Does our portfolio help anyone else?

[ERD50]

This may have been discussed before, I don't recall. I sometimes have trouble getting my head around the really big finance questions (like balance of trade, currency devaluation etc).

Many of us probably have half or more of our portfolio in equities. Sometimes you hear that "rich people" are 'hording' their money, and it would be better if it were spread out (and I don't mean for this to go into the topic of redistribution of wealth, that is just a statement). But is the money just siting there?

The answer I usually hear is, no - it is "invested" in companies that are providing products, services and jobs. It's working for us, and w/o that investment, those companies couldn't do what they do. But is it? I understand (or think I do), that the Initial Public Offering raises money for the company, but after that, what? Unless they sell off more of those shares, or make another public offering, supported by the current NAV (and doesn't that dilute the existing shares?), what good do my shares in my fund do for anyone (except me)?

And if the company pays dividends, it seems like they are paying off that initial offering essentially forever? It's like a low rate, infinite term, interest-only loan. How does NAV play into anything?

Am I missing something simple? Am I missing something complex?

-ERD50

 

[Big_Hitter]

aren't our investments considered "shareholders equity" on the balance sheet?

if so it seems that as investors we are helping the company employ people and that's a good thing

 

[exnavynuke]

The historic performance of the company's stock is an indication used by many to determine the financial health and thus suitability for financing that a company has. No one buying the stock = prices probably falling = bad financial health = more difficult to get financing for projects etc.

 

[pb4uski]

OP has a point in that the vast majority of stock trades do not directly benefit the company we are buying shares in since the transactions are between existing shareholders and the company is not involved. The company gets cash from the IPO and from secondary offerings but not from most routine trades.

However, the seller gets cash when I buy stock (or in my case, when the funds I buy purchase shares) and presumably the sellers of those shares use that cash for something... if it is to buy a house or a car or spend or something like that then there is "good" but I suspect that in most cases it is just later reinvested.

To me the major benefit to the issuer is that the market provides liquidity for it to issue new shares or issue shares for stock compensation or whatever or to buy back shares.

 

[GrayHare]

It's working for us, and w/o that investment, those companies couldn't do what they do. But is it? I understand (or think I do), that the Initial Public Offering raises money for the company, but after that, what? Unless they sell off more of those shares, or make another public offering, supported by the current NAV (and doesn't that dilute the existing shares?), what good do my shares in my fund do for anyone (except me)?

Your ongoing ownership of shares supports the whole corporate system. If suddenly no one wanted equity shares, the price of those shares would drop precipitously, and new companies would find it more difficult to raise capital.

 

[MichaelB]

This may have been discussed before, I don't recall. I sometimes have trouble getting my head around the really big finance questions (like balance of trade, currency devaluation etc).

Many of us probably have half or more of our portfolio in equities. Sometimes you hear that "rich people" are 'hording' their money, and it would be better if it were spread out (and I don't mean for this to go into the topic of redistribution of wealth, that is just a statement). But is the money just siting there?

The answer I usually hear is, no - it is "invested" in companies that are providing products, services and jobs. It's working for us, and w/o that investment, those companies couldn't do what they do. But is it? I understand (or think I do), that the Initial Public Offering raises money for the company, but after that, what? Unless they sell off more of those shares, or make another public offering, supported by the current NAV (and doesn't that dilute the existing shares?), what good do my shares in my fund do for anyone (except me)?

And if the company pays dividends, it seems like they are paying off that initial offering essentially forever? It's like a low rate, infinite term, interest-only loan. How does NAV play into anything?

Am I missing something simple? Am I missing something complex?

-ERD50

An equity investment leads to job creation when an enterprise sells new equity to raise funds to create productive capacity. When they invest that money it generates economic activity and contributes to the GDP.

When we "invest" in equity shares we are not generating any economic activity aside from the brokerage transactions, we are only exchanging assets. The only change in GDP is the brokers commission. It's a form of savings.

The difference here is that "investing" means one thing in economics and another in finance, and the two meanings are not interchangeable.

 

[sengsational]

By having funds ready to snap-up a deal, "rich people" (and not so rich alike) are making production possible.

It's easy to see if you set-up a scenario in a 1600 village. Fred knows how to weave and has one loom. 9 other villagers each buy and own a loom, but let Fred operate it (the IPO). Now one of the villagers needs a cow more than he needs the monthly weaving profits. If there were no villagers that wanted to buy that loom (i.e. a "rich person", the guy who wants the cow would have to ship the loom elsewhere, sell the loom for scrap, or whatever, to get cow money. And the production capacity would be reduced by 10%.

