# (Very) basic understanding of the stock market



## Plasmo (6 April 2008)

I'm almost embarassed to ask, but just to set this straight, because I've never studied finance or even come across the idea in my travels...

The underlying motivation for the purchase of stocks is because they are anticipated to in future pay Dividends out, yes?

For example, if I offered you for $5000 a 10% stake in a company that was guaranteed to grow earnings by 20% per year, held assets valued at $10 million, but with one catch - it would never, ever, pay dividends, that "stake" would be fundamentally worthless, right?  Or is there some psychological phenomenon that I'm ignoring here that would create a "market value" for "ownership" which has no value outside of speculation.


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## stoxclimber (6 April 2008)

Yes and no. Equity is a residual claim (i.e. you get paid after all the other owners i.e. debt holders and other security holders) on the firm's assets, these assets are generating cash flow from the operating activities of the company. So what you say is incorrect in the sense that a share is worth whatever that residual claim on the cash flows/assets is worth.

However, what you say is right to the extent that if you owned a share and were never going to sell it, and management (which itself owns shares so is usually trying to maximise shareholder value) decided not to pay dividends ever and just sit on their mountains of cash), and for some reason no-one could buy this company, then yes, you would not receive any money from your investment ever, making it worthless.


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## reece55 (6 April 2008)

Plasmo said:


> I'm almost embarassed to ask, but just to set this straight, because I've never studied finance or even come across the idea in my travels...
> 
> The underlying motivation for the purchase of stocks is because they are anticipated to in future pay Dividends out, yes?
> 
> For example, if I offered you for $5000 a 10% stake in a company that was guaranteed to grow earnings by 20% per year, held assets valued at $10 million, but with one catch - it would never, ever, pay dividends, that "stake" would be fundamentally worthless, right?  Or is there some psychological phenomenon that I'm ignoring here that would create a "market value" for "ownership" which has no value outside of speculation.




The key question is whether the holder could dispose of the securities and if this was the case, what a willing arms length party would be interested to pay for the entity....

Interestingly, I had to do a valuation on an entity like this only a few weeks ago that had a clause in its constitution preventing it from distributing profits (was not for profit and this clause was required to maintain its non for profit status). As the disposal was limited to only a few parties, we used a modified liquidation value and DCF using sustainable EBITDA + capex using a very very high discount rate (above 20%). 

Cheers


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## Julia (6 April 2008)

Perhaps I'm not understanding your question correctly, but you mention the only benefit of owning the stock in your hypothetical company to be its dividends.

Surely most people buy a stock in anticipation of the share price rising, providing them with capital growth, rather than the payment of dividends?

If looking for an income stream, then yes, of course the dividends and franking credits are desirable, but I wouldn't be happy with just that if the SP was going backwards.


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## Trembling Hand (6 April 2008)

Julia said:


> Surely most people buy a stock in anticipation of the share price rising, providing them with capital growth, rather than the payment of dividends?
> 
> If looking for an income stream, then yes, of course the dividends and franking credits are desirable, but I wouldn't be happy with just that if the SP was going backwards.




eXactly


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## Wysiwyg (6 April 2008)

Plasmo said:


> The underlying motivation for the purchase of stocks is because they are anticipated to in future pay Dividends out, yes?




No way, they`re 10 baggers or bust.:


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## stoxclimber (6 April 2008)

Julia said:


> Perhaps I'm not understanding your question correctly, but you mention the only benefit of owning the stock in your hypothetical company to be its dividends.
> 
> Surely most people buy a stock in anticipation of the share price rising, providing them with capital growth, rather than the payment of dividends?




What he's saying is still correct in a sense, because under the assumptions above (i.e. you basically have no other way to get cash apart from dividends), anyone who buys your share from you is buying on the promise of future dividends. So if there are no future dividends no-one is going to pay anything for your shares. Under those assumptions of course.


