Why Do Stocks Go Up?

[. . . Yrs to Go]

Originally Posted by califdreamer

But we always come back to "who determines what the asset value is multiplied by?"

But the concept of a "multiple" distorts the analysis that goes into valuing an asset.* In any worthwhile analysis the prospective buyer will compare the asset's expected return against his cost of capital.* To the extent the return is lower, then the asset shouldn't get sold at that price, or should be sold to someone with a lower cost or expects higher returns.* As you point out, higher expected returns create higher prices as do lower financing costs but its not as arbitrary as you imply.

Besides, the question was why do stocks go up.* Investor sentiment only reflects a short-term phenomenon.* Stocks go up, generally, because companies build and invent things that people want that didn't exist before.* In other words, they create value and that value accrues to the owners of the organizations doing the building and inventing.

[HFWR]

If a company increases their market share, improves their productivity, invents the latest trinket, etc., the stock should be worth more...

But then there's the valuation issue again.

I think we've been suckered by retained earnings. And many companies are flush with cash, because they can't find a place to invest it for an acceptable ROI. There should be more stock buybacks and/or dividends...

[Mwsinron]

So does anyone have this feeling that the market will buck the trend from the last I dunno 80 years? I dont have a clue myself.

[wabmester]

Originally Posted by grumpy

I was reading thru this thread and wondering why nobody had mentioned population growth.

It's implicit in GDP growth (as opposed to per-capita GDP growth).

We live in a country with an aging population -- that means slower consumer population growth, and fewer productive workers.

Luckily, there are still some Asian countries with young and growing populations.

[wabmester]

Originally Posted by 3 Yrs to Go

But the U.S. stock market and U.S. GDP is not a closed system.* Increasingly earnings & growth are being driven by investments made internationally.* People fear the rise of the Chinese and Indian economies but their burgoning middle class is going to fuel world economic growth for the next 100 years.

You might be right. * Maybe Wal-Mart will have the Chinese build things, and then they'll sell them back to the Chinese. * But somehow I think the Chinese are smarter than that. * They know we don't build any of the stuff here, and they can probably figure out how to emulate Wal-Mart locally.

Productivity (the be all and end all of wealth creation) has been accelerating in recent decades, not slowing down.

I've heard that, but I don't really understand it. * There has to be a limit to how much work we can squeeze out of one person, right? * Are we approaching that limit? * No idea. *But a lot of people here probably felt burned out by work.

[wabmester]

Originally Posted by unclemick2

I usually stick with Bogle - being a Boglehead(mostly):

Div + economic growth(including Inflation) *+ P/E( Mr Market's valuation).

The only problem I have with the Gordon Equation is that it looks backwards to predict forward growth. We have leading indicators that predict forward GDP growth, so why not use those?

For example, economists have predicted that the housing bubble will knock 2 points off GDP growth.

And other economists have predicted that the demographic bubble will knock another 2 points off.

We're usually growing GDP around 4%, right? What's 4 - 2 - 2?

[sgeeeee]

Why Do Stocks Go Up? . . .

I gotta stick with, "for the same reason the chicken crosses the road." When you've got an answer that can't be proven wrong, I say, "stick with it."

[eridanus]

Two words: Pyramid scheme.

[wabmester]

Bummer.* *Ha deleted his post about Triumph of the Optimists, but I think I'll have to find that book.

Anyway, it led me to this interesting quote from Steve Wisdom:

My son loves history books, and today I read to him about Elizabethan theater. What caught my eye: In those times, a ticket to see a Shakespeare play at the Globe cost 1 or 2 pence, and a 'pint of good ale' cost 2 pence. Whereas now a Broadway ticket is 10 or 20 times as expensive as a taproom beer. So the play/beer ratio has risen about 20-fold.

Beer is a capital-intensive commodity; theatre loads heavily on human capital -- ingenuity, creativity, etc. Shows in a nutshell why stocks, which are essentially a securitization of human capital, always go up in the long term relative to physical goods.

That's an interesting take.* *Stocks = an investment in human capital, and humans will always give you a better ROI than capital assets.* *I'm not sure I buy it, but I'll have to ponder it.

[saluki9]

Originally Posted by wab

So, in the short term price changes are basically a popularity contest.

Absolutely

That's why I have a lot of admiration for successful traders, and yet ALL of my long term stock market investments are into index funds.

In the short term prices are less a function of economic value and much more influenced (almost 100% IMHO) by supply and demand. I have been witness to the success of many short term traders who have a tremendous ability to understand and act on short term supply / demand inequalities and use that to their advantage

On the same breath the data shows that in the long term "expert" stock pickers prove to be nothing more that what could be expected from a random sampling of all active managers. Which is why I do not believe in active mangagement


As for why stock prices go up in the long run, how much time do we have?

[ladelfina]

It's interesting to think about why a company would be valued at something other than the value of its assets.* The only answer I can see is investors are guessing what other investors are thinking about the company and its stock value.

I am not at the level of financial/math understanding as some of you seem to be, but I found this phrase startling.. I'm surprised it got any traction!

I think you guys are over-analysing it... Thankfully, 3 Yrs to Go stepped in with exactly my thoughts:*

But how do you value an asset?* Pretty much the same way you value a stock, by discounting expected future cash flows.

Stocks go up, generally, because companies build and invent things that people want that didn't exist before.* In other words, they create value and that value accrues to the owners of the organizations doing the building and inventing.

Companies aren't in business in order to remain static; the majority make a profit of some kind. Investors want to buy into the future profit stream, just like bond buyers want to buy into an income stream.

