Why Do Stocks Go Up?

[brewer12345]

Originally Posted by wab

Well, banks don't usually grow much, do they?* *They have a high dividend payout ratio, and I'd be surprised if they grow much faster than the money supply.

Insurance companies make most of their money by investing their float, right?* *So, they should grow as fast as inflation + the growth of their investments.

Go look at the charts of a few banks, insurers, etc. for example, chart CBH and AF over the last 10 years. For insurers, try PGR and CGI. All four are in mundane businesses that haven't significantly changed in decades.

And I would suggest you pick up a finance textbook ior two if you really want to know about the theoretical underpinnings of this stuff. Brealey & Meyers' book is a good one.

[wabmester]

Originally Posted by brewer12345

Go look at the charts of a few banks, insurers, etc.* for example, chart CBH and AF over the last 10 years.* For insurers, try PGR and CGI.* All four are in mundane businesses that haven't significantly changed in decades.

But have the banking/insurance sectors (as opposed to individual companies) grown faster than the economy over time?

And I would suggest you pick up a finance textbook ior two if you really want to know about the theoretical underpinnings of this stuff.* Brealey & Meyers' book is a good one.

Can you give me a one-liner summary? How do banks grow faster than the difference between the interest they get from loans and the interest they pay on deposits?

[brewer12345]

Originally Posted by wab

But have the banking/insurance sectors (as opposed to individual companies) grown faster than the economy over time?


Can you give me a one-liner summary?* *How do banks grow faster than the difference between the interest they get from loans and the interest they pay on deposits?

The financial sector has become one of the most competitive if not THE most competitive part of the US economy over a period of decades.

My mention of a corporate finance text was in regards to stocks in general, not necessarily banks. I could bore you for hours on the subject of depository institutions. Suffice to say there are many, many levers these entities can use to increase shareholder value.

[HnE]

Stocks go up because corporations grow their earnings and create wealth. Simple enough?

[califdreamer]

"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."

Originally Posted by ladelfina

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

I think you're missing the point. *I wasn't saying stocks should be priced according to the corresponding company's liquidation value. *I'm saying something else is in play if the value is something other than that. *What is the additional value of a company (and its stock) if its something other than the stuff it owns? *Investor sentiment will make that determination. *When a stock buyer is willing to pay 15 times earnings for Stock x, that becomes the value of the stock. *That's a decision reached by the buyer and the seller. *Both are investors and their sentiment determined the selling price. *

Even if the population grows, international markets open up more, the GDP grows, productivity increases, dividend yields rise, expectations of future cash flows grow more optimistic and alternative investments become less attractive it will be up to investors to determine how much they are willing to pay for stocks. *

[ladelfina]

Even if the population grows, international markets open up more, the GDP grows, productivity increases, dividend yields rise, expectations of future cash flows grow more optimistic and alternative investments become less attractive it will be up to investors to determine how much they are willing to pay for stocks.

ok.. but if all this happens, will a stock really "go down"? Not in the short term but beneath levels before the scenario you describe? Hard for me to conceive. The "something else in play" is everything in the long run, and little to nothing in the short term, I guess is what I'm saying. Though it can have an effect, emotional sentiment only goes so far in denying fiscal reality.

[wabmester]

Originally Posted by brewer12345

The financial sector has become one of the most competitive if not THE most competitive part of the US economy over a period of decades.

I'm just trying to get an intuitive handle on the primary drivers of equity growth. * Obviously, increasing market share and increasing productivity are drivers, but it's not clear to me why the US should be able to consistently outperform other countries in that regard, and it's not clear how to predict future growth due to those factors.

If innovation is a factor (and I'm sure it is for banking and insurance), it seems like that should correlate strongly with growth in better educated countries.

Let's look at it this way: buying the total US market is attractive to people because it requires no analysis. * You're simply investing in GDP growth of the US. *So, you only need to convince yourself of one thing: that GDP growth will continue at something like the historical rate.

I can't convince myself of that. * So, I'm looking for countries and sectors that should grow faster than US GDP.

Do you think insurance and banking will grow faster than the economy? * *If innovation is really an important factor, then GOOG is a value stock, right? *

[brewer12345]

Originally Posted by wab

Do you think insurance and banking will grow faster than the economy? * *If innovation is really an important factor, then GOOG is a value stock, right? *

I think you are completely barking up the wrong tree (heck, wrong forest). Be that as it may, I will disclose that I am heavily invested in banking and insurance (and reinsurance) at the moment and I expect these sectors to do very well in the next 12 to 18 months.

