9

Sorry if the below seems like a conspiracy theory. It probably is, but I probably don't understand something. (This has bugged me to no end as long as I can remember.)

Okay, so here is what I understand about the stock market?

  • The main way money enters the stock market is through investors investing and taking money out.
  • The only other cash flow is in through dividends and out when businesses go public.
    • In a Ponzi scheme, there is usually some small source of income to hide the fact that it's a Ponzi scheme. Dividends are pretty insignificant. For the purposes of this question, we will only consider non-dividend stocks.
  • When you buy stock, it is claimed that you own a small portion of the company. This statement has no backing, as you cannot exchange your stock for the company's assets.
    • For example, if I bought $10 of Apple Stock early on, but it later went up to $399, I can't go to Apple and say "I own $399 of you, here you go it back, give me an iPhone." The only way to redeem this is to sell the stock to another investor (like a Ponzi Scheme.)
  • The stock market goes up only when more people invest in it. Although the stock market keeps tabs on Businesses, the profits of Businesses do not actually flow into the Stock Market.
    • In particular, if no one puts money in the stock market, it doesn't matter how good the businesses do.

Based on the above, it seems like the Stock Market has little to do with investing businesses to create growth, and primarily grows in a similar way to a Ponzi Scheme. (Some differences include that it is Stochastic (so when it collapses, it can be blamed on luck or the economy) and it has no top operator (similar to a Pyramid Scheme)).

Am I missing something? Does the stock market create value for investors?

  • 1
    @JBKing They made money, but that was from previous investors. Many people make money off of Ponzi schemes until they collapse (and the stock market has a way to restart after every collapse.) – PyRulez Sep 12 '15 at 1:03
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    @JBKing Oh, you are talking about the companies. I'm talking about value being created for investors. (It's sort of one-sided. Businesses get money, but then don't have to give back to the stock market.) Businesses totally make money, but investors only make money from other investors, it would seem. – PyRulez Sep 12 '15 at 1:07
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    Companies create value for investors. The stock market is just a mechanism for investing. You're confused because you're holding the tail and expecting the dog to wag. – keshlam Sep 12 '15 at 4:34
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    The downvotes here seem uncalled for. OP is asking a question in earnest. Just because his/her hypothesis isn't correct isn't a good reason to downvote the question. – JohnFx Sep 12 '15 at 17:13
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    @JohnFx Agreed. The close vote is also uncalled for. This is definitely related to investing and personal finance. – Ben Miller Sep 12 '15 at 19:37

10 Answers 10

-1

You are correct that a share of stock in a company has zero intrinsic value. Even if the company typically pays dividends, there's no guarantee that it will continue to do so. A share's only worth comes from:

  1. what someone else might someday pay you for it
  2. the potential for you to gather a majority of shareholders together and demand that the company pay out some of its value to shareholders in the form of, say, dividends, stock buyback, etc.

So that's one step better than a Ponzi scheme, because in a Ponzi scheme there's not actually any value present behind the scenes, making option (2) literally impossible.

In this way company stock is similar to paper money. It's only worth something because people believe it's worth something.

Slightly better than company stock is company bonds. Since a bond is a contract between you and the company, if the company should go out of business then bondholders at least get to stand near the front of the line when the company's assets are liquidated.

I work in finance, and the vast majority of my colleagues agree that the secondary stock market (what the average citizen simply calls "the stock market") is a giant confidence game. And yet it's so profitable to believe in the value of equities the way everyone else does, that we all happily pretend these ones and zeroes we move around have actual value.

  • 3
    Hmm, no comments from down voters? Please do point out the factual inaccuracies in my post. I would be delighted to learn them. – dg99 Sep 15 '15 at 15:48
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    I'm not one of the downvoters, but I'll take a stab at it anyhow. You seem to think that the only way an argument can be bad is if it's factually inaccurate. However, an argument can be factually accurate and still be tendentious. In your case, you use a lot of loaded language ("Ponzi scheme", "confidence game", "pretend [they] have actual value", etc.) in your answer, and a number of readers probably felt that made it misleading, even if nothing in it was technically false. – Nobody Jan 27 '17 at 20:10
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    Saying the secondary stock market is a giant confidence game isn't really accurate. They represent ownership of thousands of bits of real estate, factories, brands, patents, ip, hardware, existing deals and the hundreds of other things that make companies valuable. Buy enough of a company on the open market and all of these things can be yours to do with as you please just as they can buying a house, bar of gold, or any other asset. – Philip May 22 '17 at 15:40
  • Point 2 is pretty substantial, isn't it? If Company A wants to buy Company B they have to buy all the Company B stock. – not_a_comcast_employee Aug 13 at 0:54
19

I probably don't understand something.

