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June 17th, 2008
11:46 pm - Stocks
A word of warning: I suspect that I may be completely off-base here. My understanding of this subject is a mix of antiquated theory and limited anecdote. I'm throwing this out as a snapshot of my current understanding and perceptions. Please contradict and help fill in the gaps.
I've been thinking about the stock market lately. Not in the sense of me making investments, but in terms of how it works, how it allocates money to commercial ventures. This is part of a general curiosity about what makes the world tick, but there's also a specific self-interest in wanting to understand what motivates the companies I work for. My background coming into this is from historical reading and personal experience.
But first, why do I care about the stock market? Well, I don't, really - not the day-to-day of it. I'm not one of those guys who keeps a stock ticker running on his desktop. But it's important - these days, it's responsible for a lot of what gets done in the world. Most of our food, clothing, shelter, medicine, transportation, entertainment, etc. comes from publicly traded companies. Also, the origins and theory of it are kinda cool. Essentially, it's a mechanism that allows a whole mess of strangers to work together on a venture that's far to big for any one of them to tackle. When you look at it this way, it's a really elaborate form of human communication. And humans, I find fascinating. I'm really only interested in economics to the extent that it's about people. I'm most interested in the microeconomic end of the scale, because it's really the psychology of decision making. Why do people do what they do? How much is internal motivation, and how much is external constraints? Group behavior is also interesting, as in companies. But as economics gets more macro, it gets away from people and eventually ends up in a bad place full of aerodynamics-grade math.
The other reason for caring about the stock market is that a lot of the companies I might work for are motivated by the stock market. If they're public companies, they end up making a lot of decisions based on how it will affect their stock. If they're private, they're probably thinking about becoming public companies, or getting acquired by public companies, which influences them in similar ways.
My limited understanding of stocks comes from reading about 17th century trading ventures. You want to build a ship, outfit it and crew it, and spend the better part of a year sailing it halfway round the world to bring back spices or silver or lumber or whatever. These are huge up-front expenses and there's a very real chance that the ship will be lost to storms or pirates. The upside is that if all goes well, you'll make a ton of money. Almost nobody has the kind of money you need for that initial investment. Even if they do, they can't afford to lose it all. But if you get a big group of people together, then each can bet a share they can afford to lose. They buy shares, and they get a cut of the profits. Now if you get a really big group of people together, you can fund a bunch of ships and play the averages. Instead of feast or famine, you get a nice, predictable return on investment. Instead of shares in a one-time venture, you have an ongoing business, and the shareholders get yearly dividends. More importantly, without some mechanism like this, the happy consumers in your corner of the world will never know the joys of coffee, chocolate, or potatoes.
So stocks and dividends make sense. You invest in a company. You give them money up front, and they give you a piece of the action. It even makes sense to trade stocks. If you decide you'd rather have a chunk of money now, you sell your share to someone, and they get the dividend every year. It makes sense that the value of that share could go up, if the company prospers and grows, and the yearly dividend goes up. The important thing here is the company's focus on profit. Profit is a measure of how useful the company is, how well it provides a good or service that people are willing to pay for.
But now we get to the point where I think it starts to peel loose from reality. If you think a company will be successful, and its shares will pay higher dividends in the future, it makes sense to buy them now and sell them for more later. It's logical, but it's a critically different way of valuing the stock. You're buying shares based not on the dividend itself, on the profit from the venture, but on how much you expect to be able to resell the share for later. It's the shift from investment to speculation. The value of the stock is no longer tied to the expected dividends, but to what people think they'll be able to resell it for, what they think other people will think it's worth, which is what they think they'll be able to sell it for. Profitability, useful products, business value, all of that may still influence the stock price, but they're secondary factors.
We got a prime example of this in the dot-com boom, where there was really no business justification for the value of stocks. There were companies with no product or customers. They didn't own anything; they hardly had any employees. They didn't do anything useful. But they'd go public with a lot of buzz and their stock would skyrocket just because people thought everyone else wanted to buy it. Once investors thought it had stopped going up, they scrambled to get out before it crashed, which ensured that it did. Then the cycle would start over with the next cool idea - there was no end of those.