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## Trader Paul (6 April 2008)

Plasmo said:


> I'm almost embarassed to ask, but just to set this straight, because I've never studied finance or even come across the idea in my travels...
> 
> The underlying motivation for the purchase of stocks is because they are anticipated to in future pay Dividends out, yes?
> 
> For example, if I offered you for $5000 a 10% stake in a company that was guaranteed to grow earnings by 20% per year, held assets valued at $10 million, but with one catch - it would never, ever, pay dividends, that "stake" would be fundamentally worthless, right?  Or is there some psychological phenomenon that I'm ignoring here that would create a "market value" for "ownership" which has no value outside of speculation.






Hi Plasmo,

Expanding on your example .....

..... if you relied solely on dividends, then the stock would be worthless,
but while a stock may not pay dividends, its price may rally beyond your
buy-in price (for various reasons).

Now, if you sold out during one of those price spikes, then you make
money on your investment (a capital gain), making that stock a money-making machine for you ... creating your "market value" ... 

have a great weekend

   paul



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## Plasmo (6 April 2008)

While certainly it's possible you might find a buyer down the track for such a stock, isn't the value then entirely speculative (ie it will only go up so long as the next buyer expects they'll find a bigger sucker than themselves down the track?)

I mean, sure it could go up, but so could a rock or a bag of air, isn't the entire thing that differentiates stock ownership from the ownership of any worthless object that people could potentially speculate on the fact that it is expected to deliver guaranteed cash in hand at some point down the road?


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## motorway (6 April 2008)

If there were no buyers 
the price would fall

at a price you could take control of that stock
and pay yourself dividends

such a stock would always have a value
maybe a high one
many stocks do not pay dividends

but it is anticipated that they could

why pay dividends if the business the stock conducts
has great growth prospects and needs capital ?

look at Warren Buffett's company

earnings are more important than dividends
Return on capital  invested

dividends can be phony ( eg stocks can borrow to pay dividends )

motorway


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## Plasmo (6 April 2008)

I'm not talking about _past_ dividends, I'm talking about _anticipated future_ dividends.  Berkeshire Hathaway's executives have suggested they will pay dividends _in future_, and I don't know what would happen to the share price over there if he had the business reclassified as some kind of non-profit entity which would never be capable of paying a dividend.



> If there were no buyers
> the price would fall
> 
> at a price you could take control of that stock
> and pay yourself dividends




Well if the company which would never pay dividends actually paid dividends, then that would be entirely contrary to the point of the hypothetical example, wouldn't it?


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## motorway (6 April 2008)

No


because

we deal with dynamics

the result of buying and selling

which results in transfer of ownership..

If you what to fix that  reality
then you want to stop time

and your example has no reality

If people thought such a stock had  no value
Those people would want to sell their shares

I would offer .01 and buy all that was offered

because value is something created

How would you stop people selling to me ?

only if you could stop people selling
could you make the shares have no value ( listed or unlisted and ever )

motorway


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## Plasmo (6 April 2008)

I have a rock in my backyard, want to buy a million shares in it?  It makes a fair profit each year, but by law it reinvests all its profits in me, its sole employee.  Personally I think it's worthless, but you can prove me wrong by buying up all the available stock.


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## Dezza (6 April 2008)

Depends on if your rock is Phophate, Gold or Uranium...:


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## motorway (6 April 2008)

Show me the audited accounts
and give me  recourse if the rock does not continue to perform
as you have stated ( profits )

and yes I could be interested

Only real profits of a continuing long term nature
will interest me .... 


A lot of companies would not qualify
let alone rocks......

but with you as a guarantor ( and with a charge over  suitable assets )

 I will at least have a look

How many shareholders are involved 
and would they want to sell such a rock ?


motorway


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## Plasmo (6 April 2008)

> If people thought such a stock had no value
> Those people would want to sell their shares
> 
> I would offer .01 and buy all that was offered




Translation

"If people thought such a stock had no value
Those people would want to sell their shares

I would make up a bunch of excuses why I won't pay up, but pretend I still seriously believe it has a high value"


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## Wysiwyg (6 April 2008)

Plasmo said:


> I have a rock in my backyard, want to buy a million shares in it?  It makes a fair profit each year, but by law it reinvests all its profits in me, its sole employee.  Personally I think it's worthless, but you can prove me wrong by buying up all the available stock.




lol, can i answer this one .... 

o.k. your rock is turning a profit and you want to sell it because a profiting rock to you is worthless.You don`t have to be proven wrong.You have already decided in your own mind that the profiting rock is worthless.Produce the financial paperwork and put it on the market.


