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

  1. Oct 28, 2008 #1
    Stock market - no connection company/share - money isn't lost?!?

    I've spoken to some hobby stock market "users" but none of them could convincingly explain the basic share system without ending up in circular arguments.

    1)
    My impression is that there is no logical connection at all between stock prices and the actual company!? It is only because some analysts (who therefore earn money) claim there is, so it seems just a psychological craze.

    OK, one real connection is the right to vote about the company politics, but if one share holder keeps like 51% then the other 49% are valueless?
    And I know sometimes divident is a real value of a share, but some shares don't even give divident?

    Most people told me shares have a value because people want them and people want them because they have value. That's a circular argument. I could sell stones to people and claim they will find others who want to buy them. Obviously that wouldn't work, but apparently it does if you call the stones "shares" and make them virtual?

    Theory: A share without divident, where someone intends to keep 51% of the share, is completely valueless

    2)
    I told the people that with every transaction the total sum of the money is constant (i.e. take bank accounts of all participants and add their deposits - please add no other numbers; in the end the supermarket accepts money only). So whatever money someone wins, another one has to lose. Therefore the more experienced half of traders at the stock market wins money and the less experienced half loses money.

    Theory: So I better not enter the stock market without being above average in knowledge?!

    Can someone comment on this? But please refer to my arguments and do not restate the circular arguments.
     
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  3. Oct 28, 2008 #2

    mgb_phys

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

    The share price is a measure of the future valueof the company - if you think the company is going to do well then more people will want to own it and so the shares go up. If you thinkthe company will go bust then the shares will eventually be worthless and the valuewill go down.

    Most owners of shares don't want to run the company - they just want the managers to do whatever it takes to make the share price go up.
    This is a problem since the share holders are only concerned with what will increase the value this year so they can sell on the news of improved profits, if the company goes bust next year because of the changes thats no loss to them.

    Dividends can also be a bad thing for a company - if you are pay a dividend you are saying, we can't think of anything to do with this money, like invest in new products or technology which will make a profit. Here take it and invest it in the shares of oither companies.
    Thats why companies like Apple don't pay dividends, they are ussually paid by utilities / monopolies that have fixed markets and no competition.

    If you have an expectation that something will go up in value in the future you can sell it for a profit, wether its shares, art, antiques, houses, rocks or tulip bulbs.

    Not if you think people wil want to buy it for more in the future.
    There is another way to cash in a share - if another company wants to buy that company.

    Not quite. The stock market isn't a real market in that the value of shares can go up and down without anyone buying them.
    If you bought a house 20years ago and suddenly the area becomes fashionable and houses cost $1M are you a millionaire? Yes if you sell - but if you don't sell then you haven't gained anything. Similairly if houseprices drop 50% have you lost $1/2M ?

    It's the same with stock markets - "the $Billions wiped off shares" in the headlines isn't real money - it never existed.
     
    Last edited: Oct 28, 2008
  4. Oct 28, 2008 #3

    russ_watters

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

    You are essentialy correct, but it isn't just stocks: in a market economy, prices of everything are set by supply and demand. Someone wants some stock, someone else has stock to sell, they negotiate over price, and come to an agreement.

    Now, just like when you buy a car, there is an intrinsic value to the metal and labor that went into building it, so too with stock: if you own a piece of the company, you own a piece of the assets of the company.
    The vote isn't a very big benefit, but no one buys stock just for the purpose of voting anyway. People buy stock to make money - voting is just a way to control how the company makes you that money. Small investors don't have the time to get that deep into the companies they invest in anyway - they let the board of directors run it. It works out pretty much the same anyway: instead of voting to make a company well run, you pick stocks of companies that are well run. You could say, you vote with your stock purchase.
    Correct. A divided is essentialy sharing of the profit of the company.
    Welcome to Economics 101. Yes, it quite obviously does work.
    Shares, cars, baseball cards, bread, whatever. Nothing "virtual" about any of them. I'm not even really sure what you mean by that word.
    Speaking of circular arguments, that one is just wrong at face value. A stock that sells for $1 has a value of $1 by definition. You can't just choose to call it valueless.
    It is only zero sum if those are the only two transaction types, but they aren't. It isn't just one person buying stock and another person selling stock. You also have a person giving the company time and the company paying them for it. You also have the company giving a person a car and the person paying them for it.

    And not all of those transactions are zero sum either. The person giving the company time didn't pay for that time, they get it free with life. So they are generating money from scratch. And the company doesn't sell cars for exactly what it costs to make them, it makes a little profit (it has to, otherwise, companies could never grow). Now all those transactions go together and add to the value of the company.

