Are Stocks a Ponzi Scheme?

[audreyh1]

There is no question that the markets, particularly equities, are speculative and go through long periods of overvaluation, particularly when interest rates are driven to near zero for various reasons. That is nothing at all like a Ponzi scheme which doesn’t invest in anything for a return but instead pays earlier investors from later investors. Unless you are invested in really weird/exotic instruments you still are owning pieces of real businesses. You just have to be willing to live with the volatility. One reason I like rebalancing is because as one asset class gets more “overvalued” relative to another asset class you have a formula to trim some and add to the less valued one.

 

[HI Bill]

Not a Ponzi scheme, as they companies the shares represent exist, and have value (in most cases).

Until my former company finally went public, I didn't really understand how the issuance of shares occurs. In the case of my former company:

1) My former company sold the shares in one vast batch (~$3B) to a bank, which paid for them a fixed rate per share, before the IPO.

2) On IPO day, the shares were sold by the bank on the stock market, at whatever market value the market decided was right. Some shares went to mutual funds, and many to hedge fund investors.

3). Share prices now fluctuate with earnings estimates, world news, and in reverse correlation with the S&P500 (they typically go down when the S&P goes up, and vice versa). I attribute this to hedge funds looking to beat the market trends.

4) Share prices also go down when my former company sells additional shares annually from their ESOP (Employee Stock Ownership Plan) to pay out retirees. Most financial pundits don't understand that the ESOP value essentially hinders the share price, and annually, causes it to drop.

5) No dividends are anticipated, as the company issues new shares annually to current employees, using profits to shelter them from taxes. The CFO and CEO are heavily invested in the company, and they lose $ if their company's value tanks. And they make personal $ if the value goes up.

6) Many of my former coworkers will likely be ESOP millionaires by the time they retire, as long as they've become fully vested in the ESOP, work there for 15-30+ years, and make it to retirement age (62 for ESOP distribution).

 

[ERD50]

.... 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?... .

Have you done any research on your own? The answers are out there with a quick search:

https://www.officialdata.org/us/stocks/s-p-500/1900

If you invested $100 in the S&P 500 at the beginning of 1900, you would have about $8,794,187.70 at the end of 2022, assuming you reinvested all dividends. This is a return on investment of 8,794,087.70%, or 9.71% per year.

This lump-sum investment beats inflation during this period for an inflation-adjusted return of about 247,779.87% cumulatively, or 6.57% per year.

-ERD50

 

[RobbieB]

I'm sure glad I bought into the "stock market ponzi scheme" when I was young and continued investing until I retired -

 

[marko]

The word "casino" always irked me when referencing the market. Usually used by people with no clue of how it works.

"Well of course you lost money! You think it's a casino and you're treating it like one"

 

[target2019]

Yes, you can gamble in the stock market. I've watched that behavior in myself and others. You get a hunch, a tip, and find it is very easy to place a bet without any research whatsoever. That behavior reminds me very much of playing games at a casino.

 

[Jerry1]

The difference between a casino and the stock market is “the house”. A casino has a net advantage. For example, slot machines are rated on how much they return. Usually something in the 90% range (let’s say 95%). So, in the long run, a casino will give the player a negative return. The stock market is just the opposite. The house gives about 5% in the long run. Of course, both of these benchmarks are in the long run and applied to the universe. Individually there are a number of things that can happen to distort the averages.

I like the house payout on the stock market. My struggle is to keep playing according to the rules and not try to time the market or gamble on a particular individual stock (which is not the same as owning individual stocks).

 

[njhowie]

The difference between the stock market (stocks) and a Ponzi Scheme is that with stocks, every participant decides what the appropriate price is. The participant decides on the price to buy and sell any asset. In a Ponzi Scheme, the operator sets the prices and decides what prices the clients get when they buy or sell.

The fact that buying and selling takes place in the stock market and the investment of a buyer is used to pay a seller is simply the basis of any market. Would you consider Ebay a Ponzi Scheme? If so, why? If not, why not? How about the rare coin market? Gold market?

 

[arcyallen]

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?

Dividends, by themselves, are pretty meaningless. All you're getting is a piece of the stock price shaved off and given (back) to you. Example:

-If the stock price stayed flat, and your $100 stock paid a $3 dividend, you'd end up with a $3 dividend and a $97 share of stock. That's it. You could have sold off 3% if you'd really wanted and got a similar result.

You could argue that dividends represent financial strength, etc, but for your example dividends don't really make the stock any more solid.

