tell us what you think the correct answer is (and prove it, of course).

Shure I'll tell you what I think it is. Sorry I don't have a magazine article to link to.

Time value of money... that's all.

As has already been said in this thread, there are many many variables that impact a stocks price...like a tragic incident involving a companies product that raises moral issues in holding stock in said company. Or threat of legislation limiting salable goods.

I wouldn't restate that as moral issues have a direct impact on a stocks price, or tragic incidents have a direct impact of a stocks price.

Russ, generally speaking, assets are reflected in a stocks price. But like I said before that's the starting point. you know as well as I many factors impact a stocks price. The tech bubble is a good example of improper valuations, straying too far from a strict hard/real asset valuation, placing too much "weight" on environmental factors.

I have no idea how a company is valued (IPO), but like I said before it is not Assets - liabilities = equity / number of shares. (to be clear it is specifically the defining of what constitutes an "asset" or "liability". as in above environmental factors could be considered an asset/liability.

Here is a case, an Audio equipment manufacturer the branded Harman Kardon goods.
Was to be bought in entirety in 2007 by Goldman Sacs & KKR and taken off the securities market.

Deal fell through, and stocks went with it to the tune of 24%. Of course Harman Industries hadn't lost any assets. Second, the got a new CEO who brought the company form single digit growth to double digit growth...the stock doubled...all with in a year...do you think their assets doubled?

Or does it make more sense that stock holders thought Goldman & KKR saw something dire in the business model and subsequently pulled out. Then after the panicked selling subsided (24% drop in Stock price) and the company actually improved performance, in turn increasing demand for the stock, increasing the price of the stock beyond a hard/real asset valuation.

Does that counter your "...clear demonstration of the fact that they do." [stock price is directly related to a companies assets]

in any case I find it silly to "debate" this at this point.All that said, nothing stops you from valuating a stock as (assets - liabilities) / number of shares.

What I am saying is a stocks price is a market valuation with little to no regard to the IPO stock price beyond it being a starting point, you're saying it is a fundamental valuation of a company.

 

[nitsuj]

in the case of ex-dividend dates the cash payout is precisely why the price drops.

an important concept in securities pricing that has not been directly addressed here is arbitrage. If stock prices did not react to going ex-dividend, then one could build a strategy of purchasing stocks right before the ex-date and then selling them, pocketing a quarter's dividend with only one day of exposure to the stock price. This is an arbitrage that should not exist in a competitive market, and indeed, it does not exist.

I agree it is the event of cash disbursement for why the stock price will drop after a dividend payout.

However the Stock price doesn't change to reflect the decrease in assets. It is literal in this case...it is simply because the dividend has just been paid out and the next one is sometime in the future.

To word it different I could say the stock price drops because it is the farthest date from the next (precedence of dividends) dividend disbursement.

 

[russ_watters]

Time value of money... that's all.

That's a word, not a definition. We're discussing here why the stock price increases, not just stating the fact that it does.

As has already been said in this thread, there are many many variables that impact a stocks price...

Yes, so I'm really not sure why you keep bringing up the short term fluctuations. They aren't relevant to this thread except as being part of the misunderstanding that the OP has: The fact that short term fluctuations are not necessarily value based is confusing the OP into thinking that there is no value base whatsoever.

Does that counter your "...clear demonstration of the fact that they do." [stock price is directly related to a companies assets]

No.

What I am saying is a stocks price is a market valuation with little to no regard to the IPO stock price beyond it being a starting point, you're saying it is a fundamental valuation of a company.

I'm not sure what the IPO price has to do with anything. It's history once the company goes public. People don't even remember it. No, once the IPO is over, the IPO price doesn't have much to do with it. And I never said it did. I just said before the IPO, they try to set an IPO price based in large part on what they think the value of the company is.

Perhaps the issue here might be you're seeing/setting up a false dichotomy between me and the OP. The opposite of the OP saying stocks aren't based at all on value is not that they are based entirely on value. Don't make the mistake of thinking that I'm saying the true value of the company is the only thing that goes into setting the price. I've been very clear that that's only a long-term generality, not a day-to-day reality.

 

[russ_watters]

I agree it is the event of cash disbursement for why the stock price will drop after a dividend payout.

However the Stock price doesn't change to reflect the decrease in assets. It is literal in this case...it is simply because the dividend has just been paid out and the next one is sometime in the future.

To word it different I could say the stock price drops because it is the farthest date from the next (precedence of dividends) dividend disbursement.

