Stock market - no connection company/share - money isn't lost?

[Gerenuk]

I'm not sure how scientifically minded people are here. As common in science I would like to consider a model society and ask if stock market would work there:

People on an island trade with shares. There is no bank system, just ordinary dollar bills. No bills are lost or printed. On chocolate day not everyone can be a winner.

I think this has all essential ingredients to examine the stock market, but if someone disagrees then I'm not sure how to explain that.

 

[CRGreathouse]

One day of the year is chocolate day, when all people can buy chocolate for real dollar bills. Am I right in the conclusion that chocolate will be bought for 1000$ in total? What ever I lose over the course of all these transactions (I actually started with 1000$) someone will win.

There are less than $1000 in bills circulating, because the bank needs to hold something like $250 in reserve. But then again just because a dollar bill is used to buy chocolate doesn't mean the very same dollar bill can't be used to buy chocolate again -- the chocolate man pays for cocoa and milk with some of the dollar bills he gets, and the suppliers in turn buy chocolate from him.

In short, counting dollar bills tells you nothing even when only dollar bills are accepted. And they aren't the only things that are accepted -- checks and credit cards would be the obvious first counterexamples in the 'real world'.

 

[Gerenuk]

There are less than $1000 in bills circulating, because the bank needs to hold something like $250 in reserve.
...
In short, counting dollar bills tells you nothing even when only dollar bills are accepted. And they aren't the only things that are accepted -- checks and credit cards would be the obvious first counterexamples in the 'real world'.

I have to think what that would mean in the tables. Maybe it's possible to include all this, but that would make the explanation long and complicating.
That's why I propose the simplified island model above. I mean stock market is not just working because banks need to hold reserves and because you can use your credit card to pay at the store?!

But then again just because a dollar bill is used to buy chocolate doesn't mean the very same dollar bill can't be used to buy chocolate again -- the chocolate man pays for cocoa and milk with some of the dollar bills he gets, and the suppliers in turn buy chocolate from him.

That's correct.
I think I invented chocolate day to quantify the dollar bill wealth at one particular instant (and to justify why I count dollar bills only). So maybe chocolate day should be a one day event where the chocolate supplier doesn't use the money.

 

[CRGreathouse]

I know there is no disagreement. But there is no relation between my question and his answer either.
The first point I wanted to clarify the some people have fewer dollars. Next I would like to know what happens on chocolate day when everyone is allowed to buy chocolate, but with real money only.

You're not talking about real money. You're talking about currency. The money in my bank account is real money, even though it's not currency.

M2, by most accounts, is real money. Your measure is narrower than M0.

Didn't I translate all examples to tables?

You changed your measurement from dollars to dollar bills. Here's the discussion, in a nutshell:
You argue that dollars are constant -- fractional reserve is a counterexample.
You argue that dollars are constant -- Fed OMC is a counterexample.
You say you mean dollar bills instead.
You argue that dollar bills are constant -- printing dollar bills is a counterexample.
You say you're renormalize to exclude this.
You argue that dollar bills are constant -- currency destruction/loss/etc. are counterexamples.
You say "Let's keep some simplicity" and exclude them.


So your current argument is:
Unless someone prints or destroys a dollar bill, the number of dollar bills remains constant.

This is true. It is, however, entirely unrelated to your original post, in particular "Therefore the more experienced half of traders at the stock market wins money and the less experienced half loses money.".

Stock traders don't hoard dollar bills; on the contrary, they generally keep almost all of their assets in stocks/bonds/funds. The large majority of their money not in stocks/bonds/funds would be in checking or savings accounts; only a tiny fraction of their money would be in currency. A stock trader who is wiped out may have as much or more currency than a trader who is successful -- it's not hard to have $100 in your pocket; you care much more about whether your portfolio is worth $1 million or $500.

 

[CRGreathouse]

I think I invented chocolate day to quantify the dollar bill wealth at one particular instant (and to justify why I count dollar bills only). So maybe chocolate day should be a one day event where the chocolate supplier doesn't use the money.

In that case, as I mentioned, there is a net destruction of money by your standard in that example: not all of the $1000 is available for buying chocolate, because some of it is sitting in reserve.

 

[Gerenuk]

You're not talking about real money. You're talking about currency. The money in my bank account is real money, even though it's not currency.

M2, by most accounts, is real money. Your measure is narrower than M0.