 

[marko]

Dividends, by themselves, are pretty meaningless. All you're getting is a piece of the stock price shaved off and given (back) to you. Example:

-If the stock price stayed flat, and your $100 stock paid a $3 dividend, you'd end up with a $3 dividend and a $97 share of stock. That's it. You could have sold off 3% if you'd really wanted and got a similar result.

You could argue that dividends represent financial strength, etc, but for your example dividends don't really make the stock any more solid.

In a static situation that's true. But as an owner of the company, you're getting back a share of the profits. While the stock price does adjust downward, a well run, solid company regains that 'loss' pretty quickly and over time often dramatically.

In my case, I've lived off of just (all) dividends withdrawn for 17 years only to find that my portfolio has doubled despite the withdrawals and price adjustment.

Musing: this is an interesting discussion, but I wonder if the subject would've ever come up had the market--and our portfolios--had been up 20% this past year.

 

[sengsational]

The word "casino" always irked me when referencing the market. Usually used by people with no clue of how it works.

"Well of course you lost money! You think it's a casino and you're treating it like one"

It is casino-like in the short term. What do they say? Weighing machine vs voting machine or something?

 

[Crewer]

My worry was that baby boomers may hold most of the stock and as they age then the first ones out will have many buyers but the later ones out not so many and thus lower stock prices. An investment guy told me younger groups are buying stocks so that won't be a problem but I'm not all that sure of his answer since I understand many of the younger set are more invested in higher price housing. I know there is supposed to be a huge wealth transfer to the younger generation as baby boomers leave estates, which could come in to play. We still own plenty of stocks but then we are closer to leading edge baby boomers.

 

[OldShooter]

It is casino-like in the short term. ...

Of course. Decades of research have shown this.

But there is an issue, particularly now with information zapping instantaneously around the internet: With "casino-like" comes the certainty that there will be winners, even spectacular winners. We hear about those, especially from investment firms who have a manager who has gotten lucky. What we don't hear about is the losers.

Nassim Taleb refers to this as "silent evidence." His illustration is this:

"Diagoras, a nonbeliever in the gods, was shown painted tablets bearing the portraits of some worshippers who prayed, then survived a subsequent shipwreck. The implication was that praying protects you from drowning. Diagoras asked, “Where are the pictures of those who prayed, then drowned?”
​

... What do they say? Weighing machine vs voting machine or something?

Yes. That's a famous Ben Graham quotation. Morningstar explains:

The father of value investing, Benjamin Graham, explained this concept by saying that in the short run, the market is like a voting machine--tallying up which firms are popular and unpopular. But in the long run, the market is like a weighing machine--assessing the substance of a company. The message is clear: What matters in the long run is a company's actual underlying business performance and not the investing public's fickle opinion about its prospects in the short run. (https://news.morningstar.com/classroom2/course.asp?docId=142901&page=7)


​

 

[NW-Bound]

The father of value investing, Benjamin Graham, explained this concept by saying that in the short run, the market is like a voting machine--tallying up which firms are popular and unpopular. But in the long run, the market is like a weighing machine--assessing the substance of a company. The message is clear: What matters in the long run is a company's actual underlying business performance and not the investing public's fickle opinion about its prospects in the short run. (https://news.morningstar.com/classroom2/course.asp?docId=142901&page=7)

Indeed, what is hard is sorting out what is true value and what is added-on faddish value.

And then, even when people suspect that a stock is overvalued, they still want it. Is it not like beer drinkers liking a lot of head on a beer? There's no substance in the foam, just gas, but it looks good.

 

[ERD50]

I ... Is it not like beer drinkers liking a lot of head on a beer? There's no substance in the foam, just gas, but it looks good. ...

Now you did it!

No, beer foam does have substance to it. It is an indicator, some beer styles will have more/less//different foam than others. It tells you something about the beer if it isn't as expected. A lack of foam and "lacing" on the glass (if expected), can be a sign of a poorly crafted beer, or a dirty glass.

Much more here, it does affect your aroma/taste perception, it may even act as an insulator, keeping the beer at the proper temperature longer.

"no substance" - BLASPHEMY!

https://www.summitbrewing.com/beer-foam-importance/

https://www.craftbeer.com/craft-beer-muses/the-science-behind-beer-foam

-ERD50

 

[OldShooter]

Indeed, sorting out what is true value and what is added-on faddish value is what's hard. ...

If you're a trader, yes. Here is a worthwhile discussion between Eugene Fama and Richard Thaler. Fama is a true value believer and Thaler argues for the faddish component of stock prices. https://www.chicagobooth.edu/review/are-markets-efficient

As a long-term investor I really don't care. I wait and let the market sort it out. The short term is fun to watch, though. ARKK has been a hoot!