I think you are correct about that. :)

The main way money enters the stock market is through investors investing and taking money out.

Money doesn't exactly "enter" the stock market. Shares of stock are bought and sold by investors to investors. The market is just a mechanism for a buyer and seller to find each other.

For the purposes of this question, we will only consider non-dividend stocks.

Okay.

When you buy stock, it is claimed that you own a small portion of the company. This statement has no backing, as you cannot exchange your stock for the company's assets. For example, if I bought $10 of Apple Stock early on, but it later went up to $399, I can't go to Apple and say "I own $399 of you, here you go it back, give me an iPhone." The only way to redeem this is to sell the stock to another investor (like a Ponzi Scheme.)

It is true that when you own stock, you own a small portion of the company. No, you can't just destroy your portion of the company; that wouldn't be fair to the other investors. But you can very easily sell your portion to another investor. The stock market facilitates that sale, making it very easy to either sell your shares or buy more shares.

It's not a Ponzi scheme. The only reason your hypothetical share is said to be "worth" $399 is that there is a buyer that wants to buy it at $399. But there is a real company behind the stock, and it is making real money.

There are several existing questions that discuss what gives a stock value besides a dividend:

The stock market goes up only when more people invest in it. Although the stock market keeps tabs on Businesses, the profits of Businesses do not actually flow into the Stock Market. In particular, if no one puts money in the stock market, it doesn't matter how good the businesses do.

The value of a stock is simply what a buyer is willing to pay for it. You are correct that there is not always a correlation between the price of a stock and how well the company is doing. But let's look at another hypothetical scenario.

Let's say that I started and run a publicly-held company that sells widgets. The company is doing very well; I'm selling lots of widgets. In fact, the company is making incredible amounts of money. However, the stock price is not going up as fast as our revenues. This could be due to a number of reasons: investors might not be aware of our success, or investors might not think our success is sustainable. I, as the founder, own lots of shares myself, and if I want a return on my investment, I can do a couple of things with the large revenues of the company: I can either continue to reinvest revenue in the company, growing the company even more (in the hopes that investors will start to notice and the stock price will rise), or I can start paying a dividend. Either way, all the current stock holders benefit from the success of the company.

  • 2
    The value of a stock is simply what a buyer is willing to pay for it. This is true of everything. Although I agree with most of what you say in your answer, saying that things are worth what people pay for them does not explain why or how stocks have any value that is any different than any other sort of purely speculative trading in any kind of good. – BrenBarn Sep 12 '15 at 4:50
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    @BrenBarn That part of the question is addressed in the three questions that I linked to, but I also attempted to address it in the hypothetical story in the last paragraph. – Ben Miller Sep 12 '15 at 16:52
  • +1 for "It is true that when you own stock, you own a small portion of the company. No, you can't just destroy your portion of the company; that wouldn't be fair to the other investors." – BartekChom May 15 '17 at 16:25
11

When you own stock in a company, you do literally own part of the business, even if it's a small portion. Anyone amassing over 50% of shares really does have a controlling interest. No, you can't trade a handful of AAPL shares back to Apple for an iPod, but you can sell the shares and then go buy an iPod with the proceeds.

Stock prices change over time because the underlying companies are worth more or less and people are willing to pay more or less for those shares.

There is no Ponzi scheme because each share you own can be bought or sold on the open market. Dividends come from the company profits, not from other investors.

On the other hand, money only has value because everyone believes it has value. There's the real conspiracy.

5

With regards to "the stock market," there are actually two markets involved here:

  • The "primary market," often referred to as the initial public offering or IPO market, where companies issue new stock to raise equity capital and
  • The "secondary market," where investors trade these new shares, and maybe preexisting stock, amongst themselves.

PRIMARY MARKET

Value is created in the primary market where capital is exchanged for a residual interest in an opportunity. As a theoretical example, if a person operating solo (or with a small team) were to discover or create a breakthrough product, such as an retro-aging pill, that person likely wouldn't have the financial means to fully capitalize on his new-found idea. Others with more capital may also soon discover his idea or improve upon it and exploit it before he has a chance to.

For a real life example, a person studying at a California university during the 1990s discovered a method to index internet webpages and was approached by some students after a talk on the subject. He returned to his native southern Europe country seeking funds to develop the web-indexing business and failed to do so. Two of the students that approached him found capital readily available from investors in their campus sphere; their business is today one of the biggest in the world. They had exchanged part of their residual interest for capital to develop their business.