Sorry, for not using the correct terms. By "real" I meant what I can actually touch. That's why I wrote dollar bills in later posts.

So your current argument is:
Unless someone prints or destroys a dollar bill, the number of dollar bills remains constant.

This is true. It is, however, entirely unrelated to your original post, in particular "Therefore the more experienced half of traders at the stock market wins money and the less experienced half loses money.".

Sorry to have you confused. I think the term "money" had a special meaning of mine. I could give it a new name and rewrite the question.

you care much more about whether your portfolio is worth $1 million or $500.

True.
Just to understand why a single thought of a few people can cause a crisis, even though nothing real has happened, I was trying to make all this business in low-level real world terms.
Of course it is always possible to include more complications - even programming errors in the bank software. But that doesn't help to understand the basic principle.
Maybe the island toy model can help. It doesn't have a banking system and all it's complications. But that has nothing directly to do with the stock market.
The question is whether the island model will have a stock market system.

 

[Gerenuk]

In that case, as I mentioned, there is a net destruction of money by your standard in that example: not all of the $1000 is available for buying chocolate, because some of it is sitting in reserve.

That's right. The reserve rule complicates the considerations. I'd have to think what it actually means.

So do you think in the bank-less island society a stock market would be possible?

 

[TVP45]

I could sell stones to people and claim they will find others who want to buy them. Obviously that wouldn't work, ...

Diamonds?

 

[CRGreathouse]

I'm not sure how scientifically minded people are here. As common in science I would like to consider a model society and ask if stock market would work there:

People on an island trade with shares. There is no bank system, just ordinary dollar bills. No bills are lost or printed. On chocolate day not everyone can be a winner.

I think this has all essential ingredients to examine the stock market, but if someone disagrees then I'm not sure how to explain that.

What's behind the shares? There's a difference between money (which has value only because it is a medium of exchange) and stock (which represents a claim to a portion of a thing). If the island has productive companies and the stock works there just as it does here, so there is a great deal of wealth beyond the total value of the cash, here's how it would work.

There are a million dollar bills and a ten million dollars worth of stock. The strange chocolate man comes to the island saying that he will accept only dollar bills (but not new printed ones) that he intends to keep until the end of the day. For some reason, everyone really wants to buy the chocolate.

A few people have dollar bills with them and buy some chocolate. Others realize that they, too, want to buy chocolate so they sell their stock for dollar bills. Soon everyone is selling stock, and it takes more and more stock to buy a dollar bill. Dollar bills are in demand!

Someone sets up a market stall near the center of the island to buy dollar bills from people. He's offering stock in exchange for dollar bills, but not his own -- he's working as an agent for wealthy stockowners who want more dollars. Since it's more convenient to work with this man, everyone who wants to own more stock and isn't so sure about the chocolate man converges to the spot.

At the end of the day, most of the island's dollar bills are in the hands of the strange chocolate man. People who chose to buy the stock now own much larger parts of the island's traditional companies. People who sold their stock now have the greatly-desired chocolate. One man never heard about the whole thing; he still has his stock and his cash, just as before.​

If you substitute "kg of gallium" for "dollar bills", "inventor" for "strange chocolate man", and "gallium-based processor" for "chocolate", you now have the story of the discovery that gallium actually had a practical use. Those who happened to have gallium [mines] at the time of the discovery were fortunate enough to make money because of the sudden 'external' demand for gallium. Your fable tells the unlikely story of a sudden external demand for dollar bills, which are less likely to have an actual use than gallium.

 

[CRGreathouse]

Maybe the island toy model can help. It doesn't have a banking system and all it's complications. But that has nothing directly to do with the stock market.
The question is whether the island model will have a stock market system.

Your example has very little to do with what you're trying to understand. It has everything to do with the unnatural sudden demand for dollar bills, which is unlike the real-world situations you're thinking about.

In the real world, a sudden demand for dollar bills simply results in more money being printed. Amusingly, while the Fed can create dollars, it does not create dollars by printing money: just dollar bills. It sells the dollar bills to banks and destroys the (non-physical) money it gets in exchange, keeping the total constant for the transaction.

