From: Kevin Bluck (kevin.bluck@mail.com)
Date: Tue Sep 10 2002 - 10:41:24 MDT
>Why? The share [presuming no dividends] is still just a piece of paper,
>doing nothing for me. Why would I want a company's stock more just
>because they're growing? Why would I want to keep it more? Why would
>other people want to buy it from me more?
I think the source of your confusion is that you are trying to relate a
stock's value to what that stock can do for you *right now*. But, stocks
are not valued on "right now."
Theoretically, the "true" value of stock can be calculated as the sum of
the discounted present values of an infinite stream of dividend payments
from now into the endless future. It is true that some companies don't pay
dividends "right now", or even don't plan to for the next year or three or
ten, but there is nevertheless an *expectation* that someday, they will.
Of course, it is impossible to know with certainty what the future holds.
This means that despite the nice tidy theory, stocks can't really be valued
on a rational, mathematical basis. Instead, stocks are valued on investors'
*expectations* of future growth, which in turn they expect will produce
returns in the form of dividends. The fact that a company is not paying
dividends or even losing money "right now" may have an influence over those
expectations of future value, which can be seen in short-term price
fluctuations based on breaking news, but certainly is not the entire basis
for the market value of stocks.
Now, you might argue that most investors do not perform this calculus when
they buy stock, and you would be right. But then, do most people take pains
to compute the "rational" value of *anything* they buy? Houses? Cars?
Appliances? The fact is, most buyers of most things have no idea how to
compute the things' "true value." That doesn't make the things they buy
necessarily valueless.
It is true that speculators, through market manipulation or simple force of
numbers, can influence stock prices to irrational levels (both high and
low) over the short term. However, historically speculation has little to
no effect on the long-term prospects for any given stock. Growth of stock
prices over the long term generally tracks very closely to the growth in
earnings of the underlying company. If, for example, you compare the
long-term growth of the Dow Jones INDU average against the long-term
earnings growth of its constituent companies, you will find that the two
numbers are typically quite close, once you eliminate the irrational
short-term swings.
This expectational basis for value can be simultaneously rational and
irrational. The "dot-com bubble" was originally based on the idea that
these new dot-com companies, although they were losing money "right now",
might someday change the face of the economy, and eventually multiply into
huge revenue-generating powerhouses, transforming every single share into
dozens or hundreds of shares at some time in the future, each share paying
a nice recurring dividend. Expectations of this future profitability were
high, foolishly high in hindsight. As the mania grew, people started
irrationally paying premiums for stocks that even in the most wildly
optimistic scenarios would never generate enough profits (dividends) to
produce a return justifying the price. Sometimes, crowds simply get out of
control. Of course, eventually mobs exhaust themselves, and reality
re-asserted itself. Share premiums returned to more rational levels.
Nevertheless, ultimately what people are buying is not bits of paper, but
the expectation of receiving returns from future profits. That is the
underlying "intrinsic value" you are seeking. The fact that sometimes the
overheated public grossly overvalues (or undervalues) those expectations of
future profit-driven returns does not make stocks inherently worthless and
equivalent to "chewed-gum certificates". The difference is that nobody
expects there to be any possibility whatsoever to receive future dividends
from chewed gum.
--- Kevin
This archive was generated by hypermail 2.1.5 : Sat Nov 02 2002 - 09:16:55 MST