The key is that the investors don't actually care about the success of the business, as long as they can get out in time. They want the business to look promising, so others will want to invest and drive the price up, but it doesn't have to deliver. The rewards for investors became largely detached from value creation, from profit. The fundamental promise of capitalism, that businesses are rewarded for doing useful stuff, is broken.
Something strange and bad also happens to the company's motivations. Remember that they're always competing with other companies for investment money. The things they should be focusing on - doing useful stuff - take a back seat to activities oriented around market perception. A lot of that seems to do with growth, or the perception of. If a company is doing useful stuff, making a profit, and plowing that back into the business (buying more ships), it will grow. It will have more equipment and people than it did last year. All well and good. But this gets turned around, and growth becomes the measure of success. So companies start doing stupid things in order to have good growth numbers.
Mostly, they go out and buy a bunch of smaller companies who have little to do with their core business. They end up being less than the sum of their parts. The guys at the little company are less motivated, because now they're just working to make a bunch of strangers rich. That's even if you haven't demoralized them by laying off a bunch of their staff. Even if there are synergies to be leveraged (shudder), there are a lot of hurdles to overcome - cultural, political, technical, and organizational - and no guarantee that everyone will ever work effectively together.
So I don't know what the answer is, or if I even understand the problem. A lot of this is idle curiosity: There's a complex and important system that looks kinda broken, and I want to understand how it got that way. It's not like I run a company, or even manage investments.
But the practical side is that my understanding of this will inform decisions about where I work. I've come to appreciate how much the business environment and priorities have a real impact on my day to day job. I've worked at the little company that got bought. I have friends who've worked for the big company doing the buying. I have friends who have worked for the company that's hiring lots of useless people to make the numbers look good, and others at the one that's laying off lots of useful people to make the numbers look good.
If I can go into an interview and ask the right questions about their business, I'll end up a lot happier. I'm not job hunting now, but understanding this will also help me recognize if my company is going off the rails. Maybe the answer is to find a company that's not playing this game, where the owners aren't just looking to cash out, where they're really engaged in the business. I've actually worked at a place like that years ago, a little boutique software shop. It was really nice in a lot of ways. I left it then because I had a lot to learn, but I might be happy going back to that kinda gig now.
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Comments:
![[User Picture]](http://l-userpic.livejournal.com/78451655/715031) | | From: | ![[info]](http://l-stat.livejournal.com/img/userinfo.gif) vicar |
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| Date: | June 18th, 2008 11:34 am (UTC) |
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The problem is not radically different than the problem of any collective enterprise - say voting. To the individual, it is not worth doing the research it would take to make sound business decisions.
Add in the real speculation and the problem of making things accessible to the masses. The dot com boom isn't just about insanity - it's about the downside of making responsible investing readily available to the public. As you know from basic econ, higher demand = higher prices. Well, in the 80s and 90s spirit of deregulation, information requirements on stocks were reduced and access was increased manyfold. Old money rich folk had been staying rich for eons with their hidey-hole brokers and golf-course information. With the deregulation, oh and then money on the internet, companies started selling to a wider audience - one who didn't have degrees in finance or talks with white haired old men. The trailblazers headed out, made money, and bragged to their friends.
The dot com was partially based on this "whole new economy where we don't build anything" idiocy, but it was also based on expectations based on patterns. As more and more retirement plans and people entered the market, demand for this limited supply went up, and so did the prices. In fact, it was hard not to make money in the market for a while as the number of investors multipled over tenfold. As all prices went up, these initial investors made a mint - not over the long term based on dividends, but based on paper gains as the value of their portfolio went up. Hearing of these get rich quick stories, even institutional investors got nudged to make more risky ventures, more trades, anything to catch up to the happy rich on paper ilk. Why let your 401k only get 8% a year when your neighbor just made 50% on AOL?