[califdreamer]

Originally Posted by ladelfina

ok.. but if all this happens, will a stock really "go down"? Not in the short term but beneath levels before the scenario you describe? Hard for me to conceive. The "something else in play" is everything in the long run, and little to nothing in the short term, I guess is what I'm saying. Though it can have an effect, emotional sentiment only goes so far in denying fiscal reality.

Hi delfina,

I probably came across like I wanted to start a shooting match *

I agree in the long run stocks will continue to go up because, IMHO, all of the good trends will continue (GDP up, productivity up, etc.). *As long as investors are valuing investments as they have in the past, the good news will increase stock values. *Whether or not investor sentiment is rational, emotional or some combination of the two is for someone far smarter than me to figure out.

[haha]

Originally Posted by califdreamer

I agree in the long run stocks will continue to go up because, IMHO, all of the good trends will continue (GDP up, productivity up, etc.).* As long as investors are valuing investments as they have in the past, the good news will increase stock values.* Whether or not investor sentiment is rational, emotional or some combination of the two is for someone far smarter than me to figure out.

If I understand correctly what you are saying, it is very similar to Tobin's Q, introduced into the literature by James Tobin in 1969. Q is defined as the market value of a diversified set of securities divided by the net worth of these same companies, with assets stated at replacement value.

The effect of this is to cancel "goodwill". The theory behind this is that while their can be goodwill for an individual company, in a competitive capitalist economy the concept is nonsensical for all companies since whatever economic advantage that lay behind the goodwill would be competed away.

High Q, as pertains at present, suggests an overvalued market, low Q OTOH suggests undervaluation.

Q has been high for so long that many feel it is no longer relevant. I disagree. Things can stay odd for a long time. Remember going around looking like polyester idiots in the 70s? For 10 years!

To me it seems evident that investments will be made until at equilibrium the marginal investment commands a return equal to the marginal cost of capital. At that point, the value of firms taken in the aggregate should approach the net worth of the replacement value of their assets.

Ha

[califdreamer]

Originally Posted by HaHa

If I understand correctly what you are saying, it is very similar to Tobin's Q, introduced into the literature by James Tobin in 1969. Q is defined as the market value of a diversified set of securities divided by the net worth of these same companies, with assets stated at replacement value.

The effect of this is to cancel "goodwill". The theory behind this is that while their can be goodwill for an individual company, in a competitive capitalist economy the concept is nonsensical for all companies since whatever economic advantage that lay behind the goodwill would be competed away.

High Q, as pertains at present, suggests an overvalued market, low Q OTOH suggests undervaluation.

Q has been high for so long that many feel it is no longer relevant. I disagree. Things can stay odd for a long time. Remember going around looking like polyester idiots in the 70s? For 10 years!

To me it seems evident that investments will be made until at equilibrium the marginal investment commands a return equal to the marginal cost of capital. At that point, the value of firms taken in the aggregate should approach the net worth of the replacement value of their assets.

Ha

Yes, it sounds like the Q factor is essentially supply and demand or investor opinion or whatever you'd like to call it.* Investors will pay more or less than the replacement value of the assets of the company.*

I'm unclear on your last paragraph.* Can you translate please?*

[haha]

I am referring to investments in physical capital at the level of the firm,*not to stock investments by outside inverstors.

I agree with your synopsis of "Q"

Ha

[Nords]

Originally Posted by wab

I'm just trying to get an intuitive handle on the primary drivers of equity growth. * Obviously, increasing market share and increasing productivity are drivers, but it's not clear to me why the US should be able to consistently outperform other countries in that regard, and it's not clear how to predict future growth due to those factors.

Maybe we're just not thinking about this clearly enough.

Maybe you need to transfer this debate over to M*'s Vanguard Diehards board, where those indexing zealots and Hokus can help straighten out our valuation thinking...

[ladelfina]

I probably came across like I wanted to start a shooting match

no hard feelings, califdreamer.. I may've been feeling frustrated since I am trying to see the forest rather than the trees. (Not "why does stock X go up?" or "why should American stocks go up?" or "why do bank stocks go up?" )

Ha said:

Q is defined as the market value of a diversified set of securities divided by the net worth of these same companies, with assets stated at replacement value.

Gotcha. But that seems to be completely indifferent to the real potential of these assets (in certain hands, with certain history, distribution channels, R&D in the works, etc.).* *All that has value that may have a subjective element but to me is still quite real indeed, not just chalked up to goodwill..* In terms of "Q", obviously a negative number, which could occur, shows someone isn't paying attention* * But once you've got your positive Q, how it is determined what is 'too high'?