    Oh, and being zero sum doesn't necessarily mean there is a winner and a loser: If I buy $1 worth of stock from you, $1-$1=0, but $1=$1 too. We both made out exactly the same in the transaction.
    No. The key here is the free time thing from above. Because time is value added to the economy, the economy will always increase in value over the long term. Therefore, the average of all companies will always increase in value over the long term. So if you select a prudent investment, you can be confident that over the long term, it will make money. In fact, over any 15 year period in the past 100+ years, money invested in large stocks (ie, the Dow 30 or S&P 500) produced a positive return. And over it's history, it has averaged about 8% a year.
    Heh - we get comments like that a lot here. What you need to understand is that just because you ask a question, that doesn't mean the answer will directly address the question. Why? When you don't understand something, oftentimes that means that you don't even know what questions to ask or how to ask them. So we need to correct your questions before we even answer them.
     
  5. Oct 29, 2008 #4
    Re: Stock market - no connection company/share - money isn't lost?!?

    Hmm, that's the unsatisfactory argument I got before. I try to explain myself better:
    Why does a value go up? Because people will want to buy it for more money? Why do they want to buy it? Because they think someone else will pay even more?
    Well, that's the circular argument again. What is eventually the real value of a share?
    I mean by that circular argument I could sell stones to people and they would happily trade them?! I could say the stones relate to my health and provide news and predictions.

    Real goods have real value. Some people buy art to really keep it and look at it. Houses you can live in. Tulips are also nice to watch and keep.
    Just shares are bought to get rid of them again.

    Let me sum up:
    The final real value for a share so far is
    - divident (if existent)
    - voting right (if no-one else secures a majority)

    These billions are not exactly wiped off? I mean someone received these billions when people bought the shares. By my argument (2) money actually never disappears?!
    Now that guy sits there and laughs: "Why did you give me money for no real value?"
     
  6. Oct 29, 2008 #5

    russ_watters

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

    It may be circular, but it is how it works. And quite clearly, it does work.
    Sure! If you can convince people to want them. Good luck!
    Like we said, shares are a piece of ownership of a company. Companies have real value.
    The guy who sold was able to predict the future than the guy who bought. Neither thinks they got scammed, though, if they understand how the stock market works and why.
     
  7. Oct 29, 2008 #6
    Re: Stock market - no connection company/share - money isn't lost?!?

    I know that system, but still there must be a logical reason for someone to demand something.

    I would understand if I could go there and say: "Well, here is 40% of the shares. I want that factory over there for a big party". I think you can't do that. So what is that paper worth that say "Well, done. You own 40% of the company", if there is no way whatsoever to make a change?

    That's different things. A car you can drive. Bread you can eat. But shares you can only get rid off to someone who also wants to get rid of them?

    Hmm, I sort of heard arguments like this before, but it's not quite what I thought of in my suggestion.
    Please let me play the following game and tell me at what very instant I would be surprised:
    I write down the names of all existent share holders and ask at their banks for the dollars on their account. I plainly add all these numbers. I do this every minute. For example one day I have the numbers A,B,C another day the numbers A+T,B-T,C. The sum is always constant as one transaction is for one price only. I do not care about shares or time or whatever, but I just play my game. Can you tell me the point at which the sum of my numbers will not be constant anymore? Please do not modify my game as that's what someone could theoretically do for real.

    But it should be as close as possible to my way of thinking. I'm teaching students maths and I always try explain everything in their words. You know much more about stock market than I do. I maybe you can rephrase the book knowledge into my suggestions.
    For example the "game" from above can't be wrong. That's something I could do, even if someone claims it's stupid. But what will be the outcome of this stupid addition? Will I show that the total amount of money is constant?

    (Well, you could argue that the country prints new money. Then I would say the total amount of money is a linear function of time which corrected for inflation is again constant.)
     
  8. Oct 29, 2008 #7
    Re: Stock market - no connection company/share - money isn't lost?!?

    It used to make sense before too many people entered the market just for speculation. I'm not surprised that so many people lose money with shares, as the real value of shares is far below the market prices. Analysts know that, but they won't tell that secret as they make a good living on it.

    So the answer is "yes"? All the money that people have lost, someone else has gained (earlier)?
     
  9. Oct 29, 2008 #8

    Dale

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

    Why would the numbers be A,B,C one day and A+T,B-T,C another day? In other words, why would T dollars go from B to A in your game?
     
  10. Oct 29, 2008 #9

    Astronuc

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

    Too late - it's been done. Ever hear of 'pet rock'? :rolleyes:

    http://en.wikipedia.org/wiki/Pet_Rock

    And people fret about the stock market.
     
  11. Oct 29, 2008 #10
    Re: Stock market - no connection company/share - money isn't lost?!?

    Oh, that's because someone bought an apple or a share from somebody else. In my game I disregard the value that people attribute to apples or shares and just add the money.
     
  12. Oct 29, 2008 #11
    Re: Stock market - no connection company/share - money isn't lost?!?

    Ah OK. That sort of answers my question.
    Seems like stock market is - similarly - nowadays mostly a psychological phenomenon having nothing to do with economical reasoning. And as soon as a new generation gets the hang of it, people will notice that shares are completely overpriced. Crashes come since trading with nothing is bizarre and volatile.

