Why stock bubbles matter

nitsuj

No you don't. The entitlement (speculation) is
1.) company pays out dividends
2.) company retains earnings, and via slick management grows the business exponentially
3.) combination of the two


In the context we are talking, you don't own anything other than paper stating a particular claim, sometimes of value.

The details of any particular note, share, debt, bond what have you covers pretty much any transaction that can be considered.

So it is possible to buy "shares" in a company, and have that include some claim to real property that can be "cashed in" by the holder.


I hear what you are saying with the last comment. But consider the size of a stock market IPO company and in turn the disconnect between IPO today, and profits tomorrow.

Im not sure what you mean by "selling stock doesn't seem to create anything".

Alesak

It makes sense, really. It's just the jargon that can be difficult.



Facebook? :D


I meant when outsider shareholders sell shares to other outsider shareholders. But yeah, I think even this reselling can have influence to the company because it can change stock price, which influences company via means discussed above.

BWV

Stock prices reflect the present value of expected future earnings from the companies in the market. Arbitrary changes to either the discount rate or expected levels of profitability could in in theory have no effect, positive or negative effects on the aggregate economy. An increase in discount rates would translate into a higher cost of future investments by companies and therefore reduce future levels of investment, negatively impacting the rate of future economic growth. A transition from a less competitive market where companies were able to extract economic rents to one with normal profit margins would reduce the value of equity shares but benefit the aggregate economy.

Bubbles however refer to periods with abnormally low costs of capital and bad allocations of investments. Too much capital was invested into the information technology sector in the late 1990s and too much was invested into real estate in the last decade. This misallocation of capital created large disruptions in the real economy with the latest cycle including all the issues of a debt deflation and banking crisis

nitsuj

Don't you find that too general of a statement?

What's the timeline? Can a company have no earnings yet still improve equity?

The income statement is nice from a management perspective. A particularly "heavy" investor maybe interested in Operations.

But I would guess the balance sheet & Cash flow statement are far far better from an investment analysis perspective.

The valuation you mention above (Present Value of annuities, i.e. bonds, simple notes) seems better suited for simply annuity type investments. Something stocks shares definitely are not.

BWV

it is a general statement, but nonetheless is true.

There is no timeline other than the infinite future

sure accounting statements are important, but I was not trying to specifically refer to GAAP earnings, just earnings in the economic sense (or cash flows if you prefer that term)

nitsuj

How do you calculate a PV of future earnings if future earnings is "infinite future".


I have heard of valuation of stock being based on the dividend/retained earnings. And that being compared to the market valuation of the stock. To help determine how much "fluff" is in a stocks market price.

Do you agree with the general statement "Supply & demand determine a stocks market price."?

BWV

the PV of a stock can be modeled as earnings / r-g where r is the discount rate and g is the growth rate. 1/r is the formula for a perpetual annuity BTW. This is commonly used for dividends, not earnings but with Miller-Modigliani changes in dividend policy (or cap structure) should not impact the price of the stock.

Of course supply and demand determines the price for anything, but this is a tautology. What drives the supply and demand for stocks?

nitsuj

from "Stock prices reflect the present value of expected future earnings from the companies in the market."


to "the PV of a stock can be modeled as earnings / r-g where r is the discount rate and g is the growth rate. 1/r is the formula for a perpetual annuity BTW. This is commonly used for dividends, not earnings..."

I think the second one is much better said.



What drives the supply and demand for stocks?

Too much to cover with a general statement other than supply demand. If you speak specifically, than it's an influence in the price.

oh and PV of a stock means what ? Is it not the PV of the anticipated annuities?

BWV

the first is a better statement as "earnings / r-g" is a model for the present value of future earnings where all the inputs are anyone's guess. All prices of financial instruments are PVs of future cash flows bound by the law of one price

nitsuj

Said in a thread about stock bubbles.

Then, what determines "g" in your calculation? Oh never mind, anybody's guess.