Does stock market create wealth?

OmCheeto

You sound quite knowledgeable in this topic. I don't mean to change the subject, but I just lost the equivalent of 10% of my annual salary the other day in a stock. It's IPO was $2 billion. I was buying shares at $20 a pop, and had no fear, as they made an exceptional product, and planned on selling at $30/share. Over the last 4 years, the price went down to 5 cents a share. And now the company is bankrupt. Though shares are still being traded over the counter for 8 cents a share, yielding a market cap of around $11 million.

The problem with the picture though, is that there is another company willing to buy my company for over $500 million.

Does anyone know what it means when there is a 50:1 difference like that?

Or should I start a new thread?

(I doubled my money in GE. So yes, gambling in the stock market does create wealth: $200! )

Raises hand sheepishly.....

BWV

If the company is bankrupt then its equity is likely worthless, but its bonds are not as they have a priority claim on the assets. The existing equity owners only see a recovery if all the bondholders get paid in full, which typically does not happen. the $500 million number you saw likely represents an offer to the bondholders which would give them a partial recovery of their losses

Tosh5457

That argument was made before in the thread and I replied to it. If you exclude dividends, by owning shares of a company, and in a way that it doesn't allow you to control the company and therefore get the profits from the company by other mechanism than dividends (that doesn't happen in the stock market, that's a takeover) you don't own anything of the company. If you have 10% of the shares of a company, can you sell 10% of their capital? Can you even sell anything that the company owns to make a profit? You can't, because you don't own anything of it. So how is that claim on the company's assets going to give you profit if there aren't dividends?
I don't have to give a counter-example, because what he's talking about is a take-over and stocks with voting rights, not the usual preferred stocks that are traded in the stock market.

I'm gonna put this in more concrete terms:

If I define profit of an investor as money spent or received in the stock market, if I buy $1000 of a stock my profit will be -$1000 and the profit of the seller will be +$1000. Using that definition it's obvious that it is going to be a zero-sum game in respect to the profits. Even though this definition can seem strange, it comes from the fact that shares only have value if anyone wants to buy them. So when you buy $1000 of shares, you just lost $1000, which can be regained or not in the future.

If I define profit of an investor in a given trade as:
In case of buying, profit = 0.
In case of selling, profit = Price that the investor sold the stock - Price that the investor acquired the stock
This is the usual and intuitive definition of profit.

Now imagine that a stockholder X has 100% of all the preferred shares (no voting right, therefore no other mechanism to get money from the company other than dividends) of a company. That company has 10 shares of $10 each (for sake of simplicity). Let's say this system has $1000 and investors X(which is the current stockholder) and Y.

Balance of X = $0
Balance of Y = $1000

Now investor Y acquires the 10 shares for $100 each.
Profit(X) = 10*$100 - 10*$10 = $900
Profit(Y) = $0

The investor X now has $1000 and buys all the shares to Y for $70 each.
Profit(X) = $0
Profit(Y) = 10*$70 - 10*$100 = -$300

Now Y has $700 and X has $300 in his balance plus all the shares.

Total profits of X = $900
Total profits of Y = -$300

With profit defined like this, it's easy to show that the sum of the profits of the 2 investors can never be greater than $1000.

X balance = $300
Y balance = $700

Money that Y has in its balance + Money that X has in its balance = $700 + $300 = $1000.

Variation of X balance = Final value - Initial Value = $300 - $0 = $300
Variation of Y balance = $700 - $1000 = -$300

Sum of the variations of balances = $0

Conclusions: The sum of the money in the balances of the investors is equal to the money in the system. From that it follows that if the money in a given system doesn't vary, the sum of the variations of the balances of the investors is always $0. If it varies by an amount Δx, the sum of the variations of the balances of all investors will be Δx.
For a given system, the stock market is a zero-sum game in respect to the balances (which is what's important after all, because it's the money investors actually own). In a varying money system, as in a real scenario, it's not a zero-sum game, but there isn't any creation of money either (just like there isn't energy creation in an open system). In other words, what one gains, came from another one's pockets, which was what I was attempting to argue, although with wrong terms.

This could be proven for the general case, if any of you has the patience go ahead

BWV

the fact is that somebody could buy 100% of the stock (or more realistically a controlling interest) and then unlock the value of the company. More simply, all the small owners could just join together and elect a board of directors that would take steps to deliver value such as initiating a dividend or share buyback policy. This stuff happens all the time.

your example merely shows that accounting entries for sales and purchases of stock net to zero, as they must. Futhermore your example of a preferred share that pays no dividends and has no voting rights is ridiculous - you might as well imagine perpetual maturity bonds that pay no interest. No such financial instrument would ever find a buyer - preferred shares are a hybrid security that pays a fixed dividend.

I am not sure what you are trying to argue in this thread. Your position is inconsistent - you seem to argue that the stock market is a ponzi scheme except for the payments of dividends. This admission is sufficient to negate every other argument you made as

A) the value of a stock is the present value of if future dividends (Stock Price = div / r-g , where r=discount rate and g=growth rate of dividends)

B) company dividends come from money earned in the real economy which is not a zero sum game

C) if a stock does not currently pay a dividend, it may do so in the future. Shareholders will accept a lack of dividend payments for a new, rapidly growing company that needs capital to expand, but will require dividends once that company reaches maturity (just look at the fact that companies like Microsoft and Oracle are now paying dividends)

OmCheeto

Sorry. Listening to opera at the moment. Have no patience..