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## Plasmo (6 April 2008)

Why would I waste my time doing that if I don't believe anyone would buy it?


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## nomore4s (6 April 2008)

Is there a purpose to this thread or are you just trying to bait people?

Various posters have put forward some answers to your original question and you just keep coming back with more ridiculous scenarios.

The fact is companies don't have to pay a d/e to be worth something on the stockmarket.

In reality it is about what someone is willing to sell a share for and what the other party is willing to pay for it.


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## Julia (6 April 2008)

nomore4s said:


> Is there a purpose to this thread or are you just trying to bait people?
> 
> Various posters have put forward some answers to your original question and you just keep coming back with more ridiculous scenarios.
> 
> ...



Thank you for saving me the trouble of saying this, nomore4s.  
Plasmo, you began by suggesting you were almost embarrassed to ask the question.  We have attempted to answer what did appear to be a peculiar question in good faith.  
If you have a genuine point, it would be good to make it clear.


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## Trader Paul (6 April 2008)

Plasmo said:


> ..... isn't the entire thing that differentiates stock ownership from the ownership of any worthless object that people could potentially speculate on the fact that it is expected to deliver guaranteed cash in hand at some point down the road?






Hi Plasmo,

"speculate on the fact that it is expected to *deliver guaranteed cash*" 

..... in ordinary classes of shares, there's definitely NO GUARANTEE of
any cash, going forward ... !~!

happy days

 paul



=====


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## Plasmo (7 April 2008)

If you don't know the answer, don't bother trying to look smart by posting something up.  This is a theoretical question, not something you would have picked up reading graphs on your PC.

Obviously a share is worth what someone will pay for it.  So is a rock or a bag of air.  What I'm asking is; what differentiates a share from a purely speculative object?  Why is there an active market in share trading instead of rock trading?  Obviously "An X is worth whatever someone will pay for it" isn't going to cut it as an explanation.

So yes, I was embarrassed to ask, because I thought it would be the sort of basic knowledge everyone picks up in first year finance, frankly I'm more embarrassed now by the answers of people who think they know something about the market.


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## professor_frink (7 April 2008)

Plasmo said:


> If you don't know the answer, don't bother trying to look smart by posting something up.  This is a theoretical question, not something you would have picked up reading graphs on your PC.
> 
> Obviously a share is worth what someone will pay for it.  So is a rock or a bag of air.  What I'm asking is; what differentiates a share from a purely speculative object?  Why is there an active market in share trading instead of rock trading?  Obviously "An X is worth whatever someone will pay for it" isn't going to cut it as an explanation.
> 
> So yes, I was embarrassed to ask, because I thought it would be the sort of basic knowledge everyone picks up in first year finance, frankly I'm more embarrassed now by the answers of people who think they know something about the market.




If the question is so easy to answer, go ask a first year finance student for the answer and stop trying to flame people on an internet forum.


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## Spaghetti (7 April 2008)

Plasmo said:


> If you don't know the answer, don't bother trying to look smart by posting something up.  This is a theoretical question, not something you would have picked up reading graphs on your PC.
> 
> Obviously a share is worth what someone will pay for it.  So is a rock or a bag of air.  What I'm asking is; what differentiates a share from a purely speculative object?  Why is there an active market in share trading instead of rock trading?  Obviously "An X is worth whatever someone will pay for it" isn't going to cut it as an explanation.
> 
> So yes, I was embarrassed to ask, because I thought it would be the sort of basic knowledge everyone picks up in first year finance, frankly I'm more embarrassed now by the answers of people who think they know something about the market.




Well there is a very active market in rock trading. FMG for eg has made many people wealthy because they had rocks people perceived to have potential value in the future. May not be the case at all but they speculate that with the increased demand for this rock that one day FMG may actually make a lot of money. There is no guarantee of course but people speculate on the probability. Gold already has value but if in rock form people at the moment are not heavily speculating on it as the cost to get the bits of gold out of the rock may cost more than the amount of gold extracted. If the demand for gold continues and the price of gold goes up then people will want these rocks even if they simply sit in the ground doing nothing. The probability that one day it will be dug up increases.