The primary market of the stock market works mostly same in creating value. It is also dependent upon the secondary market.

SECONDARY MARKET

The secondary market indicates the day-to-day value of an enterprise. That market allows shareholders to manage their risk appetites and the enterprise's operators to execute their shareholders' interest for gains. In most cases, a secondary market reference will be used for pricing a primary market issuance. Without that reference, capital would be allocated less efficiently creating additional costs for all involved, issuers and investors.

Consider what would happen if you sought to purchase a house and the mortgage lenders had no indication what the property was worth. This would make capital very expensive or possibly deny you access to credit. By having an indication, all involved are better off. That is value creating.

There are some large developed economies' equity markets, such as that in Germany, where many large enterprises stay privately held and credit financing, mostly from banks, is used. The approach has proven successful as well.

So why do some nations' financial markets still rely on capricious stock markets when private credit financing may do just fine in many cases? It's largely a matter of national culture. Countries such as the Netherlands, the UK and the US have long had active equity markets in continuous use that investors have trusted for centuries.

CONCLUSION

When leaders of an enterprise wish to grow the business to a large size with investment from the stock market, they aren't limited by the size of their banks' capital. Those leaders and their prospective investors will rely on the secondary market to determine values. In addition, if the leaders raise equity instead of debt capital, they are usually accorded more flexibility to take risks since shareholders usually have their own flexibility to transfer those risks to other investors if for any number of reasons they choose to do so.

Stock markets create value in many other ways. The above are the main ways.

  • 1
    Yeah, I didn't consider the information argument. – PyRulez Jun 10 '16 at 4:01
3

Let's say that you bought a share of Apple for $10. When (if ever) their stock sold for $10, it was a very small company with a very small net worth; that is, the excess of assets over liabilities. Your $10 share was perhaps a 1/10,000,000th share of a tiny company.

Over the years, Apple has developed both software and hardware that have real value to the world. No-one knew they needed a smartphone and, particularly, an iPhone, until Apple showed it to us. The same is true of iPads, iPods, Apple watches, etc. Because of the sales of products and services, Apple is now a huge company with a huge net worth. Obviously, your 1/10,000,000th share of the company is now worth a lot more. Perhaps it is worth $399.

Maybe you think Apples good days are behind it. After all, it is harder to grow a huge company 15% a year than it is a small company. So maybe you will go into the marketplace and offer to sell your 1/10,000,000th share of Apple. If someone offers you $399, would you take it?

The value of stocks in the market is not a Ponzi scheme, although it is a bit speculative. You might have a different conclusion and different research about the future value of Apple than I do. Your research might lead you to believe the stock is worth $399. Mine might suggest it's worth $375. Then I wouldn't buy.

The value of stocks in the market is based on the present and estimated future value of living, breathing companies that are growing, shrinking and steady. The value of each company changes all the time. So, then, does the price of the stock.

Real value is created in the stock market when real value is created in the underlying company.

2

It's not a ponzi scheme, and it does create value. I think you are confusing "creating value" and "producing something". The stock market does create value, but not in the same way as Toyota creates value by making a car. The stock market does not produce anything.

The main way money enters the stock market is through investors investing and taking money out. The only other cash flow is in through dividends and out when businesses go public.
&
The stock market goes up only when more people invest in it. Although the stock market keeps tabs on Businesses, the profits of Businesses do not actually flow into the Stock Market.

Earnings are the in-flow that you are missing here. Business profits DO flow back into the stock market through earnings and dividends.

Think about a private company: if it has $100,000 in profits for the year then the company keeps $100,000, but if that same company is publicly traded with 100,000 shares outstanding then, all else being equal, each of those shares went up by $1.

When you buy stock, it is claimed that you own a small portion of the company. This statement has no backing, as you cannot exchange your stock for the company's assets.

You can't go to an Apple store and try to pay with a stock certificate, but that doesn't mean the certificate doesn't have value. Using your agriculture example, you wouldn't be able to pay with a basket of tomatoes either. You wouldn't even be able to pay with a lump of gold! We used to do that. It was called the barter system.

Companies also do buy shares back from the market using company cash. Although they usually do it through clearing-houses that are capable of moving blocks of 1,000 shares at a time.

2

In general, I think you're conflating a lot of ideas.

The stock market is not like a supermarket. With the exception of a direct issue, you're not buying your shares from the company or from the New York Stock Exchange you're buying from an owner of stock, Joe, Sally, a pension fund, a hedge fund, etc; it's not sitting on a shelf at the stock market.

