Are Stocks a Ponzi Scheme?

[joesxm3]

While having my coffee this morning, this thought crossed my mind.

We have seen it said that the recent turmoil in the crypto asset space is based on many of the assets being basically Ponzi schemes. A group issues a coin that represents some nebulous claim on the project and the value of the coin is driven by what the next person will pay for it. Recently the regulators are making the case that 99% of these assets are really securities.

Securities. That is stocks.

So, when a company wants to expand, it issues stock and sells the stock to raise money to use for company business. The people that buy the stock now own a portion of the company. All well and good, but . . .

What good comes from owning a portion of the company?

As the company grows and becomes more valuable, your portion of the company theoretically also becomes more valuable. But what good does that do for you?

Well, you can sell your portion of the company to someone else for more than you paid for it. Then what good does it do for them?

Now, if you actually built a company that you owned, you would, over time, be able to milk it for money that you could use to support yourself. But if you just hold a share of the company, you are not able to milk the company. Your only recourse is to sell the the "greater fool".

Doesn't that sort of match the definition of a Ponzi scheme? Granted, there is no formal structure where the money from new investors is used to pay a return to earlier investors. But the new buyers of the stock are similar in adding money to the mix to pay the earlier investors.

I suppose you could say it is more like gambling where people bet whether the crowd will push the price up or down, rather than a true Ponzi scheme.

The only actual way you can milk the company is if the company pays a dividend to you for owning the stock.

All of this makes me wonder if the only true investment is a dividend paying stock and all the non-dividend stocks are either a Ponzi scheme or gambling.

Any thoughts on this?

 

[Dtail]

A long history of ~7% inflation adjusted S&P 500 returns doesn't really support this concept.
As an example, a Madoff comparison would not be valid, as there never was real large returns.

 

[38Chevy454]

In extreme theory, the price of a stock is the value of the future income stream. Be that in dividends or in capital appreciation of the company. It is not a Ponzi scheme because new owners are not paying out for the older owners. New stock issues are increasing the value potential of the company. Ultimately if a company goes bankrupt, there is some base liquidation valuation that each shareholder has a claim to. That base value for some companies may be close to zero or could be more because of land and other assets.

I do see some Ponzi scheme aspect of crypto or some of the basically no asset type companies. They only have a stock price because someone outside will pay for it. There is nothing solid behind the company. That's different than a typical company that manufactures items or provides a service that has value.

 

[OldShooter]

Well, to start with, "crypto asset space" is an oxymoron. There are no assets involved. Just the greater fool theory. One of the things that amuses me about crypto is the re-emergence of technical analysis, which has long been discredited and on its deathbed. Why now? There is nothing else for the chattering monkeys to talk about. No assets. No intrinsic value. No financial ratios. Nothing.

We own shares in basically all the stocks in the world (VTWAX). In each of those companies, there are employees working to make money for the shareholders. This money comes to us in the form of appreciated stock values due to the company's money being internally invested or used for stock buybacks. It also may come to us as dividends. It is these people, working away, who are responsible for the steady growth of the stock market. Some companies are more successful than others, of course, but the average is 5+% per year growth. That is why buy-and-hold works.

The point here is that there is new value continuously being created for shareholders and reflected in the market. That is the good that comes from owning a piece of a company. New buyers pay more than existing owners to the extent the employees of the company have added value -- retained earnings, shareholder equity -- or to the extent that management of the company have bought back shares, increasing the slice of the pie that each existing shareholder owns.

 

[Fermion]

I think it really is true that long term the only really viable stocks are those that pay dividends.

I mean it is great if for 10 or 20 years you grow the company but eventually I think you need to pay out dividends.

Microsoft eventually did, so did Apple. Amazon has not but I bet they will one day.

 

[COcheesehead]

My understanding as to why traditional growth tech stocks like Apple and Microsoft started paying dividends was so that mutual funds with charters that dictated that they hold only dividend paying stocks could buy these and thus elevate the stock price.

 

[OldShooter]

I think it really is true that long term the only really viable stocks are those that pay dividends. ...

Actually the trend is away from dividends and toward the more tax-efficient stock buybacks. The gummint has realized this and is beginning to tax buybacks.

There are arguments about buybacks having the effect of enriching executives with stock options, but the fact is that buybacks enrich all shareholders. IMO the trend will continue, possibly with some fixes to the stock options issue. It would be easy enough to revalue options based on the amount of shareholder equity that was added to each outstanding share, IOW the increase in each share's slice of the pie.