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## barney (7 April 2008)

Plasmo said:


> If you don't know the answer, don't bother trying to look smart by posting something up.  This is a theoretical question, not something you would have picked up reading graphs on your PC.
> 
> Obviously a share is worth what someone will pay for it.  So is a rock or a bag of air.  What I'm asking is; what differentiates a share from a purely speculative object?  Why is there an active market in share trading instead of rock trading?  Obviously "An X is worth whatever someone will pay for it" isn't going to cut it as an explanation.
> 
> So yes, I was embarrassed to ask, because I thought it would be the sort of basic knowledge everyone picks up in first year finance, frankly I'm more embarrassed now by the answers of people who think they know something about the market.




I take a fairly simplistic view of how and why humans operate, so I'll put a quick spin on this ........... 

Humans are greedy .......

Humans need to, and love to make money, because thats what makes economies work ......

A Company is nothing more than a "group" trying to make money ....

For a Company to be listed and sell shares, it needs or wants to get "bigger" ....

It can't get bigger without an influx of money ...

Shareholders provide the money to build the company  (They are making a valued judgement that the Company has potential to make even more money  ... Call that speculation or forward looking ...... doesn't really matter what you call, its still about money and greed ....

Without shareholders the company would most likely fail in getting listed in the first place ..

Once it is listed, the simple fact that there are a large number of shareholders is what creates a market where greed can be displayed via trading ...  In the companies infancy, It is the potential of its worth which dictates its SP, not the dividend it pays ............ After it proves its ability to make money, it may pay a dividend which may then attract a different type of speculator/investor ....

The Rock scenario only has one shareholder, you, so until it displays some worth to lots of people, and you can grow that worth into a company large enough to "list", your market is very limited 

A limited market will most times attract less speculators 

Less speculators, most times, will generate less greed, so the percieved value of say your rock will be less than it possibly could be 

You need to generate some hype and advertising to generate some interest in your rock .... get some greedy investors on board, then hope your rock has more than just granite in it  ......

Not sure if that answered your question, but I am interested in this rock of yours    Barney.


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## Rainmaker2000 (7 April 2008)

This is a pretty amusing thread.......the core question is an interesting one, about the stock that will never pay a dividend, but it all seems to have been muddied.....

Dividends are nice but not essential for value.......many of the most valuable things in our world are valuable despite a lack of potential income....a painting, a stamp, wine, even lumps of gold...

These are not similar to a company however.....just because productive assets are wrapped up in the legal character of the Corporation does not make them valueless if they don't 'pay out earnings'......you will notice that companies have  a rainbow of ingenious ways of delivering value to shareholders other than dividends.......you may also note the multitude of legal circumstances that the Corporate 'veil' can be pierced...

This all renders dividends as pretty nice but pretty optional


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## Trembling Hand (7 April 2008)

Rainmaker2000 said:


> This is a pretty amusing thread.......the core question is an interesting one, about the stock that will never pay a dividend, but it all seems to have been muddied.....




Yes interesting but I suspect the original poster started the thread just so he can tell others how sharprolleyes he is rather than any genuine discussion.


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## barney (7 April 2008)

Plasmo said:


> I have a rock in my backyard, want to buy a million shares in it?  It makes a fair profit each year, but by law it reinvests all its profits in me, its sole employee.  Personally I think it's worthless, but you can prove me wrong by buying up all the available stock.




A couple of your posts have a pretty aggressive tone Plasmo ….. Not sure why, but I’ll keep buying in at the risk of being crucified ……. 

Re your above quote:-

I think you would want to sell a million shares in your rock not buy them, cause you already own the rock ??

If the rock makes a "fair profit" each year, how can you consider it worthless??

If you already own the rock (it is in your backyard after all), why are you the rocks "employee"? 

The only way you can be the rocks employee is to turn your rock into a company and share your rock with like minded "speculators" .... Of course if you "sell" the idea of your rock as being "worthless" as you state, I doubt you will get many takers !

Might be a few holes in the scenario.

