# Does stock market create wealth?

by Tosh5457
Tags: market, stock, wealth
P: 328
 Quote by nitsuj 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.
Mentor
P: 22,239
 Quote by nitsuj 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).
P: 120
 Quote by Tosh5457 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.  P: 39 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.
P: 120
 Quote by 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. The OP clearly describes a scenario where a single entity owns all of the shares. P: 1,097  Quote by russ_watters 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. P: 1,097  Quote by BWV 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. Mentor P: 22,239  Quote by nitsuj 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. Mentor P: 22,239  Quote by nitsuj 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! P: 1,097  Quote by russ_watters 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. P: 1,097  Quote by russ_watters 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.  P: 239 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.  P: 328 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  Mentor P: 22,239 Right: the growth happens BETWEEN the transactions. Those are the "events" Tosh doesn't want to consider.  P: 120 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/...#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." Mentor P: 22,239 Ugh, I didn't see this before:  Quote by nitsuj 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. Mentor P: 22,239  Quote by 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/...#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.
P: 120
 Quote by russ_watters "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.

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