    Don't get me wrong. I do see that there is some intrinsic value to shares (divident, voting), but to me it seems that most of the price fluctuations are rather a psychological hype.

    Of course, when you buy "real goods" such as oil or gold, then that's a completely different story. Because there in principle you can claim your belonging even if it's only 40% of the total.
     
  13. Oct 29, 2008 #12

    Dale

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

    If you disregard the value of the apples or shares then what is the value of the dollars?

    The dollars themselves have no intrinsic value. It is only the ability to exchange dollars for things of intrinsic value that gives any value to the dollars. I.e. the value of a dollar is only as an agreed-upon medium of exchange between other things with intrinsic value.
     
  14. Oct 29, 2008 #13
    Re: Stock market - no connection company/share - money isn't lost?!?

    I know all this. OK, then let be more clear and please try to understand what I mean.
    I play my game. I add all the bank accounts no matter how stupid that is. Will the sum I get always be constant (all participants are included and state money printing, i.e. inflation, is corrected for)? Yes or no? No digression please.
     
  15. Oct 29, 2008 #14

    mgb_phys

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

    No the economy is not a zero sum game, like a game of poker where for someone to gain someone has to lose.
    It is quite possible (and generally happens) for the overall economy to grow.
    As a simple example, if you spend $100 mining a ton of nickel and sell it for $200 to someone who turns it into batteries and sells them for $1000 to somebody who puts them into laptops and sells them for $2000 the economy has gained real value.
    The nickel doesn't have a value of $100/ton it has grown in value by people adding extra work and skill.

    Note "real goods" such as oil or gold are often worse than shares. Since they can be bought or sold they have a price which varies as a result of future market expectation rather than their use.
    Especially gold which is bought as an alternative to holding an individual currency will have gone up during the crisis. You might want to buy gold if you think the dollar is going to fall, if you think your bank is going to go bust, if you think your small country's local currency is going to become worthless. Because of this extra demand gold price will rise.
     
  16. Oct 29, 2008 #15
    Re: Stock market - no connection company/share - money isn't lost?!?

    I find it hard to understand why people do not refer to the question and recite book knowledge. I will try to explain your example in my model. Please refer to it:
    Code (Text):

    Person
    A           B          C         D          E
    0$          100$     200$    1000$    2000$   <-B buy mining equipment from A
    100$       Ni        200$    1000$    2000$   <-mining by B
    100$       200$    Batt      1000$    2000$   <-battery production by C
    100$       200$    1000$    Laptop  2000$   <-laptop production by D
    100$       200$    1000$    2000$   Laptop  <-laptop sold from D to E
     
    Note that the sum of dollars in each row is constant. That's exactly my "game".
     
  17. Oct 29, 2008 #16

    CRGreathouse

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

    Man, you're going to have a ton of fun with velocity...
     
  18. Oct 29, 2008 #17

    CRGreathouse

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

    If someone will buy a share of stock from you, its value is what someone will pay you for it. If no one is willing to buy it from you, or you're not willing to sell it, you get:
    • Dividends as long as the company pays them
    • Voting rights, if your share is voting class
    • The present value of the salvage value of the company, minus its liabilities, divided by the number of shares of stock, at the time that it is dissolved.
     
  19. Oct 29, 2008 #18

    CRGreathouse

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

    Maybe an example will help.

    A company has an IPO and offers a million shares of stock at $20 each; all are sold.
    Paper value: $20 million = 1 million * $20
    Money that has changed hands: $20 million
    Total paid (by current investors) to buy the stock: $20 million

    The company spends $5 million on R&D; investors don't care one way or the other. 50,000 shares are sold at $20 apiece, bought by other investors.
    Paper value: $20 million = 1 million * $20
    Money that has changed hands: $21 million
    Total paid (by current investors) to buy the stock: $20 million

    The company announces that they have a new product that's come out of R&D. Investors think it will be profitable and buy 80,000 shares (from other stockholders) at $25 apiece.
    Paper value: $25 million = 1 million * $25
    Money that has changed hands: $23 million
    Total paid (by current investors) to buy the stock: $20.16 million
     
  20. Oct 29, 2008 #19

    Dale

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

    This is an excellent example which shows exactly how an economy is not a zero sum game. The sum of each row is not constant
    $3300
    $3300 + Ni = $3500
    $3300 + Batt = $4300
    $3300 + Laptop = $5300
    $3300 + Laptop = $5300

    The value of the economy as a whole has increased and now includes the value of new assets/goods that have real intrinsic value that is reflected in their price. Thus, even if you have a fixed supply of money the value of an economy is not a zero sum game.
     
  21. Oct 29, 2008 #20
    Re: Stock market - no connection company/share - money isn't lost?!?

    Please read my post carefully. I sum up dollars only. Nothing else and I said before no matter if it makes sense. Just the 3300$ dollars for my game.

    (the reason I sum up dollars only is because I want to buy chocolate after and the supermarket accepts money only - no laptops)

    So is the sum of dollars constant or not?
     
    Last edited: Oct 29, 2008
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