 

[Gerenuk]

At the end of the day, most of the island's dollar bills are in the hands of the strange chocolate man. People who chose to buy the stock now own much larger parts of the island's traditional companies. People who sold their stock now have the greatly-desired chocolate. One man never heard about the whole thing; he still has his stock and his cash, just as before.[/i][/INDENT]

I'm glad your using the model. Tell me if I missed something in your story.
So everything is working as expected. The one point where I would disagree is that people with shares will own the companies. I mean they are told so, but how would that ever make a difference in their lives if there is no way to profit from owning shares?
If I were a real owner or manager I'd make a living on it, i.e. I'd receive money (just like dividents).

Those who happened to have gallium [mines] at the time of the discovery were fortunate enough to make money because of the sudden 'external' demand for gallium.

That makes sense to me as owning mines probably meant that you receive money from selling gallium (i.e. a way to profit apart from selling the share).

Sorry if I haven't put a new idea in here. Maybe this diagram will help:
(there must be someone out there who is able to put stock market into mathematical form, as mathematics contrary to words can pinpoint the meaning of something.)
If a share is sold from A to B to C, then this makes sense
ValueToA = ValueToB = ValueToC = MoneyThatCCanReceiveFromCompany
But if there is never an "end-value" then
ValueToA = ValueToB = ValueToC = ValueToD = ... ??
could just as well be all zero. What I am trying to say is that at some point there must be someone who profits from having a share by other means than just selling the share.

 

[CRGreathouse]

What I am trying to say is that at some point there must be someone who profits from having a share by other means than just selling the share.

The ways are:
* The company pays dividends
* The company is dissolved, with the residual value being divided amongst the stockholders
* The company is acquired, with the purchase price divided amongst the stockholders

 

[CRGreathouse]

That makes sense to me as owning mines probably meant that you receive money from selling gallium (i.e. a way to profit apart from selling the share).

You totally missed the analogy. The chunks of gallium (or gallium mines, but ignore that since that's confusing you) aren't the shares of stock. They're the dollar bills.

 

[Gerenuk]

You totally missed the analogy. The chunks of gallium (or gallium mines, but ignore that since that's confusing you) aren't the shares of stock. They're the dollar bills.

I admit I sort of felt there was a point behind the dollar bills, that I didn't understand.
I was just saying why the gallium example makes sense to me without any analogy needed. So in principle I should transform this understandable gallium example back to the dollar bills.

 

[Gerenuk]

The ways are:
* The company pays dividends
* The company is dissolved, with the residual value being divided amongst the stockholders
* The company is acquired, with the purchase price divided amongst the stockholders

That's something that explains the stock markets - at least if these possibilities are there. I just had the impression that these non-reselling values are too unlikely, far in the future or even non-existent to explain large price fluctuations.

It's not easy to understand how a single thought can cause a crisis, when nothing has happened to real goods.

 

[CRGreathouse]

I admit I sort of felt there was a point behind the dollar bills, that I didn't understand.
I was just saying why the gallium example makes sense to me without any analogy needed. So in principle I should transform this understandable gallium example back to the dollar bills.

Frankly, I don't think you understood it in the first place. The point was that the model does not fit the situation you want to describe, since it describes a change (strong external demand for dollar *bills*) that would be dealt with differently than in the model:
* If the economy needs more dollars, the Fed creates new money.
* If the economy needs more dollar bills, the BEP converts (electronic) money into paper money.

The model says that stock would be used to purchase dollar bills, which actually wouldn't happen in any real scenario.

That's something that explains the stock markets - at least if these possibilities are there. I just had the impression that these non-reselling values are too unlikely, far in the future or even non-existent to explain large price fluctuations.

These factors anchor the price. If a company looks like it's going to go out of business, its stock value falls (because it may need to be dissolved to pay its debts, and its residual value would probably be 0).

The day-to-day value is determined, as all things are, by the market. If you are further confused about the relation between intrinsic value and market value, look up vulture funds: groups that seek to buy companies that have more assets than market capitalization.

It's not easy to understand how a single thought can cause a crisis, when nothing has happened to real goods.

Of course the stocks can plummet without having any effect on the real economy, as often happens. But you can see the stock market as a source of information on how much things are worth. If it falls, it causes people to act differently. It is these actions which cause crises, not the stock market as such.

If we think that AOL is worth $5 billion and Time Warner is worth $1 billion, then it makes sense to have AOL buy Time Warner and for massive numbers of employees to work for the AOL side rather than the Time Warner side. When the tech bubble burst and we realized that AOL (the AOL division, that is) wasn't worth $5 billion, suddenly we questioned that asset allocation... the real changes were allocating employees and assets (new buildings, etc.) between companies or divisions.

