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Strategies & Market Trends : Booms, Busts, and Recoveries -- Ignore unavailable to you. Want to Upgrade?

To: Ilaine who wrote (6289)	7/26/2001 12:45:49 PM
From: smolejv@gmx.net	Read Replies (1) \| Respond to of 74559

Let's take it for granted, that it IS a zero sum game. So below the line, there's not more or less wealth to talk about. Point is thou, the cash, that was originally in the J6p's pockets, is now in somebody else's hands. Las Vegas, same thing. I wonder sometimes, if IBM, CSCO, MU are not just a variant of the "establishments" on the Strip. dj

To: Ilaine who wrote (6289)	7/26/2001 12:58:58 PM
From: Don Lloyd	Respond to of 74559

CB - I've been thinking about how to explain the concept, and came up with an analogy which I like, see if you like it too. Company XYZ has 1 billion shares of stock, keeps 500 million in the treasury, and sells 500 million at an IPO. On the day of the IPO, the shares sold for $5, so the total market cap is $2.5 million. It should be obvious when reading the above that total market cap doesn't give you a lot of information, because it doesn't tell you anything about the shares which are in the treasury - what are those worth? Further - as we all know - total market cap doesn't tell you anything about what the company is actually worth. The assets are valued using book value. Other methods of valuation would be sales revenue, earnings, etc. The only thing $5 tells you is what the stock sold for at 4 p.m. on the date of sale. It could have opened at $100 and plummeted down to $5 - it could have opened at $1 and soared to $5. Who knows? Now suppose that on IPO day, 400 million shares were bought by large institutions that never, ever trade. That leaves 100 million shares in the hands of people who do trade. So the market cap is going to be determined by the float - what does that tell you about the shares which have been authorized but never sold? What does that tell you about the shares that never trade? If the shares in the float trade at $50, are all the authorized shares "worth" $50? Are all the outstanding share "worth" $50? Obviously, they are only worth $50 if you actually sell them for $50. What the price is in the newspaper is helpful information, but that only tells you what one set of buyers paid one set of sellers at one time on one day. Further, because every time someone buys a share, the transaction is zero sum - if I pay $5 to you, then you get $5 from me. Nothing is "lost." Nothing is "destroyed." Thus, it is meaningless to say that wealth is destroyed when stock prices go down, just as it is meaningless to say that wealth is created when stock prices go up. ~~~~~~~~~~~~~~~~~~~~~~~~~ That said, I know for a fact that people who look at their brokerage statements feel rich when the net value goes up and feel poor when the net value goes down. So if I tried to explain to them that they haven't lost anything when the market crashes, they'd either laugh at me or string me up. A couple nitpicks - 1. The treasury shares and any authorized shares not issued, to the best of my understanding, have no effect on anything and can simply be ignored. Since tomorrow new shares could easily be authorized and issued to the executives, the fact that some shares have already started that process is of little or no meaning. 2. The shares that never trade are fully equivalent to those that do. They have exactly the same rights of ownership of the company. The effectively reduced float that results from the untraded shares causes increased volatility and reduced buy side liquidity. If you want to buy 100 shares, the untraded shares have little effect. If you want to buy 1M shares you will likely have to pay a higher price because the untraded shares cannot help fill your order. OTOH, if you want to sell 1M shares you will probably get a better price since you will not be competing with the untraded shares. Prices are set on the margin and vary with exactly what the marginal quantity is. For example, let's say you are the owner of a fresh water lake and a man crawls out of the adjacent desert and wants to buy a cup of water. While the local property tax board might like to re-assess your property on the basis of the negotiated price of the cup of water, the proper price of the lake would be the result of a negotiation between you and someone who wanted to buy the lake in its entirety. Stocks of public companies are somewhat different in that the price of the whole often does even exceed the sum of its parts. This is not true of equivalent private companies. This indicates that public companies are more valuable than equivalent private companies, at least when there is some possibility of a buyer for an entire public company. This probably follows from the law of diminishing subjective marginal utility, which indicates that the value of the first 100 shares owned is far more subjectively valuable than the last 100 shares of a large position. Regards, Don Thanks for collecting the posts. PS - The wealth effect is real, even if the value cannot universally be realized in practice. Before your stocks soared, you might have maintained a liquid cash balance of $10K for future emergencies and bargain opportunities. Afterwords, You might reduce that to $5K. The reduction in cash balance from $10K to $5K is equivalent to a reduction in the purchasing power of money as you now have been willing to spend $5K on something that you wouldn't have before. Since inflation and deflation are, by (at least some) definition, the subjective marginal value of money in terms of goods and services, the wealth effect of stocks is both inflationary and deflationary in turn.