 

[Mdlerth]

When I took economics (back when it was only the S&P five dozen), they said that the capital a business raised was always still there. Whether you bought their stock at the IPO or a century later only changes the name on the dividend check. The capital remains in the company in the form of factories and inventories and delivery trucks and forklifts, etc.

Elmer Fudd explains it all in "Yankee Dood It":

So, yes, your investment is busy funding the world's economy. Thank you for doing good!

 

[ERD50]

...
The difference here is that "investing" means one thing in economics and another in finance, and the two meanings are not interchangeable.

Thanks, that is probably where I'm getting hung up, trying to equate the two?

And thanks to others for their replies - I 'get' that those stocks support the whole system, but it still seems somehow like an illusion to me.

Consider a company that on their IPO, declare no dividend, and say they never plan to pay one. So my shares represent a % of the company? How? I guess it is similar to the US dollar - it is worth $1 because the Feds say so, and they are willing to back it up, to the extent that someone will give me $1 worth of goods in exchange for my paper (or ledger entry) dollar. And that's all that really matters.

So the company says that share is equal to 1 millionth of the company, and someone buys it from me on the trust that that is true, and that when the company valuation goes up, they can profit by selling to someone else who also accepts that it is worth 1 millionth of the company.

I guess that's it, it is still all a little 'virtual' for me, I'm sometimes a real nuts-and-bolts thinker, depends on the topic.

-ERD50

 

[MichaelB]

Consider a company that on their IPO, declare no dividend, and say they never plan to pay one. So my shares represent a % of the company? How? I guess it is similar to the US dollar - it is worth $1 because the Feds say so, and they are willing to back it up, to the extent that someone will give me $1 worth of goods in exchange for my paper (or ledger entry) dollar. And that's all that really matters.

So the company says that share is equal to 1 millionth of the company, and someone buys it from me on the trust that that is true, and that when the company valuation goes up, they can profit by selling to someone else who also accepts that it is worth 1 millionth of the company.

Don't get hung up on the dividend. Your initial investment entitles you to fractional ownership of all the future cash flows of that enterprise. If they generate a positive cash flow they have two (theoretical) options for the cash - pay it to you as a dividend or reinvest it. If they reinvest, they create even more economic activity and the potential for even greater future cash flows.

When you sell that share (or buy it) you are transferring ownership of that future cash flow.

 

[sengsational]

Consider a company that on their IPO, declare no dividend, and say they never plan to pay one. So my shares represent a % of the company? How? I guess it is similar to the US dollar - it is worth $1 because the Feds say so, and they are willing to back it up, to the extent that someone will give me $1 worth of goods in exchange for my paper (or ledger entry) dollar. And that's all that really matters.

I wouldn't equate a fiat currency (the US dollar, or any currency) with something that produces something. Stockholders own a fraction of a producing asset. Completely not like a currency, which does nothing. Even though they don't pay dividends, they will still be producing. If not, they'll go out of business.

 

[haha]

Thanks, that is probably where I'm getting hung up, trying to equate the two?

And thanks to others for their replies - I 'get' that those stocks support the whole system, but it still seems somehow like an illusion to me.

Consider a company that on their IPO, declare no dividend, and say they never plan to pay one. So my shares represent a % of the company? How?

So the company says that share is equal to 1 millionth of the company, and someone buys it from me on the trust that that is true, and that when the company valuation goes up, they can profit by selling to someone else who also accepts that it is worth 1 millionth of the company.

-ERD50

First of all, I doubt many shares are traded based on much other than a feeling that prices are going up, get on the train, or prices are going down, get off quick!

As to the fractional ownership of a company, it isn't because the company says so, it's because if you own 1000 shares, and the company has 1 million shares outstanding, you have residual claim to 1/1000 of the profits of this company. But getting cash is going to depend on payouts like dividends or return of capital, or selling shares. In the very rare circumstance of a shutdown, in the even more rare circumstance that there is any equity left after all claimants ahead of you including various legal beagles and "officers", you would be entitled to 1/1000 of the remaining equity that could be turned into cash.

Probably poker chips have more certain value, in a serious game where losses will be enforced in favor of winners.

It is an unbalanced game, but for many of us, at certain times anyway, it is worth playing.