What happened then was neat - all the new investors had the perspective not of investing for gains, but investing based on the expectation that their brilliant 30 days of research would consistently yield 2 and 3-fold gains by selling stocks every 6-24 months. The style section was peppered with stories about basement-dwelling internet day traders who made millions overnight on trades by the minute. Dividends dropped out of the picture entirely in the eyes of the average new investor, and many companies never really bothered with dividends as their stock buyers did not. Some silly people said this couldn't last forever, but the people paying to hear news wanted to hear about the next big 4banger. Supply. Demand.
So the dream of IT is partially to blame, but the real insanity was giving people the power to use information wisely - like voting, it ended in disaster for many.
For a more current "more of the same" phenonenom, see the real estate "bubble." Again, instead of long term investment in a slowly appreciating asset that requires initial research, continual investment, and constant familiarity - people switched to the buy, wait 5 minutes, sell...profit! Model. And disaster followed.
I think that your ship example is much more analogous to angel funding or venture funding then it is to investing in the stock market.
And when it comes to dividends, you also have to remember that in many circles dividends are seen as bad because it means that the company isn't innovative enough to take their existing money and make additional money from it. It is one of the reasons that being slightly in "debt" isn't necessarily a bad thing for a company that is growing at a good pace. But they also have to be able to slow or stop growth and build up their coffers at their whim.
But I think that you are leaving out that the stock market does allow ownership in companies and that the short term sale of stocks needs to be viewed in the bigger picture (long, short, calls, puts), the big holders (such as funds and hedge funds), and that there are a lot of stock transactions that are for the sake of actual ownership. I bet Berkshire Hathaway would be an interesting study for you.
Taking your own personal situation - the things that bothered me were consistently having numbers that could not be met quarter after quarter, a process that was not very scalable as it grew, a level of disjointedness by people even just one level up from what it took to make something happen, and mostly the desire to explain away the numbers rather then to fess up to them and take the short term steps to fix them for the longer term.
Edited at 2008-06-18 11:50 am (UTC)
Oh good - you were one of the people I hoped to hear from on this. :)
Yeah, as I was writing this, I was thinking that Warren Buffet may be an interesting case. He has a rep for focusing on fundamentals and going into things for the long haul.
On growth vs. dividends, that may be a matter of market maturity and/or specialization. I suspect that a lot of companies hit a point where they've got a good-sized, stable customer base, and they start doing stupid things in a desperate attempt to grow. It's not that growth isn't a good yardstick, it's that it seems to be the only one.
The big reality check that I want to get out of this is how much the market is driven by short-term vs. long-term investment. You hear about the day traders because they're flashy, and you hear about the big firms when they lose big on something risky, but there's some quiet mass of institutional investors who make up a lot of the market. What are the ratios there?
On the personal level, I think the core of the problem is focusing on the numbers to the exclusion of all else. There's a lot of fuzzy things like technology debt and morale that aren't really measurable, so they don't get measured, they don't show up in the balance sheet, and they get largely ignored in decision-making.
So, Galaxy Hut sometime? :)
Yeah - that sounds good.
I get you on the focusing on the numbers only. In part what I was saying was that the right numbers were more important then honesty on the numbers as well.
Also respecting skilled workers that are stilled in talents other then their own as truly skilled and thus worth making sure their jobs are good, interesting, and compensated for.
I think what has happened recently is that there are huge clumps of money in hedge funds and index funds right now, and they are basically being constantly shifted back and forth to wherever is considered beneficial.
Apparently, the largest, shortest-term gain is considered best. You can maximize the speed and amount of money you make if you can drive up the perception of demand and then time the move of your money into a different market. This is super-easy thanks to the internet. Another thing that helps is if the market doesn't have a lot of pesky regulations that make you announce to the public who you are and what you are buying; that way it is much more difficult to anticipate what the market is going to do.
That seems to be what has happened with oil this year: huge amounts of money were shifted into oil futures, a market that is considered a "dark market" thanks to a deregulation rider added by Phil Gramm (McCain's guy) to one of the last bills Clinton signed into law. George Soros and some others claim that the money is actually being shifted from the US dollar itself to oil - which exacerbates the plunge in the value of the dollar as well as pushing gas prices up ridiculously.
Anyway, I think a stock market requires some regulation by a governmental authority or it will eat itself. |
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