 

[arcyallen]

In a static situation that's true. But as an owner of the company, you're getting back a share of the profits. While the stock price does adjust downward, a well run, solid company regains that 'loss' pretty quickly and over time often dramatically.

In my case, I've lived off of just (all) dividends withdrawn for 17 years only to find that my portfolio has doubled despite the withdrawals and price adjustment.

Musing: this is an interesting discussion, but I wonder if the subject would've ever come up had the market--and our portfolios--had been up 20% this past year.

That's all true. But a well run, solid company generating profits that you're living off of (congrats!) is irrelevant to the dividend. You could have just sold off an amount of stock equal to the dividends you've been spending with a near-identical result.

And I agree with your musing: If someone is asking these questions today, "why" always pops into my head. I like to ask these types of questions at all points in the market cycle. In some ways, if I'm having to ask when I'm concerned with it, it indicates I would have benefitted from asking when I wasn't concerned with it!

 

[freedom2022]

yes and no

Dotcom frenzy in 2000 was a ponzi scheme.
GOOG IPO $85/share was not, in hindsight.

We don't know for sure if it is a ponzi scheme before it collapses.

A new corporation goes IPO, develops into a sustained business with revenues and accountability, not a Ponzi scheme.

A new corporation went to IPO, the business failed, the stocks became penny stocks, a Ponzi scheme.

We only know in hindsight.

 

[pjigar]

I am late to this thread but my basic definition of investment (I think this is what Warren Buffet defined a while back): Any asset that throws positive "free" cash flow.


Some examples:

Stocks i.e share of a company: Company sells products and services that has a positive net profit margin. Company may not always pay that profit in the form of dividend but instead it may invest the profits to grow the company. Either way, share holder either see a check in the bank or appreciated share prices because those profits over time are a part of the company valuation.


Bond: Easy, they pay you interest regularly on the debt.


Real Estate: If you rent the property that has positive cash flow after paying all expenses and depreciation.






Any asset that does not meet the "free cash flow" test are not investments in my book and hence a Ponzi scheme. e.g. Tulips, gold, crypto, stamps, baseball cards, art, NFT, etc.



My 2 cents.

 

[Amethyst]

I remember the first time I learned about the stock market, at age 17. I couldn't understand how it was any different from gambling. Still can't.

However, I have thrown plenty of money at index funds, whereas I've never set foot in a casino.

 

[NW-Bound]

Now you did it!

No, beer foam does have substance to it. It is an indicator, some beer styles will have more/less//different foam than others. It tells you something about the beer if it isn't as expected. A lack of foam and "lacing" on the glass (if expected), can be a sign of a poorly crafted beer, or a dirty glass.

Much more here, it does affect your aroma/taste perception, it may even act as an insulator, keeping the beer at the proper temperature longer.

"no substance" - BLASPHEMY!

https://www.summitbrewing.com/beer-foam-importance/

https://www.craftbeer.com/craft-beer-muses/the-science-behind-beer-foam

-ERD50

Hah hah hah... I knew I would ruffle some feathers.

 

[NW-Bound]

If you're a trader, yes. Here is a worthwhile discussion between Eugene Fama and Richard Thaler. Fama is a true value believer and Thaler argues for the faddish component of stock prices. https://www.chicagobooth.edu/review/are-markets-efficient

As a long-term investor I really don't care. I wait and let the market sort it out. The short term is fun to watch, though. ARKK has been a hoot!

Well, let's just say I am tired of reading Fama's hardcore argument. I wonder if he's similarly obstinate in real life.

 

[captain3d]

A growing population is a ponzi scheme which is served by growing businesses which grows the stock market.

 

[kjpliny]

I think over the past 25 years or so, the stock and bond markets have benefitted from money printing more than anything else. I don't know if that qualifies as a Ponzi scheme, but it sure doesn't seem right that each time the "market" corrects, they have to print more and more money to reverse the fall. This doesn't strike me as a true functioning free market. In 2008, our national debt was about $7T. with less than a trillion dollars on the Fed's balance sheet. Now it is over $31T with another $9T on the balance sheet. That is all debt.

Something doesn't smell right.

 

[marko]

That's all true. But a well run, solid company generating profits that you're living off of (congrats!) is irrelevant to the dividend. You could have just sold off an amount of stock equal to the dividends you've been spending with a near-identical result.

Well that's the same thing; a discussion we've had here dozens of times over the years.

The trouble is selling shares of stocks that pay no or very low dividends. After you've sold all your shares, that very last share left had better be worth $200,000 and you'd better be on your death bed.

Plus, even in a severe downturn like this one the dividends come in the same regardless of share price.