Ha

 

[ERD50]

Don't get hung up on the dividend. Your initial investment entitles you to fractional ownership of all the future cash flows of that enterprise. If they generate a positive cash flow they have two (theoretical) options for the cash - pay it to you as a dividend or reinvest it. If they reinvest, they create even more economic activity and the potential for even greater future cash flows.

When you sell that share (or buy it) you are transferring ownership of that future cash flow.

I was just trying to eliminate the dividend, to strip it down to its simplest form.

OK, so here's one thing that is sinking in from this discussion, that makes this more tangible for me. If the owners sell off say 3/4ths of the company, they are limiting themselves to a 1/4 share of any future profits. I can see the intrinsic value better when I think in terms of the original owners losing something, so therefore some else must gain - it's a real thing.


Well, that assumes I know how an IPO works - does that initial offering represent a % of the company, in a legally binding form? So if they sell off that 3/4th portion of the company, and issue 3 million shares for that 3/4 portion, each share represents 1/4 of one millionth of the company? And the company is essentially holding back (or actually holding) one million shares?

-ERD50

 

[pb4uski]

By having funds ready to snap-up a deal, "rich people" (and not so rich alike) are making production possible.

It's easy to see if you set-up a scenario in a 1600 village. Fred knows how to weave and has one loom. 9 other villagers each buy and own a loom, but let Fred operate it (the IPO). Now one of the villagers needs a cow more than he needs the monthly weaving profits. If there were no villagers that wanted to buy that loom (i.e. a "rich person", the guy who wants the cow would have to ship the loom elsewhere, sell the loom for scrap, or whatever, to get cow money. And the production capacity would be reduced by 10%.

Not a great analogy... the villager that wants a cow would have to just either reduce what they are asking for the loom or keep the loom until someone wanting to buy it comes along... same thing would happen with a stock, the holder would have to reduce their asking price until it entices a buyer.

 

[haha]

I was just trying to eliminate the dividend, to strip it down to its simplest form.

OK, so here's one thing that is sinking in from this discussion, that makes this more tangible for me. If the owners sell off say 3/4ths of the company, they are limiting themselves to a 1/4 share of any future profits. I can see the intrinsic value better when I think in terms of the original owners losing something, so therefore some else must gain - it's a real thing.


Well, that assumes I know how an IPO works - does that initial offering represent a % of the company, in a legally binding form? So if they sell off that 3/4th portion of the company, and issue 3 million shares for that 3/4 portion, each share represents 1/4 of one millionth of the company? And the company is essentially holding back (or actually holding) one million shares?

-ERD50

All you need is a very basic look at balance sheets. Once about 20 years ago my former wife gave me a great book for Christmas. It explained the operation of a firm with diagrams of flows and reservoirs. I wish I still had that book.

Ha

 

[dixonge]

I was just trying to eliminate the dividend, to strip it down to its simplest form.

OK, so here's one thing that is sinking in from this discussion, that makes this more tangible for me. If the owners sell off say 3/4ths of the company, they are limiting themselves to a 1/4 share of any future profits. I can see the intrinsic value better when I think in terms of the original owners losing something, so therefore some else must gain - it's a real thing.


Well, that assumes I know how an IPO works - does that initial offering represent a % of the company, in a legally binding form? So if they sell off that 3/4th portion of the company, and issue 3 million shares for that 3/4 portion, each share represents 1/4 of one millionth of the company? And the company is essentially holding back (or actually holding) one million shares?

-ERD50

I was researching this just the other day! So what helped me wrap my head around all this was an understanding of primary and secondary markets. The IPO is primary - mainly institutional and large investors. But if they feel like they might get stuck holding stock, they may want better prices or dividends. But with a healthy secondary market, they gain liquidity, knowing they can find buyers if they want to sell. Any selling to the secondary market is taking an original share and trading it. No new shares are created. So the ownership of the company stock is being shuffled infinitely every day.

So boycotting a company by not owning their stock doesn't really work, unless a large number of investors join in and drop the price. Even then, it only works because it's dropping the net worth of employees and management who own employee stock options. Here's some info:

https://en.wikipedia.org/wiki/Secondary_market_offering

 

[Sunset]

.....
Well, that assumes I know how an IPO works - does that initial offering represent a % of the company, in a legally binding form? So if they sell off that 3/4th portion of the company, and issue 3 million shares for that 3/4 portion, each share represents 1/4 of one millionth of the company? And the company is essentially holding back (or actually holding) one million shares?....

