Investing- Done before but worth repeating

[moresex4me]

So when the market tanked last year the money supply tanked too?
Even if every share traded every day, this would not be true.

Of course assets are created but an economy needs sound money to pay for them.
Why doesn't the government just give everybody unlimited platinum cards so that everybody can accumulate more assets and enjoy more services and stimulate business for everybody?

Brazil did that in the '70's (not quite, but they did start printing extra money). This led to hyper-inflation, in the 1000's of percent per MONTH. You need REAL GDP growth in order to be able to safely increase your money supply.

And last year's market crash was just that: market valuation. The real wealth created by companies still existed in the real world, which is why the market rebounded in less than a year. My own company lost 60% of it's value without any corresponding loss of business or assets in the real world. Guess what? Back up about 20% over the pre-crash value now.

 

[Malibook]

Phew, thank heavens Malibook finally gets it.

Perhaps there is a glimmer of hope for me but I suspect that Fuji would not agree.

 

[Malibook]

Brazil did that in the '70's (not quite, but they did start printing extra money). This led to hyper-inflation, in the 1000's of percent per MONTH. You need REAL GDP growth in order to be able to safely increase your money supply.

And last year's market crash was just that: market valuation. The real wealth created by companies still existed in the real world, which is why the market rebounded in less than a year. My own company lost 60% of it's value without any corresponding loss of business or assets in the real world. Guess what? Back up about 20% over the pre-crash value now.

You make a lot of sense.

Company valuation, like anything, is simply what someone is willing and able to pay.
Mathematical valuation models can vary dramatically based on many things in addition to a company's numbers.

 

[fuji]

The stock will often have a pop upon such announcements but these are often not material in the grand scheme of things.

Sure a lot of things are not material in the grand scheme.

Here's the math, made simple by small numbers:

A company has $100 in cash, and 100 shares outstanding. The underlying enterprise is worth an additional $100. The company is now trading at $2/share as a consequence, each share being worth the $1 enterprise value plus $1 cash.

Plan A: The company pays a $1/share dividend. The enterprise value remains at $100 but the $100 in cash is gone, so the company is now worth $1 per share, and investors have $1 in cash in hand. Each investor still has $2 in value, but half of it has been converted to cash.

Plan B: The company spends $100 in cash to buy back 50 of the outstanding shares. The enterprise value of $100 remains, there is no longer cash on hand, and there are now 50 shares outstanding. Each share is worth 100/50 = $2 just as before. However, half the former investors now have $2 in cash instead of $2 in stock.

The distribution--who gets the money--is slightly different but mathematically it's the same. One way or the other the company has taken that $100 and distributed it to shareholders. All shareholders still have $2 in value aftewards, but after the transaction some of the $2 is stock and some of it is cash.

The stock buyback has one key advantage over the dividend: Under the buyback it is the investors who decide whether they will convert to cash, and how much of their holdings they will convert. Under the dividend some of their holdings are converted to cash regardless of what they wanted. Moreover under the buyback investors can choose which year to convert, maximizing their tax position. Under the dividend they have no choice--they receive the dividend when it is paid, paying the tax in that year, like it or not.

Any actual change in value resulting from either a dividend or a stock buyback has more to do with what the company is communicating than what it is doing financially. A company executing a stock buyback is communicating "we think you understimate our enterprise value", while one paying a dividend is saying, "we are making profit as usual". It's really a communication from management more than anything else. Sometimes it's a tax game.

No financial trick, such as a dividend, or stock buyback, will increase an investor's net worth--only move it around.

However companies can and do increase net worth of investors, as I previously described--by the physical creation of new goods and services, creating new value that never previously existed, and adding that to the value of their enterprise. We call this "profit".

 

[Malibook]

Sure a lot of things are not material in the grand scheme.

Here's the math, made simple by small numbers:

A company has $100 in cash, and 100 shares outstanding. The underlying enterprise is worth an additional $100. The company is now trading at $2/share as a consequence, each share being worth the $1 enterprise value plus $1 cash.