To me it seems evident that investments will be made until at equilibrium the marginal investment commands a return equal to the marginal cost of capital. At that point, the value of firms taken in the aggregate should approach the net worth of the replacement value of their assets.

I understand how the first part of that refers to capital investment, but doesn't the second sentence refer to stocks? If so, that is really pessimistic!

wab.. is the US 'outperforming' important to this discussion? Starting from "Why Do Stocks Go Up?" are we talking only US stocks w/r/t the rest of the world? [Are there markets where stocks in the long run always go down? That would be strange indeed.]* If US productivity drops (that's all relative anyway) or its market share diminishes, that means that, somewhere, someone else is picking up the pace. I take "stocks" to mean all stocks, in the aggregate, everywhere.

Some stocks may go up more or less than they "should", but to me it is a given that 'stocks go up'. Otherwise are we saying that all the world's combined raw materials, labor, and ingenuity are worth a net of zero, or less than zero?*

[haha]

Originally Posted by ladelfina

Gotcha. But that seems to be completely indifferent to the real potential of these assets (in certain hands, with certain history, distribution channels, R&D in the works, etc.).* *All that has value that may have a subjective element but to me is still quite real indeed, not just chalked up to goodwill..* In terms of "Q", obviously a negative number, which could occur, shows someone isn't paying attention* * But once you've got your positive Q, how it is determined what is 'too high'?

Although I suppose it is mathematically possible for Q to be negative, in reality I can't imagine the conditions wherein this would occur.

As far as intangible drivers of corporate profitability being ignored, the theory is that while intangibles can be important to individual firms, it is fallacious to try to scale this up to a large diversified set of firms which include most participants in an industry, and most industries. This makes sense to me; it is part of basic finance theory in a capitalist competitive economy. Still, IMO whatever weakness there might be in this approach lies in this area.

As to how do you know when Q is high, you can look at history, and of course you have to make judgments.

Remember, it isn’t my theory-I am not well enough informed to be a very good defender of it.

Ha

[wabmester]

Originally Posted by ladelfina

wab.. is the US 'outperforming' important to this discussion? Starting from "Why Do Stocks Go Up?" are we talking only US stocks w/r/t the rest of the world? [Are there markets where stocks in the long run always go down? That would be strange indeed.]* If US productivity drops (that's all relative anyway) or its market share diminishes, that means that, somewhere, someone else is picking up the pace. I take "stocks" to mean all stocks, in the aggregate, everywhere.

I believe a lot of people get their "feel" of stock markets from US stocks, and both our market and our economy have been pretty unique in terms of performance.

Are there markets where stocks don't go up in the long run? * Interesting question. *I haven't found much long-term international stock data. * Obviously, Japan's market has had net-zero growth over almost 20 years now, and they have one of the world's strongest economies.

When Bernstein looked at this, he found that stock market capital growth always lagged GDP growth. * In the US, the lag was around 2%. * He accounted for this as dilution due to options and secondary offerings. * He found that in some international markets, the dilution factor was as high as 30%!

But I'm not totally satisfied with the GDP relationship.* Since companies are contributors to GDP, it makes more sense to consider the fundamentals that produced company growth rather than capital growth as a function of GDP growth.

Anyway, as I said in the original post, I'm still baffled.* *The stock market is incredibly complex.* *The US market is one of the most liquid, most transparent, and most highly regulated markets in the world.* *And the US economy probably has the highest developed infrastructure in the world.* *I'm not ready to give up on the US by any means.

But I am getting less enamored by the "total market" approach in the US due to the potential drags on the economy going forward.* *And I'm getting less enamored by international markets due to the general lack of transparency and high incidence of dilution and outright theft in some of those markets.

[brewer12345]

Wab, this is pretty basic so I suspect the answer is yes, but did bernstein factor in dividends?

The lack of transparency and opportunities for outright theft are some of the major reasons I am squeamish about emerging markets securities. That sort of thing is exactly why I have zero interest in owning any Chinese equity whatsoever. I even have to hold my nose a bit to own Greek shipping company stocks, although being listed on a US exchange helps a bit.

As far as the US equity market, well, that is an exercise for the reader. It is hard to ignore the historical returns generated by a passive holding of US indexes, and I think the same can be said for other developed countries. That said, I find it a lot easier to fully analyze and get comfy with individual securities simply because I can pull them apart and look at the guts. Hard to do that with a total market fund.