Tosh5457

It's a good example, and I'll explain you why: most shares traded are preferred shares (which means they don't have voting rights), and since my first post on this thread I always said excluding dividends. If you want to account for maybe 0.1% of the shares traded ok it's not a good example, but it's a good example for the other 99.9% of shares traded. My point is to show that the stock market doesn't create wealth if there aren't dividends, which is a myth widely accepted by stock traders.

You didn't read all my posts, I corrected the part of the Ponzi scheme. I admit my position looks inconsistent, because I was using the wrong terms. You can just see my last post to understand... But your position seems inconsistent as well, you seemed to drop the argument that owning a stock is like owning a part of the company and instead focused on the dividends when I said on all my posts I'm excluding dividends, and that including dividends it's a positive-sum game. Somehow I get the impression your motive for posting is just to show me wrong, not because you're interested in the topic.

BWV

You are not correct, most shares traded are common shares with voting rights. Preferred shares have both a fixed dividend and liquidation preference

You cannot create some wildly unrealistic conditions like no dividends or voting rights and then extrapolate this to the real world where those conditions do not hold

Tosh5457

As I said in my last post, my point was to debunk the myth that the stock market creates wealth, even if one doesn't account for dividends. Many stock traders actually believe that, hence my interest in it. My point wasn't to show that in the real stock market where there are dividends it's a zero-sum game, as you seem to think. As for voting rights, the common stock trader and many of the big traders don't use it, the great majority are just speculators...

BWV

The stock market in aggregate reflects wealth created in the real economy and contributes to its creation by channeling savings into productive investment. Trading stocks is a zero sum game relative to owning the entire market (say through an index fund) as the average invested dollar must get the market return less expenses

OmCheeto

I don't know anything about bonds.

But here's the latest news on my company:

I guess I'll have a $4000 tax write off for the year. Yay!

Just in time for post christmas sale bargains.

BWV

its not a good sign when your battery fails during the Consumer Reports test ;)

but you can only use the loss against other capital gains on passive investments, so unless you have other winner stocks your loss is of no use (but you can carry it forward and use it against future gains on stocks)

jim mcnamara

@Om Cheeto -
The fact is that a large percent of transactions on the NYSE are automated, about 50% of volume, so called HFT:
http://topics.nytimes.com/topics/ref...ing/index.html

Overall,70% of the NYSE volume is algorithmic based trading (see ted.com link below)

These folks are making huge volume trades in millseconds. If you Google for the term "quant" you can get an idea about this whole arena.

The point is the HFT or maybe "quant"-driven institutions are the ones who make the megabucks. Of course they are also having to back their purchases and sales with real liquidity. It means two things:
1. as a private investor you are at a huge disadvantage if you want to trade stocks to make money. You can invest well and come out ahead, don't get me wrong. Chances of you catching a rising star are diminished, since the star will rise in millseconds.

2. you will probably fare better longterm if you have the quants (or whoever) on your side, using your money to make millions and giving you a chunk. This probably means investing with funds. I dunno which ones, and some of them do tank.

A really interesting discussion of this whole deal from a geek perspective:
http://www.ted.com/talks/kevin_slavi...our_world.html

OmCheeto

Sorry, but I believe Russ was talking about me when he mentioned "stupid".

My other stocks have netted me less than zero. (I keep it around 10, as I can't even find the time to monitor 1)

My mentor who got me interested in investing is now the director of risk management in one of the largest holding companies in my area. I think it was he that told me not to "invest with a conscience". I of course, ignored his advice. He's a friend on facebook. He scuba-dives routinely in the Caymens. I fart in the bathtub.

OmCheeto

Thank you Jim. This is why I gave a special vote for edward the other day. He'd already pointed this out to me earlier.

This is why I like PF. I am surrounded by smart people.

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Why is it that some people seem to like to surround themselves with stupid people? Is it to make themselves feel smart? I once found myself surrounded by smart people, and could not absorb their knowledge fast enough.

enosis_

I made the mistake of selling at year end to take a tax credit before understanding my company had significant value - just not in it's original
line of business.

russ_watters

I'll elaborate later, but Tosh, it just sounds to me like you are describing one of the fundamental principles of economics: The value of anything is what people will pay for it. I think concerns about that are mostly philisophical.

russ_watters

Elaboration: No, I'd rather not. I don't really understand those markets and I don't think it is useful to take a simple concept and complicate it with an analogy when it stands just fine on its own.
Cars, movie tickets, intellectual property, a gallon of gasoline, money itself -- the value of anything is determined by what people are willing to pay for it. Don't think that this fact is unique to stocks or worse, don't let this fact fool or scare you into thinking that all of economics is just some sort of nefarious scheme.

The part that you're missing is that there are always people wanting to own parts of businesses....cars, movie tickets, etc. And being actively for sale is not a prerequisite of having value. Many companies are privately held. They aren't for sale, so people can't even choose to try to buy them. It may be difficult to assess the value of such a company, but just like that used car that you haven't sold yet, the fact that it hasn't sold yet does not mean it has no value.