 

[Gerenuk]

Frankly, I don't think you understood it in the first place. The point was that the model does not fit the situation you want to describe, since it describes a change (strong external demand for dollar *bills*) that would be dealt with differently than in the model:
* If the economy needs more dollars, the Fed creates new money.
* If the economy needs more dollar bills, the BEP converts (electronic) money into paper money.

First, I'd like to say that at the moment I have no good idea that would bring this discussion further. I need to think how to be more precise or maybe if I missed a point.

What I'd like to note about your statements that I was trying to introduce a model to get away from the personalized word that have no well defined meaning. That's why I was trying to make abstract tables.
That was the biggest problem with other economists, that they were very religious. They use words like "economy", "needs", "market" or even "value" and they were unable to rephrase their arguments into precise examples where pure logic holds with the only assumption that people want to get happy (by obtaining goods or service). They never question what they learned and took the rule-of-thumb like knowledge sometimes too far.

It's probably too much work to work out a good abstract example here, but if you understand what sort of explanation I'd find helpful and if you know a good reference for that, let me know.

Reading the rest of the post I think I want to understand how "value" arises from the desire of people to buy stuff, i.e. I'd like to see how "the share has value" follows from "bob wants chocolate".

If we think that AOL is worth $5 billion and Time Warner is worth $1 billion, then it makes sense to have AOL buy Time Warner and for massive numbers of employees to work for the AOL side rather than the Time Warner side.

Maybe I just comment on this point. What if, while someone with AOL shares spends time thinking about how much AOL is worth, overnight people decide that shares are bu!sh!t and they rather forget about all that. I mean AOL is still definitely worth a lot. But how would you convince the people that you own some of that? Isn't that weird?
(I know money can be questioned similarly, but it's not good practice to answer with a counter-question)

 

[CRGreathouse]

That was the biggest problem with other economists, that they were very religious. They use words like "economy", "needs", "market" or even "value" and they were unable to rephrase their arguments into precise examples where pure logic holds with the only assumption that people want to get happy (by obtaining goods or service). They never question what they learned and took the rule-of-thumb like knowledge sometimes too far.

I think more likely is that economists have no good way of explaining their thoughts (which are based on complicated models that non-economists wouldn't understand) and have to fall back on dogmatism to explain things to the rest of us. I don't think it's fair to say that this is how they actually do their work -- in fact I'll flat-out state that it isn't.

It's probably too much work to work out a good abstract example here, but if you understand what sort of explanation I'd find helpful and if you know a good reference for that, let me know.

Reading the rest of the post I think I want to understand how "value" arises from the desire of people to buy stuff, i.e. I'd like to see how "the share has value" follows from "bob wants chocolate".

Perhaps like the economists I described, I'm mostly at a loss as how to explain this. I'm willing to work within an unambiguous model you propose, and also to try to explain the importance of the various ways in which the model differs from life. But I'm not at all sure how to give simple explanations for you.

Further, there are hard questions left unasked -- like the value of a stock buyback, for example.

Maybe I just comment on this point. What if, while someone with AOL shares spends time thinking about how much AOL is worth, overnight people decide that shares are bu!sh!t and they rather forget about all that. I mean AOL is still definitely worth a lot. But how would you convince the people that you own some of that? Isn't that weird?

I'm not sure what you're asking, exactly, but I think I see where you're going. This is actually one of the major points of the market: to tease out information from the participants.

If you held AOL stock and realized that it was overpriced, you'd sell it (just because you want to get out before other people realize it, so you don't lose money). This would result in more stock being offered, which in turn drives the stock down a tiny bit. If lots of people feel the same way, the price goes way down. Similarly, if someone has faith in AOL's ability, they'll buy stock causing the price to rise (slightly). So the market acts as an aggregator of knowledge as well as a place to buy and sell.

 

[Gerenuk]

I think more likely is that economists have no good way of explaining their thoughts (which are based on complicated models that non-economists wouldn't understand) and have to fall back on dogmatism to explain things to the rest of us. I don't think it's fair to say that this is how they actually do their work -- in fact I'll flat-out state that it isn't.