 

[Aerides]

Let's leave Crypto out of it, please.

 

[Fermion]

Buybacks if done correctly are fine but yeah it is always a bit aggravating to see a company do buybacks then issue a ton of stock awards to mediocre performing execs.

 

[joesxm3]

I understand that one can attempt to calculate the "value" of the company using cash flow, earnings, expected earning growth etc.. The price of the stock may track the calculated value as the company grows.

However, it still comes down to being able to sell your stock to someone to get any value out of it. It is not like you can show up at a Google data center and say "I am here to take home a server, here is 5 shares of stock."

I read somewhere, probably in a Neil Fergusson history of money book, that in Great Britain they used to say "He is worth 1000 pounds." That meant that his investments threw off 1000 pounds per year. That would be similar to us saying "he is worth $80,000 instead of he is worth $2,000,000 (SWR 4%).

I can see that the stock market has a track record of going up. But is that the stock market going up, or is it the value of the dollar going down? Hasn't the dollar lost something like 99% of its purchasing power since the early 1900's?

The idea of a company initially growing and directing all the excess into fueling the growth until it reaches the point of diminishing returns and then switching over to the "milk the company" model and start paying dividends makes sense.

 

[Car-Guy]

IMO, It's not a Ponzi scheme but it is often manipulated by big money firms/individuals, particular in the shorter terms (Insider trading, pump and dump, poop and scoop, short and distort, market makers, etc) Longer term I do think the fundamentals/valuation play the bigger role.

 

[calmloki]

i admit to being baffled by the stock market. Only problem is that "everyone" seems to have voted that that is where money needs to be stored and it is persistently profitable (over time). Putting money into a company for growth and greater productivity and profit, paying dividends - that I get. Twitter or companies that don't pay dividends I don't (counter: Berkshire Hathaway or Amazon).

My gal was a long-time GM car dealership service manager and back when GM was in a pickle she bought shares to support the company; doing her part to give the company some financial support. Unfortunately her infusion was inadequate to save the company and GM went bankrupt. Thought we would get a box of ball joints or something as her share of the assets, but she got nada, zip, zero. In a few months GM emerged from bankruptcy and kept selling cars, but her shares were as smoke in the wind - of no value and gone. weird.

Amazon, according to the market, is worth just about exactly 1/2 what it was worth one year ago. Really? Pandemic, bursting desire to go visit physical stores, blaw blaw blaw - I don't buy it. I see Amazon trucks all day long criss-crossing the streets.

Really think stock values are based on what people think the stocks are worth - there is no intrinsic value. That's why we still have rental property - we provide a service; housing, and have a physical structure we can see and touch and improve. Only problem is the work involved. I've given up thinking I'm smarter than the rest of the world though, so now we have about a third of our net worth in stocks. We go along with the herd and I hope to hell it finds good pasture.

 

[ShokWaveRider]

More like a Casino rather than a Ponzi Scheme. A gamble whichever way one looks at it.

 

[Fermion]

I mean, rental property is also only worth what someone else is willing to pay for it...

 

[NW-Bound]

Really think stock values are based on what people think the stocks are worth - there is no intrinsic value...

There's intrinsic value, but how much a dollar figure that people attach to it varies with time.

No different than home values going up in a housing bubble, then two years later some homes are abandoned to the lender for short sales.

Yes, in the long run, most companies go bankrupt, or get bought out for salvage value. No different than homes in the long run get abandoned or torn down.

With poor management or maintenance, nothing lasts forever.

 

[Car-Guy]

More like a Casino rather than a Ponzi Scheme. A gamble whichever way one looks at it.

I always felt that way too but some folks here get really upset whenever I say that. If I were an investor (and not so much a trader) I might see it a little differently.

 

[OldShooter]

More like a Casino rather than a Ponzi Scheme. A gamble whichever way one looks at it.

Well, there is a half-century of research and data showing that the market approximates random over short periods of time. That's why stock picking doesn't work; no one can predict random. So from that angle you're right. Enough people get lucky, though, that many are encouraged to play the game -- just like those people on the casino billboards holding the big fake checks.

The research also supports a broad index, long term strategy. This averages out the randomness and relies on the long term upward bias of the stock market.

 

[NW-Bound]

More like a Casino rather than a Ponzi Scheme. A gamble whichever way one looks at it.

I always felt that way too but some folks here get really upset whenever I say that. If I were an investor (and not so much a trader) I might see it a little differently.

