ehud, "It's quite simple to explain:"
No, it is not that simple as you tend to believe,
there are nuances that you prefer to close your
eyes on. Let's look at your example:
"Step 1: Johnny has $1."
Ok, maybe. Money is something you don't have, or don't have
at all. Then, we must be clear, it is not Johnny's $1,
it is a company $$, and the company is owned by
shareholders (no matter how naive this sounds).
"Step 2: Johnny buys 1 share for $1."
There is a question though, why would Johnny do such a
silly thing like buying his own share at market price?
More, Johnny buys the share for current price of $1,
... and tears the share down!!!
Why??? Because his owners, company shareholders,
were upset with too many other shares that
Johny issued every year, and the stock was continuously
diluted. I specifically pointed you to the term
"retirement of common shares" as per company financial
statement.
"Step 3: Johnny grants Mary an option to buy 1 share for $1 next year."
... without having any shares since he shredded the paper,
and waived the shred on a shareholder's meeting making
them happy. Johnny rightfully hopes that either Mary could
be fired, or options will be underwater, who knows what
else can happen in many years ahead. But Mary worked hard
and Johnny's company got $4.20 in profits this quarter.
"Stay with me Ali... It'll come clear in a minute..."
Ok, I am all ears...
"Step 4: Next year Mary hands Johnny $1. Johnny hands Mary 1 share."
Oops!, Johnny does not have that share! To honor his
obligations to Mary, he issues a new share, and gets
his $1. However, the company owners still demand to
control dilution, so they instituted and approved
a stock buy-back plan. Accordingly, Johnny (or his
accountant) orders his designated brokerage
house to buy another share, but it could happen only
at open market price, which happens to be around $5
this quarter. Then Johnny pays the broker out of company's
bank account, $1 he got from Mary, and $4 he got from
profits. Then, in accord with shareholder's will, Johnny
retires the share he just bought.
Funny that the $4 happened to be Johnny's whole
quarterly profit, so his enterprise has yielded no profits
in contrast to what he tells the shareholders.
In addition, the services of Mary cost Johnny
effectively $4 while he told shareholdrs that Mary was
working for free and made his gross margins skyrocket,
which again appears to be not effectively true.
"Goto Step 1:"
Whatever, if you have any $$$ left. Actually, you
need to go to Step 3 now since Johnny has to
get through Step 1 and Step 2 in process to honor
Mary's grant and shareholder's will during Step 4.
"Ask a big person to explain it to you."
I'm afraid you'll need to take your own advice :-)
See, the subject is a bit more complicated. It probably
can be simplified and logically reduced to your example
if the stock is steady at $1 over all years. It is not.
- Ali |