Plan A: The company pays a $1/share dividend. The enterprise value remains at $100 but the $100 in cash is gone, so the company is now worth $1 per share, and investors have $1 in cash in hand. Each investor still has $2 in value, but half of it has been converted to cash.

Plan B: The company spends $100 in cash to buy back 50 of the outstanding shares. The enterprise value of $100 remains, there is no longer cash on hand, and there are now 50 shares outstanding. Each share is worth 100/50 = $2 just as before. However, half the former investors now have $2 in cash instead of $2 in stock.

The distribution--who gets the money--is slightly different but mathematically it's the same. One way or the other the company has taken that $100 and distributed it to shareholders. All shareholders still have $2 in value aftewards, but after the transaction some of the $2 is stock and some of it is cash.

The stock buyback has one key advantage over the dividend: Under the buyback it is the investors who decide whether they will convert to cash, and how much of their holdings they will convert. Under the dividend some of their holdings are converted to cash regardless of what they wanted. Moreover under the buyback investors can choose which year to convert, maximizing their tax position. Under the dividend they have no choice--they receive the dividend when it is paid, paying the tax in that year, like it or not.

Any actual change in value resulting from either a dividend or a stock buyback has more to do with what the company is communicating than what it is doing financially.

No financial trick, such as a dividend, or stock buyback, will increase an investor's net worth--only move it around.

However companies can and do increase net worth of investors, as I previously described--by the physical creation of new goods and services, creating new value that never previously existed, and adding that to the value of their enterprise. We call this "profit".

Your simplistic math has no basis in reality.
First of all, any buying of such substance would dramatically drive up the price and the slice of the pie accumulated would be substantially less.
Secondly, if CSCO float increases by 100 million shares from exercised employee options, how do you come out ahead if CSCO turns around and buys 100 million shares and cancels them?
This is a transfer of wealth to the employees, not the shareholders, and given that the cash could have gone to the shareholders as dividends instead, one could argue that it is at the expense of the shareholders, who just happen to own the company.

 

[fuji]

Mathematical valuation models can vary dramatically based on many things in addition to a company's numbers.

That's true. I glossed over this by lumping it into "enterprise value" in the dividend/buyback scheme.

In reality the enterprise value is everything: What is your expectation for how much profit the company can generate, and therefore, how many future cash transfers it can make to you, via one of those buyback/dividend mechanisms?

A company that executes a dividend or buyback when it does not have the profit to back it up is essentially returning back to you your own money, it is not really growing, and it cannot sustaint that sort of behavior.

Assuming that dividends are, as people expect, paid out of profit rather than out of invested capital, then they represent real material growth in wealth.

Of course some unscrupulous managers will pay dividends out of invested capital, and there if they get too aggressive in doing that, essnetially that is a "ponzi scheme".

A profitable company though is worth more each year than it was the previous year, and every investor in such a company can be a winner. You buy it, enjoy the profits for awhile, and sell it to me, and I enjoy the profits for awhile and sell it to someone else, who goes on enjoying the profits.

No-one need lose investing in a profitable business, it is not a zero sum game. Only ponzi schemes are zero sum (or worse, negative sum).

 

[fuji]

First of all, any buying of such substance would dramatically drive up the price and the slice of the pie accumulated would be substantially less.

The math has a complete basis in realty: A company that executes a buyback or a dividend payment makes the pie smaller by the exact amount of investor profit.

The *only* want to make the pie bigger is to operate a profitable underlying business. That makes the pie bigger.

Secondly, if CSCO float increases by 100 million shares from exercised employee options, how do you come out ahead if CSCO turns around and buys 100 million shares and cancels them?

Let's say an employee has a choice of receiving $10k worth of cash or a $10k stock option. At some level this choice is made when they negotiate their employment contract.

If they choose the option the company is getting $10k in value for nothing--the employee is literally investing $10k in new cash in the business by way of their labour.

The stock issued later is therefore merely a recognition of the capital invested into the company by way of the employee's free labour. It is just exactly as though you had paid the employee $10k in cash and they had turned around and purchased the stock.

 

[Malibook]

Plan B: The company spends $100 in cash to buy back 50 of the outstanding shares.

