Does our portfolio help anyone else?

[Midpack]

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.

Or a third option, buying back shares?

 

[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%.

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.

The point I was trying to make had to do with your original proposal "w/o that investment, those companies couldn't do what they do". The story I told attempts to show that if there were a certain lack of investment, the company would not produce as much.

Contrast a prosperous village where people had savings and were willing to invest with a poor village where there was no savings. In the prosperous village, loom production would be 100% because someone bought the loom from the guy who'd rather have the cow than the income stream. In the poor village, where nobody that had any ability to to invest in anything, the price of the loom might become the same as a pile of good firewood. The valuation of the assets is not a huge point in the story, though. If I want "out" and it's my loom, I'll get whatever I can get for it, make a cart out of it, or burn it to keep warm. The main point is that loom would go out of production if there were no investors. So having a village with people that have enough savings to become investors means a higher level of productivity; their ability to invest (their portfolio) helps society (someone else).

 

[MichaelB]

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?

The underlying value of a share of stock is the future free cash flow it earns. This is how an owner, such as Warren Buffet, evaluates and chooses. You evaluate a publicly traded stock the same way you would a private business you consider buying. How much cash will it return to me? There are definitely metrics to judge " expensive or cheap". This is one reason the prevailing interest rate is so important.

The ponzi statement makes no sense to me, and if someone thinks that of the stock market, I doubt you or anyone else will change that view.

 

[Johanson]

Some companies will also have a "secondary" offering of shares that are usually sold below market value to raise more money. NRZ just did that this week "to help fund its mortgage servicing rights deal with CitiMortgage." I sold half of my DHT to add to my shares of NRZ Friday. Unfortunately, the drop in price earlier in the week evaporated and my price was $15.90. But, I like the company and the dividend is $.48/share.

New Residential prices 49M-share offering at $15 - New Residential Investment Corp. (NYSE:NRZ) | Seeking Alpha

 

[GrayHare]

After the IPOs, stocks merely support the whole equity system, and a huge part of the economic system. If instead all stock was declared worthless tomorrow, it's not like Amazon's already-built and stocked warehouses would immediately crumble or disappear. There would be plenty of other trouble, and not just for the next IPO.

 

[GrayHare]

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!

I'd not call it ponzi, but there is an element of prestidigitation involved. Money is created out of thin air and backed by the full faith and credit of a big bank (or government) rather than a tangible asset. For example, banks are permitted to loan 10 times (is it higher now?) the assets on deposit. This money gooses the economy, and as long as a large number of depositors don't want their money back at the same time, the system works.

 

[ERD50]

...

The ponzi statement makes no sense to me, and if someone thinks that of the stock market, I doubt you or anyone else will change that view.

Agreed, but I have to have a ready answer, or I'll feel like the dufus.

-ERD50

 

[523HRR]

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)?
-ERD50

Without a deep and liquid secondary market, there would be minimal market appetite for the Initial Public Offering (IPO).

 

[ejman]

I think that somewhat overlooked in this discussion is that those shares in the open market do represent ownership in the company. In a hostile takeover for example, shares are purchased to a sufficient amount to take control of the company, fire the current management and take control of the real assets of the company. Ownership of those shares is no Ponzi scheme. Real companies, real assets, real ownership fractions.

 

[Texas Proud]

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.

First, the sandwich shop IS making a profit... it has decided to invest its free cash flow in new stores... but that does not mean it did not make a profit... in your example, it would have make that $50 million (less whatever new stores opened) the year before you calculate...

But Amazon is NOT making that profit... it keeps expanding market share, but with little margin... now, people keep thinking that one day it will stop expanding and be able to raise its margin and be rolling in the cash... I do not... other companies are expanding their online sales and if Amazon raises prices there will be others who will take its place...

It is also a $385 bill market cap... it should be making more money by now... look at AAPL... trading at 16X... who would you rather own

Also, look at JPM... trading at less than 15X and if interest rates go up is said to be able to make an additional $3 bill in profits... now it is making $22 bill... so a nice uptick...

BTW, Apple made almost $46 bill, but Amazon made a staggering $600 mill..... and lost money in 2014....

 

[Texas Proud]

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!



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

In my second example, the owner still wanted to own a good chunk of the company... he could have sold all his shares if he wanted out... like Steve Jobs did with Apple... but then he probably will not be running the company either... if he kept the 2 mill shares, he is putting all his assets in that one company... not the best option... you do want to cash out some... you know, so you can buy your private jet etc....