Yes, the company registers a total of 4 million shares.
Now normally a company can issue more shares, which dilutes the existing ones as each existing one becomes less valuable.
So if this same company issued an extra 4 million shares, then the value of all shares would be worth 1/2 of what they were before the issuance.

 

[rayvt]

So the company says that share is equal to 1 millionth of the company, and someone buys it from me on the trust that that is true, and that when the company valuation goes up, they can profit by selling to someone else who also accepts that it is worth 1 millionth of the company.

I guess that's it, it is still all a little 'virtual' for me, I'm sometimes a real nuts-and-bolts thinker, depends on the topic.
-ERD50

Don't get hung up on overthinking it.
"Res tantum valet quantum vendi potest" (A thing is worth what someone else will pay for it.)
Basically, a thing is worth what you can get for it. With a $5 bill you can get a cup of (overpriced) coffee at Starbucks. The $5 bill isn't "worth" anything in and of itself -- you can't eat it or drink it. But you can get a coffee or a hamburger.

 

[calmloki]

Thank you for this thread. I have had the same difficulty understanding how a company benefits after the initial stock sale, except in any retained shares. Have a huge problem with understanding how the market - people swapping stocks for money - has any validity if dividends are ignored. Company value going up or down makes some sense - Ox Yoke Inc. probably dropped in value when Ford demonstrated a functional truck. OTOH, we bought some Amazon stock a few days ago - P/E of 190? How does that make sense unless it is just a matter of "everyone knows and uses Amazon, therefore it must be worth a bunch" - "Look - the price of Amazon is through the roof - we better get on board".

We have bought into the market, because everybody does it and I know I'm not smarter than everybody. Still, loaning money to house flippers makes a lot more sense to me.

 

[Texas Proud]

Don't get hung up on the dividend. Your initial investment entitles you to fractional ownership of all the future cash flows of that enterprise. If they generate a positive cash flow they have two (theoretical) options for the cash - pay it to you as a dividend or reinvest it. If they reinvest, they create even more economic activity and the potential for even greater future cash flows.

When you sell that share (or buy it) you are transferring ownership of that future cash flow.

A good example of this is Amazon... now worth $385 billion....

 

[target2019]

Don't get hung up on overthinking it.
"Res tantum valet quantum vendi potest" (A thing is worth what someone else will pay for it.)
Basically, a thing is worth what you can get for it. With a $5 bill you can get a cup of (overpriced) coffee at Starbucks. The $5 bill isn't "worth" anything in and of itself -- you can't eat it or drink it. But you can get a coffee or a hamburger.

This is a nice description. You're trading faith in paper money for faith in stock. For stock, your hope is that the initial 'bet' will return something like bet + growth, so that in the future you can buy necessities.

 

[Texas Proud]

I was just trying to eliminate the dividend, to strip it down to its simplest form.

OK, so here's one thing that is sinking in from this discussion, that makes this more tangible for me. If the owners sell off say 3/4ths of the company, they are limiting themselves to a 1/4 share of any future profits. I can see the intrinsic value better when I think in terms of the original owners losing something, so therefore some else must gain - it's a real thing.


Well, that assumes I know how an IPO works - does that initial offering represent a % of the company, in a legally binding form? So if they sell off that 3/4th portion of the company, and issue 3 million shares for that 3/4 portion, each share represents 1/4 of one millionth of the company? And the company is essentially holding back (or actually holding) one million shares?

-ERD50

No... the company is not holding back one million shares.... the original owner of the company owns those shares....


An example.... owner of a company has 1 mill shares... but he wants to get more money into the company.... 'the company' (which is the BOD which he is running, so it is him) will issue 3 mill shares of new stock... the owner has the option of buying these shares OR doing an IPO and having other people buy them... either way, the company gets new capital... if an IPO, then the original owner now owns 1/4 of the company....


Another example... say he want to cash out.... now we will say he owns 2 million shares... the company will issue 2 million new shares, but the IPO will be 3 million... 2 mill from company and 1 mill from owner.... now the owner is a 1/4 owner of the company, but he now has a bunch of money....

 

[Totoro]

Consider a company that on their IPO, declare no dividend, and say they never plan to pay one. So my shares represent a % of the company?