If you can't see a flaw in this, there is no point in continuing this discussion.
I'll give you a hint, those 50 shares in your hypothetical example represent 50%.

BTW, options are not free.
They come at the expense of the shareholders and companies must now record options as an expense.

 

[Gyaos]

As long as the GDP grows, equities and real estate values will grow with it. My friend said his parents bought their house in High Park in the 1950's for $5,000 (yes, $5,000) and it is currently worth north of $500,000.

Actually, the reality is the dollar weakened from $5000.00 to $500,000.00 from 1950 to now. It's the same house. The value is based on the same 1929 fuzzy math where they allowed $10.00 for every $1.00 invested in the stock market, until the piper came calling. In real estate, a bank coughed up $9.00 in debt for every $1.00, in the hopes of investor swapping. That debt has no money behind it. Governments can reverse that trend (like the current housing collapse).

If someone pays you $500,000.00 for it, then yes, it's worth $500.000.00 at the moment the cash is in your hand, then someone else is swapping the debt behind that $9.00 x $1.00.

Gyaos Baltar.

 

[moresex4me]

Actually, the reality is the dollar weakened from $5000.00 to $500,000.00 from 1950 to now. It's the same house. The value is based on the same 1929 fuzzy math where they allowed $10.00 for every $1.00 invested in the stock market, until the piper came calling. In real estate, a bank coughed up $9.00 in debt for every $1.00, in the hopes of investor swapping. That debt has no money behind it. Governments can reverse that trend (like the current housing collapse).

If someone pays you $500,000.00 for it, then yes, it's worth $500.000.00 at the moment the cash is in your hand, then someone else is swapping the debt behind that $9.00 x $1.00.

Gyaos Baltar.

The dollar did not weaken that much, and there is growth in constant dollars for housing in the GTA, because it has out-paced inflation over the long term.

The debt CREATES the money, and adds to the money supply. It used to be the bank needed 3% cash reserves, i.e. for every dollar in cash deposited, the bank could borrow $33.33 from the B of C. I think this has been reduced to 1% to create some liquidity, but don't quote me on that.

 

[fuji]

If you can't see a flaw in this, there is no point in continuing this discussion.
I'll give you a hint, those 50 shares in your hypothetical example represent 50%.

I did the math for you.

BTW, options are not free.
They come at the expense of the shareholders and companies must now record options as an expense.

Yeah, that's exactly the point, they come at the expense of shareholders just exactly as salary does.

Note the labour that those options bought isn't free either, that labour generated value that benefitted the company.

Imagine that the company handed out options worth $10k to an employee. How is that different than if the company had paid the employee $10k, and on their own they went out and bought the $10k in options on the market?

The answer of course is that it is no difference whatsoever.

 

[moresex4me]

I did the math for you.



Yeah, that's exactly the point, they come at the expense of shareholders just exactly as salary does.

Note the labour that those options bought isn't free either, that labour generated value that benefitted the company.

Imagine that the company handed out options worth $10k to an employee. How is that different than if the company had paid the employee $10k, and on their own they went out and bought the $10k in options on the market?

The answer of course is that it is no difference whatsoever.

Actually if they did that, they would still get the $10K back. What they've given is not $10K to the employee to invest, but an option to buy $10K worth of stock at a fixed price, usually for 10 years. The employee's benefit is that they get the growth in value without making the initial investment. The company's advantage is if they buy the stock and hold it in trust, they get back their initial investment when the employee exercises, so it is cheaper than just giving them $10 grand.

 

[Malibook]

I did the math for you.

How many ways can I tell you that your simplistic math has nothing to do with reality?

If a company were to take an amount of cash equal to 50% or their current market cap and begin to acquire shares on the open market, there is not a chance in hell that they would end up with 50% of the shares.
Perhaps this is possible in your fantasy world but it has nothing to do with reality.

 

[Old Milwaukee]

My head hurts after reading all this.

My advice - Pay down your mortgage, pay your VISA bill in full, and pay off your car. Be debt free as soon as possible.

Allow a credible, well-known investor to manage your investments.

Done.