I believe those who receive nobel prizes actually do work with mathematical equations or at least abstract schemes. I can't image a model that would be too complicating to understand. There might be a lot to memorize, but unless a model is incomplete, it should be understandable.
I also suppose that there are some economists who do "OK" work, but comparable to an engineer. They are good at what they have been told, but to obtain novel ideas they lack deep insight knowledge.I heard the Google share has halved over some period?! So why should Google care? Where is a connection between share price and company? I mean Google still has its computers, its employees, people who want to put ads and everything else. It could continue normal day business and forget about the stock market?

Or if I make up a fake company and sell shares. Then I create fake news and reports and no-one ever notices. Wouldn't that be weird that there is a market with nothing real behind?
(Of course if the shares promised real value like divident, then I'd be in trouble.)

 

[CRGreathouse]

I believe those who receive nobel prizes actually do work with mathematical equations or at least abstract schemes. I can't image a model that would be too complicating to understand. There might be a lot to memorize, but unless a model is incomplete, it should be understandable.

So there'd be no problem with you understanding the Greeks of Black-Scholes, or Leontief's input-output 'capitalism replacement' model?

I also suppose that there are some economists who do "OK" work, but comparable to an engineer. They are good at what they have been told, but to obtain novel ideas they lack deep insight knowledge.

I honestly think you don't know what you're talking about.

I heard the Google share has halved over some period?! So why should Google care? Where is a connection between share price and company? I mean Google still has its computers, its employees, people who want to put ads and everything else. It could continue normal day business and forget about the stock market?

The causation is the other way: Google's performance changes the stock price. The stock price doesn't affect Google very much in turn, unless it wants to do something like:
* offer stock
* buyback stock
* pay dividends
* acquire another company (Google does this frequently)
* be acquired by a company
* avoid being acquired by a company

So ignoring these things, I agree: the stock price doesn't affect a company much. But for Microsoft's attempted acquisition of Yahoo, stock price was a major factor -- there's too much to summarize here, but you can look it up if you're interested.

Or if I make up a fake company and sell shares. Then I create fake news and reports and no-one ever notices. Wouldn't that be weird that there is a market with nothing real behind?

It's no different from selling snake oil, except the would-be customers are slightly more sophisticated.

 

[Gerenuk]

So there'd be no problem with you understanding the Greeks of Black-Scholes, or Leontief's input-output 'capitalism replacement' model?

Is that some scientific models? Yes, if I had a complete description from which I could learn, then I could solve any question related to this without mistakes. In science nothing is complicating - just sometimes a lot to learn.
The tricks is to not accept arguments from books, before they make sense.

So ignoring these things, I agree: the stock price doesn't affect a company much.

So it's perfectly fine if I sell shares for my company and then forget about them, being happy owning so much money now. That's kinda weird.

It's no different from selling snake oil, except the would-be customers are slightly more sophisticated.

When you buy snake oil you probably can check for yourself if it works the way it was promised. Shares you cannot check. Because they aren't supposed to do anything (provided there are no dividents etc.)

 

[CRGreathouse]

Is that some scientific models? Yes, if I had a complete description from which I could learn, then I could solve any question related to this without mistakes. In science nothing is complicating - just sometimes a lot to learn.
The tricks is to not accept arguments from books, before they make sense.

I'd love to have you explain some of the finer points of those models to me, then, since they're so easy for you. They've always been a bit hard for me to pick up.

So it's perfectly fine if I sell shares for my company and then forget about them, being happy owning so much money now. That's kinda weird.

You still have fiduciary responsibility toward them -- you can't run your company into the ground now -- but things go on pretty well as they did, as long as you have a controlling share.

It's like buying a house with a mortgage. As long as things go as planned, you don't even know that the title company exists -- but the fact that they can pull the house if you miss enough payments is enough to entice most people to pay. You could say, "But even in this weak market, forclosures are rare -- I've never had one, no one in my family has, none of my friends either", but all of you know that it *could* happen, and that keeps things running. Hostile stock takeovers, shareholder lawsuits, liquidations, etc. are likewise rare but their threat keeps the company running as it should for the stockholders.

When you buy snake oil you probably can check for yourself if it works the way it was promised. Shares you cannot check. Because they aren't supposed to do anything (provided there are no dividents etc.)

I think it's a lot easier to check if a company's shares are legit than if a medicine works properly or not ("is snakeoil"). But each to his own. [I assume you're not familiar with SEC regulations on information disclosures to stockholders.]