None of that disagrees with the stated reasoning by the example other than just a word-play or re-stating the obvious. It's like saying my bank account doesn't have less value the day before payday, it just appears that way because it happens to be the day before payday.

No: the stock price drops because it is reflecting the decrease in assets of the company. The fact that that day is also the furthest from the next disbursement is just another way of saying the same thing.

There's no substance to any of that. It almost sounds like you are just disagreeing to disagree!

 

[nitsuj]

Don't make the mistake of thinking that I'm saying the true value of the company is the only thing that goes into setting the price. I've been very clear that that's only a long-term generality, not a day-to-day reality.

! In setting an IPO, I feel it is fair to say that it is a representation of the actual value of the company ( and am sure it includes more than just real assets / liabilities).

There is no connection between the assets of a company and the "asset" that a stock holding would be, this is unlike a bond or similar debt.

If I set up a company that is a bar of gold, I contributed that capital and then when public (yea idealizing here) and you buy the stock you are NOT entitled to the bar of gold. It is still owned by the company, it's in the corporate bylaws which also say your stock merely entitles you to a vote of who makes decisions for the company...not what the decisions are. Such as liquidate company and send cheque to shareholders.

There will always be a disconnect between a companies assets and the (voting) stock, whether it be corporate bylaws or legislated ones.

The intrinsic value of common stock is faith/belief/foresight ect, not said company's balance sheet. There is no "gold standard" for common stock values.

That is to say there is no claim for common stock holders in a companies assets.

 

[nitsuj]

None of that disagrees with the stated reasoning by the example other than just a word-play or re-stating the obvious. It's like saying my bank account doesn't have less value the day before payday, it just appears that way because it happens to be the day before payday.

No: the stock price drops because it is reflecting the decrease in assets of the company. The fact that that day is also the furthest from the next disbursement is just another way of saying the same thing.

There's no substance to any of that. It almost sounds like you are just disagreeing to disagree!

One point of view strongly implies there is a direct connection between stock value and the companies assets.

There other point of view strongly implies the stocks value is a direct connection to market valuation + TMV. That is a HUGE difference perspectives.

 

[Tosh5457]

As I see it, this will only be settled when we define the game mathematically. So we need to define:
- the possible events of the game
- the players of the game
- utility function (a function that assigns a real value to each event that can happen in the game)

The only possible events are trades between 2 players, and the players are obviously defined as the speculators in the stock market.

Defining the utility function as the profit, in money, of the investors in a given trade, it'll be a zero-sum game. Each transaction is zero-sum, and since the secondary market is just made of transactions, it follows that the game is zero-sum. Agree? If you don't agree, please give a counter-example that proves me wrong.
It'll be a constant-sum game if we define the utility function as the balances (zero-sum for the variations of balances).

You could argue that that defining the utility function like that doesn't make sense. In the real economy for example, it wouldn't make sense, because what is really useful there is the production (whether people are getting products or not), not money.
In the stock market, maybe we could define the utility function of a given trade between 2 traders as the profit/loss in regards to the fundamental value of the stock. In that sense, it would be zero-sum in relation to the fundamental value. But because the fundamental value grows over time and it's obvious to see that everyone can win in this game, defining the utility function by taking time into account (for example, the profit/loss over 1 year), it would be clearly a positive-sum game. But does it make sense to define the utility function like that? Whether the corporations grow or not, in reality the stock holders don't benefit anything from it. Unlike the case in the real economy, where more production means people get more products, a growth in the companies don't benefit the stockholders in any way.

So IMO the only reasonable way to define the utility function is using money, because that's ultimately what's "useful" for the traders. In the real economy the products are what's useful. In a hunting game for example, what's useful are the meat you can get. In the stock market, the only useful thing you'll get is money. And if you define the utility function by the profit/loss of money, it's indeed a zero-sum game.

 

[BWV]

this has been settled repeatedly then you keep trying to raise the dead horse. Yes, trading stocks is a constant sum game - the constant sum being the aggregate return of the stock market. Investing in the aggregate stock market is not a zero sum game because it tracks growth in the real economy (through dividends, no-arbitrage assumptions and all the other mechanisms discussed here). If the real economy is not a zero sum game then the aggregate stock market is not

 

[russ_watters]

Right: the growth happens BETWEEN the transactions. Those are the "events" Tosh doesn't want to consider.