When you buy an Apple stock you don't own $10 of Apple, you own 1/5,480,000,000th of Apple because Apple has 5,480,000,000 shares outstanding. When a the board gets together to vote on and approve a dividend the approved dividend is then divided by 5.48 billion to determine how much each owner receives. The company doesn't pay dividends out to owners from a pot of money it received from new owners; it sold iPhones at a profit and is sending a portion of that profit to the owners of the company.

"When you buy stock, it is claimed that you own a small portion of the company. This statement has no backing, as you cannot exchange your stock for the company's assets."

The statement does have backing. It's backed by the US Judicial system. But there's a difference between owning a company and owning the assets of the company. You own 1/5,480,000,000 of the company and the company owns the company's assets. Nevermind how disruptive it would be if any shareholder could unilaterally decide to sell a company's buildings or other assets.

This is not a ponzi scheme because when you buy or sell your Apple stock, it has no impact on Apple, you're simply transacting with another random shareholder (barring a share-repurchase or direct issue). Apple doesn't receive the proceeds of your private transaction, you do.

As far as value goes, yes the stock market provides tons of value and is a staple of capitalism. The stock market provides an avenue of financing for companies. Rather than taking a loan, a company's board can choose to relinquish some control and take on additional owners who will share in the spoils of the enterprise.

Additionally, the exchanges deliver value via an unbelievable level of liquidity. You don't have to go seek out Joe or Sally when you want to sell your Apple stock. You don't need to put your shares on Craigslist in the hope of finding a buyer. You don't have to negotiate a price with someone who knows you want to sell. You just place an order at an exchange and you're aligned with a buyer.

Also understand that anything can move up or down in value without any money actually changing hands. Say you get your hands on a pair of shoes (or whatever), they're hot on the market, very rare and sought after. You think you can sell them for $1,000. On tonight's news it turns out that the leather is actually from humans and the CEO of the company is being indicted, the company is falling apart, etc. Your shoes just went from $1,000 to $0 with no money changing hands (or from $1,000 to $100,000 depending on how cynical you are).

1

The stock market exists for two reasons. It lets companies raise money to invest, and it lets company owners cash out and get money instead of part-ownership of a company when they are ready to do so. But to accomplish these goals effectively, it needs many more transactions than just those kinds of transaction, because you have to be able to find a buyer when you need one and to have a market price. So there are also a lot of transactions that are just to try to make short-term profit. But we need those transactions to provide the market liquidity to let the stock market work properly for its actual purposes.

-2

When you own a share, you also own a vote (in most cases). That vote is your means of controlling the assets and management of the company. If you had enough votes and wanted to trade a share for an iPhone or liquidate the company entirely, you could do it.

The only thing that prevents you from doing that is that companies are not set up to handle the transaction that way. Stock holders are usually trying to buy investments, not iPhones.

There are companies that have more cash in the bank than the market cap (total value) of their stock. They usually don't remain as public companies for long in that case. An investor or group of investors buy them up and split the cash. If you had enough shares of Apple, you could do that to; or, just trade one for an iPhone.

-2

You are right, it is a Ponzi scheme unless it pays all of the profits as dividends.

Here's why: today's millenials are saving a lot less, and instead they choose to be spenders. It's just that their mentality is different. If the trend continues there will be more spenders and less savers.

That means that in 20 years from now, a company might sell more and make more profits, but because there are less investors on the market it will worth less (judging by supply and demand this has to be true).

Doesn't that seem like a disconnect to you guys? Doesn't that just prove that all those profits are not really yours, but instead you're just sitting on the side making bets about them?

If I own a company from the point where it goes public and while the value goes up I hold on to it for 50 years. Let's say for 45 years it made tons of profits but never paid a cent in dividend, and then in 5 years it goes out of business. What happened to all the profits they made throughout the 45 years?

If you owned a restaurant that made a profit for 45 years and then went bankrupt you are fine, you took your profits every year because why on earth would you reinvest 100% of the profit forever?

But what if you could sell 49.9% of that restaurant on the stock market, get all of that IPO money and still keep all of the profits while claiming that you reinvest it forever? That's exactly what they do!

They just buy expensive things for personal use, from fancy cars to private jets, they just write it down as an investment and you can't see what the money was spent on because you are not a majority stakeholder, you have no power.

It was not like this forever, companies used to pay all of their profits in dividends and be valued according to that. Not anymore. Now they are just in it for the growth, it will keep growing as long as people keep buying into it, and that's the exact definition of a Ponzi scheme.

  • 1
    There are companies that know they can't grow but have steady profits and there are companies that give good dividends. – Dheer May 22 '17 at 11:03

protected by JoeTaxpayer May 22 '17 at 9:47

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