I must say I don't get the point of looking that much at 'assets'. With most things of any value, the whole is greater than the sum of the parts. When you buy a pair of pants, you're not buying 10,000m of cotton thread, a plastic button, and a metal zipper, you're buying valuable body-covering "pants-ness" into the future. You can take .02 of flour, a .10 egg and make it into fresh pasta "worth" a few dollars...

It's about the positive power of transformation. Also, sustainability, contacts, distribution. If you buy Coke you are buying all that intangible stuff.. all part of the likely power of Coke to continue making products that people will buy.

The desire to make and transform 'stuff' and the profitability of doing so may experience a lull here and a Kim Jong Il there but it can never be completely extinguished as long as the world survives. Human nature will keep stoking the fire.

-------------------
I like the quote posted by wab.. I sorta buy it, but in most parts of the world, I'm sure beer is expensive compared to indigenous local entertainment. A Broadway show is a ridiculously over-produced anomaly; there are plenty of free poetry slams and jam sessions around these days, and an off-off B'way ticket can be had for $10 (which I dare say at this point might be the same as the price of a Heineken some places in NY).

More important, who knows if in the Westernized world there will come a time again when talent is cheaper than basic resources like food..??* ..we ignore that this is currently still the case in many places.

[brewer12345]

I have been exposed to various theories as to why equity markets as a whole go up over time, but I can't say that I have a satisfying explanation except that the individual equities that make up the indexes go up over time.

So why do indvidual stocks go up? In the short term, sentiment, random influeces, space aliens, and Gawd knows what moves stocks around. Over the long term (years) stocks go up because the present value of the discounted cash flows they produce increases. So what does that phrase mean? Over time, companies tend to grow their businesses and figure out how to operate them more efficiently. This increases the amount of cash they generate, which can be used to reinvest in the company, buy back stock, pay dividends, pay off debt, or pile up a warchest of cash. All of the above enhance shareholder value, some more than others.

[slepyhed]

Originally Posted by wab

Productivity (the be all and end all of wealth creation) has been accelerating in recent decades, not slowing down.

I've heard that, but I don't really understand it. * There has to be a limit to how much work we can squeeze out of one person, right? * Are we approaching that limit? * No idea. *But a lot of people here probably felt burned out by work.

In the olden days, you hired a high-school drop-out to run a press and stamp out frying pans all day (and this was considered a good job). You increased productivity by making the machine run faster, or maybe building a machine that stamps out four frying pans per cycle, etc.

Then some smart guy figured out that the press operator is doing repetitive things all day long, so more machines were built to feed the material, remove the product, package it, etc. Now you need just someone with mechanics skills to maintain all these robots. Even so, that one skilled mechanic and all the robots make more frying pans than a whole room full of high-school dropouts ever could.

But manufacturing in this country has been on the decline for my whole life (born in 1972). Have we reached the limit of just how many frying pans the world needs? Not yet, they're just being made elsewhere. Maybe there will come a day when one person floats around in a pan-manufacturing satellite producing enough pans to satisfy the entire human population's demand for frying pans. This guy's job will be to turn a dial to regulate the pan production rate, and worry about when someone is going to wise up and hook up the knob to the internet so it can be adjusted remotely.

[ladelfina]

naah.. we'll just be cooking our food in nuclear-powered ovens, then we'll paying someone to figure out new disposal methods for transuranic waste.

[wabmester]

Originally Posted by 3 Yrs to Go

Stocks go up, generally, because companies build and invent things that people want that didn't exist before.* In other words, they create value and that value accrues to the owners of the organizations doing the building and inventing.

I find this the most compelling argument so far.* *For companies producing commodity widgets, their growth is limited by demand, regardless of how much of their earnings they reinvest.* But for companies that leverage their human capital smartly, by continuously creating new products and new demand, their growth is basically limitless.

So, the spoils should go to the country with the most innovation, and there should be a high correlation between equity growth and an educated populace, right?* *I'll have to dig into this some more.

Interestingly, I compared the price growth of Phillip Morris (Altria) -- a commodity maker of tobacco products with the growth of 3M, who's stated mission is basically "to make things that didn't exist before."



And that's just price growth without dividends!

BTW, MO is supposedly the only stock that Bernanke owns.

[ladelfina]

mm yeah.. too bad the heroin/cocaine/marijuana industries aren't figured into to national economic figures
Can you say "28,000% markup"?

Really, you can paint any kind of scenario, and there will be someone who wants something -- anything -- a little more fervently than the next guy. And someone will profit off of that differential by providing it.

[kcowan]

Why did my AAPL go from $13 to $78? Because they invented iPod and iTunes and everyone wanted it. A mania set in and soon everyone wanted their shares too. Then we sold most of our holdings (1100/1400) because it was just too big in size for our portfolio. Obviously others did too because the stock retraced down to $50.67 on July 14th.

Then they posted another record quarter and showed that they were still gaining iPod share (in spite of competitive threats) and that they were now gaining market share in PCs (+12% shipments) when the traditional PC business was flat (and market leader Dell was declining). They bounced back to $69.59 on Aug 3rd. Then portfolio balancing started again with more selling. Of in the case of traders, profit-taking.

What is AAPL worth? Whatever the market will pay for it!

[brewer12345]

Originally Posted by wab

I find this the most compelling argument so far.* *For companies producing commodity widgets, their growth is limited by demand, regardless of how much of their earnings they reinvest.* But for companies that leverage their human capital smartly, by continuously creating new products and new demand, their growth is basically limitless.

So, the spoils should go to the country with the most innovation, and there should be a high correlation between equity growth and an educated populace, right?* *I'll have to dig into this some more.

So companies that don't innovate on something should never show any growth? *Doesn't compute. *How do you explain the banking and insurance industries, then?