 

[enosis_]

Sometimes a stock's market price has very little to do with assets or the balance sheet. The price to earnings ratio is summarized in the following link.

http://www.investopedia.com/terms/p/price-earningsratio.asp#axzz2HQQGw3UB

"The P/E is sometimes referred to as the "multiple", because it shows how much investors are willing to pay per dollar of earnings. If a company were currently trading at a multiple (P/E) of 20, the interpretation is that an investor is willing to pay $20 for $1 of current earnings."

 

[russ_watters]

Ugh, I didn't see this before:

If I set up a company that is a bar of gold, I contributed that capital and then when public (yea idealizing here) and you buy the stock you are NOT entitled to the bar of gold. It is still owned by the company, it's in the corporate bylaws which also say your stock merely entitles you to a vote of who makes decisions for the company...not what the decisions are. Such as liquidate company and send cheque to shareholders.

As I said to Tosh several pages ago, don't let the complexity added by multiple owners confuse you into thinking the definition of "ownership" changes. It doesn't. The stockholders own the company. So "The company owns" is still synonymous with "the stockholders own".

And incidentally, since you were non-specific and you worded it badly, the case you described was for one shareholder: You set up the company and sold the entire company to me, making me the sole owner of the bar of gold. But since I know you meant there are multiple shareholders...it is still wrong. The bylaws may or may not include direct voting on policy. If the voting is direct, all you have to do is convince 50%+1 shareholders to vote with you. If the voting is indirect, you just have to do the same except electing a representative who will do what you want.

The fact that it is cumbersome for stockholders to make major changes in large companies and doesn't happen often does not change the status of stockholders.

In any case, this was already discussed in detail and I have rehashed more than I really wanted to. For fuller treatment, read back a couple of pages.

 

[russ_watters]

Sometimes a stock's market price has very little to do with assets or the balance sheet. The price to earnings ratio is summarized in the following link.

http://www.investopedia.com/terms/p/price-earningsratio.asp#axzz2HQQGw3UB

"The P/E is sometimes referred to as the "multiple", because it shows how much investors are willing to pay per dollar of earnings. If a company were currently trading at a multiple (P/E) of 20, the interpretation is that an investor is willing to pay $20 for $1 of current earnings."

"Sometimes"

But over the long term, the average P/E ratio of the market stays within a relatively small range.

 

[enosis_]

"Sometimes"

But over the long term, the average P/E ratio of the market stays within a relatively small range.

I agree - but as link indicates - it varies by industry. The fun starts when a company has negative earnings (a loss) but still maintains an industry multiple.

 

[BWV]

I agree - but as link indicates - it varies by industry. The fun starts when a company has negative earnings (a loss) but still maintains an industry multiple.

Multiple of what? Not of earnings obviously

Investors are smart enough to discern that a company currently losing money may not do so in the future and price the stock accordingly

 

[russ_watters]

I agree - but as link indicates - it varies by industry.

As well it should. Growth industries will have higher P/E ratios than stable industries because they are growing faster. So tomorrow's predicted earnings are expected to be much higher than today's. Basically, the earnings are expected to "catch-up" to the P/E ratio.

 

[enosis_]

As well it should. Growth industries will have higher P/E ratios than stable industries because they are growing faster. So tomorrow's predicted earnings are expected to be much higher than today's. Basically, the earnings are expected to "catch-up" to the P/E ratio.

Yep - except for those situations when they don't.

 

[russ_watters]

Yep - except for those situations when they don't.

Sure -- it's a prediction. Sometimes predictions don't pan out.

 

[nitsuj]

And incidentally, since you were non-specific and you worded it badly, the case you described was for one shareholder: You set up the company and sold the entire company to me, making me the sole owner of the bar of gold. But since I know you meant there are multiple shareholders...it is still wrong. The bylaws may or may not include direct voting on policy. If the voting is direct, all you have to do is convince 50%+1 shareholders to vote with you. If the voting is indirect, you just have to do the same except electing a representative who will do what you want.

It was really poorly worded, even to say I sold the company to you doesn't makes sense. I'll refine it more, just need to review the accounting.

 

[Tosh5457]

Right: the growth happens BETWEEN the transactions. Those are the "events" Tosh doesn't want to consider.

Russ, please use the game theory formulation, it simpler to discuss it. Yes, that happens, and what that means is that more players will come into the game (more capital to be invested). That doesn't change the nature of the game, like more players coming to a poker cash game table doesn't change the fact that poker is a zero-sum game (excluding house commissions).