I am a long-time investor, and also a short-term trader.

I only buy shares of companies whose future prospects I believe in. However, if other investors bid the price to level I think is overvalued, I will let them have it via covered call options.

Not different than buying a house for $500K which you believe is a fair value, then let it go for $700K a year later when people clamor to buy it. Then, buy it back at $300K when nobody wants it.

Of course buying/selling stocks is infinitely easier than flip houses. Hence, I don't do houses.

 

[W2R]

A long history of ~7% inflation adjusted S&P 500 returns doesn't really support this concept.
As an example, a Madoff comparison would not be valid, as there never was real large returns.

+1

 

[mrfeh]

Doesn't that sort of match the definition of a Ponzi scheme?

No.

 

[target2019]

Stockholders own a piece of the company's equity, and the hope is that value is returned to the careful investor from the legitimate company in share appreciation and maybe income. Compare that to this wikipedia definition of Ponzi Scheme:

"A Ponzi scheme is a form of fraud that lures investors and pays profits to earlier investors with funds from more recent investors. Named after Italian businessman Charles Ponzi, the scheme leads victims to believe that profits are coming from legitimate business activity (e.g., product sales or successful investments), and they remain unaware that other investors are the source of funds. A Ponzi scheme can maintain the illusion of a sustainable business as long as new investors contribute new funds, and as long as most of the investors do not demand full repayment and still believe in the non-existent assets they are purported to own."
https://en.wikipedia.org/wiki/Ponzi_scheme

Watchdogs keep an eye on budding schemers as much as possible. Of course there are failures and some lose money in spite of that.

 

[ejman]

Well, if owning stocks (and presumably bonds?) is a Ponzi scheme, it has kept my 20+ year retirement nicely funded so far. It seems to me the basic difference between a Ponzi scheme and "real asset" investments is that the Ponzi schemes collapse when they run out of new investors. The stock/bond market players keep coming back for more with the occasional swings. Maybe they know something ( or think they do)

 

[Chuckanut]

Well, if owning stocks (and presumably bonds?) is a Ponzi scheme, it has kept my 20+ year retirement nicely funded so far. It seems to me the basic difference between a Ponzi scheme and "real asset" investments is that the Ponzi schemes collapse when they run out of new investors. The stock/bond market players keep coming back for more with the occasional swings. Maybe they know something ( or think they do)

Ponzi schemes are usually identified by not having some good or service that is ultimately sold to others for a profit.

Some near Ponzi schemes will have a product (perhaps bookmarks) that they supposedly sell to others, but in reality the real money is mad by bringing others into the scheme.

The last time I checked most of the stocks I own via mutual funds actually produce something others will trade for. And, if they don't, they fail and are gone

 

[NW-Bound]

I guess some are bothered by the fact that many stocks do not pay a dividend. It is easier to see the value of a house that provides a rental income.

But a house that's bought for speculation does not provide rent, and people suspect that the price appreciation part is somewhat like a Ponzi scheme.

However, it is not correct to use a spec home as an analogy to growth stocks that pay no dividend. It's better to compare the latter to an orchard full of young trees. These trees do not yet bear fruits, but they are growing and will provide returns in later years.

Of course, some orchards may turn out to be full of trees that don't bear fruits, or bear sour fruits, or they get wiped out by boring insects. And that's the risk with growth stocks.

Hence, some people like to own established trees that already provide fruits each year.

In any case, there's intrinsic value in both growth stocks and dividend-paying stocks. How to price that value is what's difficult.

 

[kingkarmann]

Based on past experience I can comfortably say I’m ok risking assets with the stock markets.

Back in the day I worked for real estate firm “General Development Corporation”
The Ponzi Scheme was simple, buy a piece of semi developed Florida real estate.
Hold that real estate until enough equity was built to acquire a down payment on a home to be built on that piece of fantasy land. Move into your Florida dream home in your golden years. The more the merrier!

Just the bare minimum of infrastructure was done to keep investors and local government off GDC’s back.
A whole bunch of acreage sat incomplete for years with 1/4 plots waiting for that house to be built.
In the late 80’s into the early 90’s during the cocaine wars (that Miami Vice & Tony Montoya so chillingly romanticized) made those plots scattered about southern Florida ideal landing strips for the drug runner pilots.
I was young dumb and naive, just what they wanted.
Thankfully I didn’t end up in the penitentiary…..
Or witness protection.