 

[AeroFunk]

Gerenuk, i think where your getting hung up on is the subjective theory of value. Let's take dollars out of the equation and pretend were in a barter economy. Adam has an Apple and Eve has an orange. They decide to trade, was any value created or destroyed? Yes. Value was created, the economy grew. Here's why, people value things differently Adam and Eve would not agree to this voluntary exchange unless Eve valued the apple more then her orange, and Bob would not trade unless he valued the orange more then his apple.

Money serves to make this exchange easier so you don't need to find someone who has what you want and wants what you have, there is a common medium of exchange. Just because the supply of money is constant(assume that it is) doesn't mean that no wealth is ever created. Any time two people trade real wealth is created, by transferring goods from those who value them less to those who value them more.

You can think of stocks in the same way although it gets a bit more complicated.

 

[Gerenuk]

I'd love to have you explain some of the finer points of those models to me, then, since they're so easy for you. They've always been a bit hard for me to pick up.

Sure, if I ever find time or reasons to study that area, I'll make a try
Coming from physics and mathematics areas I'm can say that if there is a good explanation then nothing is complicating. Unfortunately most books (and often course recommendation books) are incomplete and it's tedious to search for book that fill the gaps. And often when I found a book and I thought "wow, this guys is answering my questions before I even ask them", then it turned out to be a nobel prize winner.

No really: if you always question your own knowledge and keep look for books until you fill the gaps, you will know the topic as exact as is possible.

 

[Gerenuk]

Gerenuk, i think where your getting hung up on is the subjective theory of value. Let's take dollars out of the equation and pretend were in a barter economy. Adam has an Apple and Eve has an orange. They decide to trade, was any value created or destroyed? Yes. Value was created, the economy grew. Here's why, people value things differently Adam and Eve would not agree to this voluntary exchange unless Eve valued the apple more then her orange, and Bob would not trade unless he valued the orange more then his apple.

I can understand the real world example. The apple and the oranges have measureable pleasure value. I just can't see how (divident-less, voting-less) shares would ever turn into measureable value. Value doesn't have to be defined by books. It comes out naturally from logics of people. If you tell people the apple has no value, they might answer "think whatever you want, but I'm going to eat it now and I don't care what other people think about it". If you tell people that shares have no value, then they think "Damn, it's true that for me they have no value, but I hoped they had value for other people so that I could sell them. But wait, if they think the same then I'm screwed..."

 

[CRGreathouse]

I can understand the real world example. The apple and the oranges have measureable pleasure value. I just can't see how (divident-less, voting-less) shares would ever turn into measureable value. Value doesn't have to be defined by books. It comes out naturally from logics of people. If you tell people the apple has no value, they might answer "think whatever you want, but I'm going to eat it now and I don't care what other people think about it". If you tell people that shares have no value, then they think "Damn, it's true that for me they have no value, but I hoped they had value for other people so that I could sell them. But wait, if they think the same then I'm screwed..."

They always have claim to the company's assets in case of acquisition or insolvency. As I explained, this drives their value in a way similar to other ostensibly rare events like foreclosure.

If a person cared only about value, they could buy stock and hold it until the company is sold/goes private/etc. The value in having other people buy stock in the interim is to judge how much your share of the company is worth, and to provide liquidity (because you may not want to hold it that long).

 

[AeroFunk]

When you buy a stock you become a part owner of the company, meaning you are entitled to a share in the profits, in the form of dividends. However some stocks don't pay dividends but instead invest their profits back into the company, raising the expected future profits, and thus raising the value of the stock. A company can keep investing, never paying dividends, but its stock price will continue to rise if those investments pan out.

People trade stock because they have different valuations of expected future profits of the company and because people have different risk sensitivity. For example, when a company decides to invest in a risky project this triggers people holding stock with high risk sensitivity to sell to people with low risk sensitivity.

A stock has real value, the value of the companies future profits. The company may or may not make a profit, but the value is in the expected profit.

 

[Gerenuk]

Hi AeroFunk,
if you look at the thread progress, you will see that such kind of explanations I've heard before, but I do not want to accepts them as statement and rather would like to know where they come from.

When you buy a stock you become a part owner of the company, meaning you are entitled to a share in the profits, in the form of dividends.

That would be great. Then everything would make sense to me.

However some stocks don't pay dividends but instead invest their profits back into the company, raising the expected future profits, and thus raising the value of the stock.

Wait, no. That's cheating. The managers receive money and I'm as an owner don't receive anything? Investment is fine, but I also want to live from owning the company.