You don't accept the fact that the company growing doesn't give the stockholders any direct benefit. The only benefit they'll have, in average, will be to see their stock rise in price because of others investors expectations rising. But a game just made of transactions will always be zero-sum. It doesn't even matter if the stockholders have the power to change something in the company or not, if they're not getting any of the profits companies get, they can only show a profit by selling their stock in the secondary market. And again, that's just made of transactions, it's zero-sum.

Anyway, I still haven't understand something. Russ, are you trying to say the stock-market isn't a zero-sum game in respect to the profits of the stockholders, or are you saying that only analyzing profits doesn't make sense, and something is missing?

 

[BWV]

Russ, please use the game theory formulation, it simpler to discuss it. Yes, that happens, and what that means is that more players will come into the game (more capital to be invested). That doesn't change the nature of the game, like more players coming to a poker cash game table doesn't change the fact that poker is a zero-sum game (excluding house commissions).

So what do the aggregate real (i.e. net of inflation) gains and losses of all poker players since 1950 years sum to?

A. zero

what do the aggregate real gains and losses of all stock traders (gross of taxes and transaction costs) sum to?

A. a 5844.180% return (http://dqydj.net/sp-500-return-calculator/) including dividends. The price gain alone is about $12 trillion in current dollars

so tell me again how both are zero sum games?

 

[enosis_]

Russ, please use the game theory formulation, it simpler to discuss it. Yes, that happens, and what that means is that more players will come into the game (more capital to be invested). That doesn't change the nature of the game, like more players coming to a poker cash game table doesn't change the fact that poker is a zero-sum game (excluding house commissions).

You don't accept the fact that the company growing doesn't give the stockholders any direct benefit. The only benefit they'll have, in average, will be to see their stock rise in price because of others investors expectations rising. But a game just made of transactions will always be zero-sum. It doesn't even matter if the stockholders have the power to change something in the company or not, if they're not getting any of the profits companies get, they can only show a profit by selling their stock in the secondary market. And again, that's just made of transactions, it's zero-sum.

There are other possible benefits to investors including dividend disbursements, stock splits that increase the number of shares held and possibly warrants that could be exercised or sold.

 

[Tosh5457]

So what do the aggregate real (i.e. net of inflation) gains and losses of all poker players since 1950 years sum to?

A. zero

what do the aggregate real gains and losses of all stock traders (gross of taxes and transaction costs) sum to?

A. a 5844.180% return (http://dqydj.net/sp-500-return-calculator/) including dividends. The price gain alone is about $12 trillion in current dollars

so tell me again how both are zero sum games?

You're only seeing one side of the picture in the stock market case. Tell me, where did those $12 trillion come from?

 

[BWV]

that is beside the point - you said to use game theory jargon. The sum of the winnings is a positive number, hence its not a zero sum game

 

[John Creighto]

that is beside the point - you said to use game theory jargon. The sum of the winnings is a positive number, hence its not a zero sum game

This would seem to be a different issue then the topic of the original thread as it only answers if on average people in the stock market benefit. On the whole, the stock market would create wealth to the extent it improves the efficiency of production by properly allocating resources. It would destroy wealth to the extent which it either hinders the allocation of resources (by hoarding assets, diverting liquidity away from smaller players) or adds an extra administrative cost which could be better devoted to other uses.

Given that in economics these days questions are often posed in marginal terms, it might be better instead to ask: if a small change in the wealth traded on the stock market would create more wealth (How would we measure this wealth and who would benefit from it?).

Remember that the stock market is not the only way to allocate capital. People can invest through savings, through profit, they can borrow from banks, they can borrow from friends, they can borrow from the government. The stock market favors large public companies. It is an irrelevant means of acquiring capital for private companies and small companies.

 

[BWV]

yes, but all you would have to show is that with a purely private market for companies the cost of equity capital would be higher

 

[Tosh5457]

that is beside the point - you said to use game theory jargon. The sum of the winnings is a positive number, hence its not a zero sum game

You're ignoring the players who gave the money to those players who won money. That's like analyzing a fixed number of poker players in a table, without accounting for the new players that enter. In that case it can be a positive or negative sum game, since you're not accounting for all the players.

 

[russ_watters]

You're ignoring the players who gave the money to those players who won money. That's like analyzing a fixed number of poker players in a table, without accounting for the new players that enter. In that case it can be a positive or negative sum game, since you're not accounting for all the players.