Actually I’m not sure of the point behind your question.  …....  If you perceive that trading shares is in essence no different to speculating in general, what does that matter?  Does it create moral issues, or simply create hesitancy due to a lack of confidence in the market as a system? ……….. (Serious question).   Barney.


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## kloid (7 April 2008)

This is an interesting topic.

Just say for example that I bought shares in Berkshire Hathaway in 1990.  Let's assume that I bought 20 shares at $8000 for $160K.  Now, 18 years later my shares have a market value of over $2m.  I haven't received any dividend in that whole time but my "wealth" has increased substantially.  The only way I can realise my wealth is to sell the shares right?  What I can't get my head round is why someone would buy those shares off of me if they will NEVER (theoretically) receive any cash for them.  They could be sold and sold on forever but unless Berkshire starts liquidising its assets and returning cash to shareholders how would I ever realise my wealth?

I hope this makes sense to someone.

Cheers
Kloid


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## Rainmaker2000 (8 April 2008)

That's why it is indeed a good issue to think about Kloid..........

The market often gives too much credit for companies just because they pay dividends......while punishing companies which could, but choose not too......just consider the company whose share price shoots up because they declare a large 'special dividend'.......the fact is, why should this mean the company is more valuable.....after all, earning the money is the hard part, giving it out is easy...

The stock is still valuable even if there are no dividends......buybacks, shareholder discounts, capital resturctures can all be employed instead of dividends.........the key is of course actually having valuable assets and good earnings...that's what matters


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## kloid (8 April 2008)

Rainmaker2000 said:


> That's why it is indeed a good issue to think about Kloid..........
> 
> The market often gives too much credit for companies just because they pay dividends......while punishing companies which could, but choose not too......just consider the company whose share price shoots up because they declare a large 'special dividend'.......the fact is, why should this mean the company is more valuable.....after all, earning the money is the hard part, giving it out is easy...
> 
> The stock is still valuable even if there are no dividends......buybacks, shareholder discounts, capital resturctures can all be employed instead of dividends.........the key is of course actually having valuable assets and good earnings...that's what matters




OK, I understand that not paying dividend can be a good thing - if a company can invest all of its surplus funds and generate a return in excess of the cost of capital then I'd rather it didn't pay a dividend as I'd only waste it on something rubbish anyway.    But if we took my earlier example to a silly extreme maybe I'll be able to make my point a bit more clearly:

Let's say I hold my shares until I die in 2050 at which point they're worth about $200m having grown at 10% per annum.  They then pass to my son, who also holds them until his death in 2090 at which point those shares are worth around $5bn.  The process could continue on for generations.  My great-great grandchild could in 2150 have shares worth $1.5 trillion but unless they sell them they will not have anything to show for it.  Those shares would represent massive amounts of physical assets, goodwill, employee skills, land, buildings, and so on - I guess what I'm trying to ask is - is the mere ownership of those assets the motivation to buy (and hold) shares even if the owner never sees a $ in their own pocket because everything goes back into the business....someone mentioned owning paintings above - I get that because I can look at a painting, enjoy it, use it to liven up my living room but I can't really do that with shares, or can I?


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## Arkad (8 April 2008)

Value is a nebulous concept.

Lets just say I own shares in a failed textile mill worth about $50 Billion.

I don't plan to sell them. I'd like to pass them on to my kids. Or maybe give them to Bill Gates one day.

What value would they have to me personally?

Well as a start. I would have almost unlimited credit at any bank at any time to buy whatever I choose. No questions asked. Why? Because I would be a zero risk customer.

Given that I have accumulated such an enormous sum, other members of the business community would want my help and advice. I would be offered seats on countless company boards. Governments would want to appoint me to various advisory panels. These would all be paid positions. Why? Because my personal time would have a very large financial value attached to it. I might even be able to charge $650,000 just to have lunch with me.

Why? 

Because the creation of vast wealth suggests some expertise in the area of financial management and capital allocation. These are highly marketable skills. They may not be well deserved in some instances, particularly if my shares were themselves inherited.

So even without any desire to sell my shares, which of course, never pay dividends, there would still be value, in a capitalist society, attached to owning them.

Obviously this is an extremely fictitious example and any resemblance to any person living or dead is merely coincidence.

Have fun!


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