Sometimes the selling of shares is first to existing shareholders and then to the market... that way you are not diluted... but for big companies, it is usually the market... and if you do not want to be diluted, you can just go into the market and buy some more....


Nobody else has mentioned another aspect... shares are 'cash'.... many of the mergers you hear about are really purchases of one company by another... they will issue stock to the company being acquired... Say comp A wants to buy comp B.... both stocks are trading at $10 per share... both are the same size, each with 1 mill shares outstanding... what happens in a perfect world is that A issues 1 mill new shares and take back all of comp B shares... so your ownership of the total company has been diluted, but it is still worth the same...

What really happens is that A will offer 1.2 mill shares and B will take it... A hopes to create savings or extra income to make up for that 'dilution' by giving up more than what the stock was trading....

 

[CaliforniaMan]

T... I 'get' that those stocks support the whole system, but it still seems somehow like an illusion to me...

I think you have touched on the underlying theme of what makes up human society, all human societies. It is indeed an illusion, but that does not mean it does not exist. It is an example of things that exist because we collectively believe that they exist.

For example the cement steps leading up to an Intel factory exists, the steel and machinery and desks and computers in the factory exist whether we believe they exist or not. If all humans on earth suddenly disappeared those things would still be there. But Intel as a company does not exist in the same way. Intel exists only because we collectively believe it exists. It has an identity apart from its desks and computers and factories. If all those things were sold off, Intel would still exist. Or Intel might go bankrupt and would cease to exist, even with the factories still there.

This is the case with money, and the bits in the computer ledgers in the companies that identify what part of that company you own. It is all supported by laws and customs and governments, all which exist only because we collectively believe that they exist. Yet that does not mean they are not real.

We see this throughout human history, things that exist because they are collectively believed to exist at that time, the divine right of the king, democracy, shells as money, gold as money, dollars as money, money being a thing itself etc.

There is a great book on the subject, "Sapiens" by Yuval Noah Harari.

Anyway I would not get too caught up on whether something is an illusion or not. Everything really important is.

 

[rayvt]

Agreed, but I have to have a ready answer, or I'll feel like the dufus.

-ERD50

In that case, I'd stick with the analogy of "trading vessels sailing across the Indies". A hundred (rich) people each chip in $100,000 and each owns 1% of the venture. Their profit is 1/100th of the profit when (if!) the ship makes it to the Indes and then gets back home with a cargo of valuable spices.

The stock certificate represents 1% of the company. The stock doesn't know or care who owns it. If man A sells his share to man B, B is just stepping into the shoes of A. As people sell & buy that share, each is stepping into the shoes of the previous owner.

 

[ERD50]

In that case, I'd stick with the analogy of "trading vessels sailing across the Indies". A hundred (rich) people each chip in $100,000 and each owns 1% of the venture. Their profit is 1/100th of the profit when (if!) the ship makes it to the Indes and then gets back home with a cargo of valuable spices.

The stock certificate represents 1% of the company. The stock doesn't know or care who owns it. If man A sells his share to man B, B is just stepping into the shoes of A. As people sell & buy that share, each is stepping into the shoes of the previous owner.

Yes, that seems like a solid, concise way to put it.

-ERD50

 

[Totoro]

First, the sandwich shop IS making a profit... it has decided to invest its free cash flow in new stores... but that does not mean it did not make a profit... in your example, it would have make that $50 million (less whatever new stores opened) the year before you calculate...

You are not waiting for a full year's earnings to accumulate and pay tax on it before you start investing.

Simplified: If you invest and open new stores in December (christmas opening!) using profits gained from January up to the current date in the same year, your free cash flow for that year will be 0, and your profits too.

Regarding specifically Amazon: I don't pretend to be able to value Amazon with strong confidence, they may be very overvalued.

As far as I know from random articles I've read: There are portions of their business that are quite profitable (AWS if I recall correctly). To what extent dropping out of growth mode and optimizing for earnings to be returned to shareholders would result in a reasonable P/E (or better yet, return on capital invested), I don't know.

Some say they would have to raise prices to get a reasonable return and subsequently lose their dominance, others say they are underlying very profitable (in supermarket retail terms). All I see is a very fast growth trajectory without asking shareholders for additional capital. That investment is coming from the underlying operations (unless they have a bunch of debt?).