 

[red]

i don't put too muck stock in the advice in this thread

 

[wet_suit_one]

Those of you who think the market is a zero sum game fail to see that the market is a reflection of the real world of wealth.

I assume all the doubters would agree that society as a whole is "wealthier" than society was in 1900. There's more tech, more stuff and everyone has more of everything from soup to nuts.

To the extent that the market reflects that increase (say going from 20 points to 10,000 points), it is a reflection of the increase of wealth in society which is NOT zero sum.

Now, I'm ignoring all the math and just looking at the market and society as distinct wholes (which they aren't). What I hear the deniers saying is that the market does not reflect the increase in wealth in society. To which I say, how so? The two sure do seem to be linked (and I could show that they are linked but not at the moment, gotta get to work!!!).

Chew on that for a bit...

 

[moresex4me]

Those of you who think the market is a zero sum game fail to see that the market is a reflection of the real world of wealth.

I assume all the doubters would agree that society as a whole is "wealthier" than society was in 1900. There's more tech, more stuff and everyone has more of everything from soup to nuts.

To the extent that the market reflects that increase (say going from 20 points to 10,000 points), it is a reflection of the increase of wealth in society which is NOT zero sum.

Now, I'm ignoring all the math and just looking at the market and society as distinct wholes (which they aren't). What I hear the deniers saying is that the market does not reflect the increase in wealth in society. To which I say, how so? The two sure do seem to be linked (and I could show that they are linked but not at the moment, gotta get to work!!!).

Chew on that for a bit...

What he said.

 

[Malibook]

Those of you who think the market is a zero sum game fail to see that the market is a reflection of the real world of wealth.

I assume all the doubters would agree that society as a whole is "wealthier" than society was in 1900. There's more tech, more stuff and everyone has more of everything from soup to nuts.

To the extent that the market reflects that increase (say going from 20 points to 10,000 points), it is a reflection of the increase of wealth in society which is NOT zero sum.

Now, I'm ignoring all the math and just looking at the market and society as distinct wholes (which they aren't). What I hear the deniers saying is that the market does not reflect the increase in wealth in society. To which I say, how so? The two sure do seem to be linked (and I could show that they are linked but not at the moment, gotta get to work!!!).

Chew on that for a bit...

I agree with you but do you know how much is your share of the debt?
http://www.usdebtclock.org/

DOW 10,000 or whatever is no big deal to me in nominal terms.
The DOW index to gold ratio was around 40 just 10 years ago and now it is less than 10 and likely heading much lower.
How much purchasing power has the US$ lost since being taken off of the gold standard.
http://en.wikipedia.org/wiki/File:Value_of_US_dollar.gif

 

[Bear669]

And for business geeks, see this IBM summary-

Those of you who think the market is a zero sum game fail to see that the market is a reflection of the real world of wealth.

I assume all the doubters would agree that society as a whole is "wealthier" than society was in 1900. There's more tech, more stuff and everyone has more of everything from soup to nuts.

To the extent that the market reflects that increase (say going from 20 points to 10,000 points), it is a reflection of the increase of wealth in society which is NOT zero sum.

Now, I'm ignoring all the math and just looking at the market and society as distinct wholes (which they aren't). What I hear the deniers saying is that the market does not reflect the increase in wealth in society. To which I say, how so? The two sure do seem to be linked (and I could show that they are linked but not at the moment, gotta get to work!!!).

Chew on that for a bit...

(Another excellent summary above)


http://www-03.ibm.com/ibm/history/history/year_1980.html

Now THAT is wealth creation, even AFTER considering inflation!

 

[fuji]

How many ways can I tell you that your simplistic math has nothing to do with reality?

With counter-examples, that's the only way I'll accept. I won't take your word for it.

If a company were to take an amount of cash equal to 50% or their current market cap and begin to acquire shares on the open market, there is not a chance in hell that they would end up with 50% of the shares.

Sure, so redo the math with 5% instead of 50%, the numbers aren't as clean, which is why I did the math with 50% but you should be able to comprehend the point.

A 5% buyback can be executed cleanly if it's done over a period of time and with limit prices and in that case the math works out exactly.