Yes. A company is nothing more than a group of people coming together to finance a venture. A share represents a partial ownership, and usually entitles you to a share of the profit. It started originally to finance trade vessels sailing across the Indies that would have been too risky for one investor to finance alone.

In case of an IPO: this is nothing more than a few of the current owners selling off a piece of their ownership and placing in on a freely traded market.

So the company says that share is equal to 1 millionth of the company, and someone buys it from me on the trust that that is true [..]

Not exactly, you legally own 1 millionth of the company. You trust the underlying legal system.

Just like you could own 1 millionth of farmland together with other people. The value or worth of that land is of course a strong matter of debate and perception. It the farmland produces nothing and won't ever in the future, does it still have value? Some would say yes, most would say no. Dividends by the way are nothing more than returning excess profits to shareholders. Paying no dividends either means you are losing money, or that it is a better idea to reinvest those profits in expansion of the venture (buy more farmland, better equipment etc ..)

Now, another 'neat' feature of the company concept is that it can raise additional money, should it be needed. Say you want to double acreage of the farmland [the plot next door is for sale], and there is no money on hand to buy that. You need say 10 million dollars.

One way you can do that is by offering a share in the company to anyone who wants to bring in a portion of that 10 million dollars in exchange for a portion of the current company.

There are several ways you can do that, but usually what happens is new shares are created. Say first there were 1 million shares, and the company issues 1 million new shares. These 1 million shares are then offered to whoever wants to have them.

As a result, the old shareholders now only own 50% of the company, and whoever came up with the additional cash is now also a proud owner of a partial interest in the company. It may happen of course that the old shareholders actually buy those new shares as well, in which case they still own 100% collectively. Only thing that changed is that more capital was injected into the company.

Does that address anything?

 

[Totoro]

OTOH, we bought some Amazon stock a few days ago - P/E of 190? How does that make sense [..]

Suppose you have a fantastic business. For sake of discussion: you have the most profitable sandwich store in the world.

Opening a store costs money, say 100k. Every store you open though makes 50k in its first year, and every year after! 50% returns, what a dream. Clearly you want as many of these stores as you can.

One way to do that is to reinvest any profits made by the existing stores in opening up new stores. You take 2x50k (two stores) and invest in a new store. At the company level this however looks like you are not making any profit at all while expanding! Every dollar you make goes into expansion.

So why pay good money for this company? Well, once it stops expanding, say after 1.000 stores, you end up with 50k x 1.000 = 50 million USD in profits, every year. How much would you pay for such a company in its expansion years?

That's why Amazon shouldn't be valued on current earnings alone. Last year they added over a 100.000 employees as an example. Whatever they make is reinvested in expansion. So the correct way to evaluate Amazon is by looking at how they would make if they stopped expanding + the value of said future expansion.

 

[ERD50]

Don't get hung up on overthinking it.
"Res tantum valet quantum vendi potest" (A thing is worth what someone else will pay for it.) ....

I don't feel I'm overthinking it, this is pretty fundamental and basic, I'm trying to understand the underlying fundamentals and logistics.

Sure, a thing is worth what someone else will pay for it, but that's not the end of the story. Why are they willing to pay that? Is it only because someone else will, or is there something underlying it?

I want to have an answer, for myself, and also for anyone who tries to tell me that the stock market is just some kind of ponzi scheme (not literally, but some sort of 'scam'). They say, don;t invest in anything you don't understand, so I ought to understand this!

No... the company is not holding back one million shares.... the original owner of the company owns those shares....


An example.... owner of a company has 1 mill shares... but he wants to get more money into the company.... 'the company' (which is the BOD which he is running, so it is him) will issue 3 mill shares of new stock... the owner has the option of buying these shares OR doing an IPO and having other people buy them... either way, the company gets new capital... if an IPO, then the original owner now owns 1/4 of the company....


Another example... say he want to cash out.... now we will say he owns 2 million shares... the company will issue 2 million new shares, but the IPO will be 3 million... 2 mill from company and 1 mill from owner.... now the owner is a 1/4 owner of the company, but he now has a bunch of money....

In the last example - why wouldn't the owner just sell those 2 M shares on the open market?

And selling more shares, diluting the ones I bought seems like a rather unfair thing to do to me. But I guess that's part of the deal going into it, and the dilution is to raise cash, presumably in the long term interests of the company (and shareholders), so I guess I should look at it as a (hopefully) temporary setback, or (less hopefully) an attempt to keep things going, but could eventually lead to BK anyhow.

-ERD50