Count any players you want to count, Tosh, you can't make poker a positive-sum game: the sum of all of the returns is zero. The analogy was your choice. If it doesn't work, it hurts your argument, not ours.

You don't accept the fact that the company growing doesn't give the stockholders any direct benefit.

Incorrect and annoying since we've covered this already. I'm perfectly aware that there is no direct benefit besides the ownership itself. The part you don't understand is that a direct benefit isn't necessary. I've said this many times.

The only benefit they'll have, in average, will be to see their stock rise in price because of others investors expectations rising.

Right, as long as you acknowledge that those expectations aren't completely imaginary. Apple's profit projections for this year and Apple's profit projections for 1982 are a lot different from each other, for good reason.

But a game just made of transactions will always be zero-sum.

Er. Well, if you pay me $100 for a stock only worth $1 I don't think that's a zero-sum transaction. I think you argue against your point by calling this a pyramid scheme, then describing it as zero-sum. Regardless, no, the game is not just made of transactions. In between the transactions, something else happens that adds or removes value from the game.

Transaction 1: Boeing stock is trading for $100 and I buy it at $100.
Event: Boeing is awarded a $1 billion airplane contract. The market recognizes the new earnings potential of Boeing and the perceived value rises to $150.
Transaction 2: I sell my stock for $150.

Transactions 1 and 2 are zero-sum transactions; nobody won, nobody lost. The Event is the actual value of the stock changing between the two buy/sell transactions. So I gained money because the stock gained value because the company grew.

A second scenario regarding dividends:

Transaction 1: I buy a stock currently valued at $100.
Event: The company pays me a dividend of $5/share.
Transaction 2: I sell the stock for $95.

Again, transactions 1 and 2 are each zero-sum transactions. In the Event , my stock lost exactly $5 of value because the company took $5 from its bank account and gave it to me. So the stock instantly became worth $5 less.

Come to think of it, that's kinda how poker works in a casino: the house takes money out of the game.

Anyway, the only way for each transaction to be zero-sum is if there is actual value added to the company (or removed) in between, which is exactly what happens.

Anyway, I still haven't understand something. Russ, are you trying to say the stock-market isn't a zero-sum game in respect to the profits of the stockholders...

This is also annoying because I stated it explicitly in post #5. You're not absorbing anything that's being said, which implies to me you aren't interested in real discussion (much less learning), just arguing one point at a time, regardless of if they repeat. But again:

The stock market overall is positive sum with respect to the profits of the stockholders because the value of what they are trading rises. The value of each transaction is zero sum.

The value of what is being traded has to rise otherwise the transactions aren't zero sum. Let me say that again, another way:

In a pyramid scheme, each transaction is negative sum. That's why they collapse: the value of the pyramid is always negative, so if too many people try to cash-out, it collapses.

For stocks, if you pay $100 for a worthless piece of paper, that's not zero-sum. The piece of paper has to actually be worth $100 for it to be zero sum.

 

[nitsuj]

Transaction 1: Boeing stock is trading for $100 and I buy it at $100.
Event: Boeing is awarded a $1 billion airplane contract. The market recognizes the new earnings potential of Boeing and the perceived value rises to $150.
Transaction 2: I sell my stock for $150.

Transactions 1 and 2 are zero-sum transactions; nobody won, nobody lost. The Event is the actual value of the stock changing between the two buy/sell transactions. So I gained money because the stock gained value because the company grew.

A second scenario regarding dividends:

Transaction 1: I buy a stock currently valued at $100.
Event: The company pays me a dividend of $5/share.
Transaction 2: I sell the stock for $95.

Again, transactions 1 and 2 are each zero-sum transactions. In the Event , my stock lost exactly $5 of value because the company took $5 from its bank account and gave it to me. So the stock instantly became worth $5 less.

Come to think of it, that's kinda how poker works in a casino: the house takes money out of the game.

"So I gained money because the stock gained value because the company grew." by signing a contract? Turns out it cost Boeing two billion to fulfill the contract, what worse is the planes were negligently faulty; effect is they abruptly fall from the sky.

Who could've guessed there were risks to a company signing a contract worth a billion dollars to build one of the most complicated machines this world has that transports the most valuable assets of all. Seems the guy who bought your stock for an inflated 150 thought it was a sure bet. Lucky for them they won't be named in the lawsuits. Not too bad a deal, having no claim to the assets of the company.