A company can keep investing, never paying dividends, but its stock price will continue to rise if those investments pan out.

Strictly speaking there is no (obvious) logical reason why they should rise. Most people think so, but where does this idea come from?

For example, when a company decides to invest in a risky project this triggers people holding stock with high risk sensitivity to sell to people with low risk sensitivity.

I was disappointed when I once went to a counselor at a bank. She talked about risk sensitivity and profit. Then I asked which option has supposedly the highest average profit. She argued that you cannot know the outcome of a gamble and concepts of probability theory were completely strange to her. I would have accepted "I don't know", but not a "I have no idea what you are talking about".
An the essential concept of half-logarithmic plots she didn't know either. I wonder how they test their applicants because she wasn't that good looking either.

A stock has real value, the value of the companies future profits. The company may or may not make a profit, but the value is in the expected profit.

Have you ever questioned if a stock has real value or others your statements? I mean I also read them in books, but how/when are they true?
Books say the sky is blue, but if you know where that comes from, you can say why it is not completely blue or sometimes not at all.

I think we make no progress with these common explanations. To find out the deeper principle you need to use abstract schemes!

 

[CRGreathouse]

Wait, no. That's cheating. The managers receive money and I'm as an owner don't receive anything? Investment is fine, but I also want to live from owning the company.

The money that the managers get isn't yours, it's a loss to you. But the company has to pay the managers in any case.

The company makes profits and can either reinvest the profits in the company (so the company owns more stuff), increasing the value of the company and thus the value of your share. The company can instead decide that it doesn't need to buy any more stuff and give the money to you directly in the form of dividends.

You're confusing pay and reinventment.

 

[Gerenuk]

You're confusing pay and reinventment.

I'm sure that when I own a company, I own it for a reason - to make money. So as soon as it is anyhow possible I will try to live from its profits and reinvest only part of it. I think that's how shares started and at that time it made sense to me.

But without prospect for dividents its like the father saying to his child "Yes sweetie. I made an account for you with a lot of money. It's yours but you can't get any of it."

 

[CRGreathouse]

But without prospect for dividents its like the father saying to his child "Yes sweetie. I made an account for you with a lot of money. It's yours but you can't get any of it."

Well, on, that note, I'll leave you with your thoughts. It's clear that I can't explain what is evident to everyone else posting on the thread.

Perhaps if I were a better teacher I could explain it, and the next more complicated things that make sense only when you understand the foundations, but alas that is not to be.

 

[AeroFunk]

Maybe a simplified example will help you understand, as you seemed to understand my last example.

Assume there is a company AppleCo. Also assume people value the future as much as they value the present. Assume that there is no risk, and assume there is perfect information (none of these assumptions will affect the basic principle but adding them in will complicate things to much)

You own stock in AppleCo say 10% but have no voting rights.

It is year 0.
AppleCo has an orchard that produces apples. It can make a profit at the end of the year of $10. Your stock is then worth $1. As people would be willing to buy that stock up to that price(again assuming no risk and no present/future trade offs, in reality it would be a little less then that because of uncertainty).


It is now Year 1.
AppleCo has now just made a profit of $10. AppleCo's managers have a decision to make, they can either use that money to pay dividends to all the stock holders giving $1 to you right now, or they can use that money to invest back into the company and buy more trees to put in there orchard.

If they invest they can make a profit of 20$ in year 2, with all the extra trees.
This will raise your stock price to $2.

If it chooses to pay the dividends then you will get your $1 now, and the company will make a profit of $10 in year two, so your stock price will be $1.
The one dollar dividend plus the one dollar of your stock price equals $2. You are just as well off either way!

You can add in probabilities, discount rates, and etc, but the basic principal is the same.

hopefully this helps.

 

[AeroFunk]

As for claiming that just because things are in books doesn't mean there true, I agree with you.

But if you claim that stocks have no value then you are left will two conclusions.
People obviously buy and sell stocks you can't deny that, so either

A. people behave irrationally

or

B. stocks actually do have value.


I find A much more unlikely.

 

[russ_watters]

But without prospect for dividents its like the father saying to his child "Yes sweetie. I made an account for you with a lot of money. It's yours but you can't get any of it."

Not accepting the reason people invest will not help you understand the reason people invest. So there really isn't much else we can do for you here. You simply prefer not to understand. Thread closed.