patrick.net

Pretty much like gold or currency. But just because something has little intrinsic value does not make it a ponzi scheme or worthless. Are you burning your dollar bills?

Are you really an econ major or economist?

Gold can be used as a decoration/jewelry or in manufacturing. Currency is used in transactions. Both have value outside the belief they have value. Therefore their intrinsic values are not zero. Stocks are bought for the sole purpose that people think they are valuable, therefore their intrinsic value is zero. Don't compare apples to oranges.

Thanks for trying though, ha-ha.

Thanks for the post. That more or less puts into words my entire opinion of the financial system & & stock markets. It only works because people think it does. In my opinion, it is a fragile system, and dangerously misunderstood by the general public. Given how badly it is being beaten by large players, for their own benefit, I get the uneasy feeling that it is going to collapse on itself, and bring down our entire way of life with it. This notion of never-ending annual growth has always struck me as totally bizarre...when you are measuring YoY growth in percent, and want it to stay positive, you get an exponential curve. Nothing is unlimited, and that sort of behavior always leads to collapse as reality catches up with everyone.

There is one huge difference though:

Most stocks are paid for with cash.
Most houses are paid for with debt.

So your stock can go to zero, but it can't get worse than that, if you paid cash.

But your house can wipe out all your equity and then keeping going negative way past zero. Then you can't sell and you can't move, and you've got this giant millstone around your neck. Assuming you took out a mortgage.

Patrick, that is not entirely true. People that make large put- & call-option bets can end up owing money, although I think that it is a lot harder to "borrow" for that than a house. A buddy ended up owing a moderate sum of money to his brokerage (I think) after making a bad gamble with Netflix recently.

Seriously who didn't see this whole Facebook stock offering being a fail? Not the epic fail it has been so far, but something that didn't work out well in the long run.

This thing is mostly likely going to end up in courts for a long time and sour people appetites for IPO's.

bmwman91 says

Patrick, that is not entirely true. People that make large put- & call-option bets can end up owing money, although I think that it is a lot harder to "borrow" for that than a house. A buddy ended up owing a moderate sum of money to his brokerage (I think) after making a bad gamble with Netflix recently.

You're right, but the normal situation is to just pay cash to buy stock. Options are still rather exotic for most people.

The normal situation with housing is to take out as much mortgage debt as you possibly can.

Stock Market from the beginning was design to lose money by retail investors. Main purpose is to take money from street, what will happen later, nobody care.
Dow Jones is going up only because represent the best performing, largest, company in US, but if one got busted it’s simply delisted. How many the same companies stay in DJ index today than 100 years ago???

You're right, but the normal situation is to just pay cash to buy stock. Options are still rather exotic for most people.

The normal situation with housing is to take out as much mortgage debt as you possibly can.

Agreed.

EconPete says

Gold can be used as a decoration or in manufacturing. Currency is used in transactions. Both have value outside the belief they have value. Therefore their intrinsic values are not zero. Stocks are bought for the sole purpose that people think they are valuable, therefore their intrinsic value is zero. Don't compare apples to oranges.

Thanks for trying though, ha-ha.

Ok... What's gold's value in decoration and manufacturing? Is it even a couple bucks an ounce?

If a stock pays dividends or if the company has large amounts of cash, would it have an intrinsic value then? Believe it or not, stocks can be used in transactions too.

EconPete says

So, what gives stocks their value? Other idiots who think stocks are valuable, that’s all.

Actually no. Your stock is a representation of a portion of a corporation. A corporation is a collection of individuals and assets (and debts/liabilities) working together to create value and wealth. Wealth has been steadily created since the beginning of time. Increases in productivity and technology have lead to a greater standard of living for all humans. This is a net increase in wealth. This is what your share in a company is purchasing. The future value of the wealth that an organization will create.

Not all organizations will create wealth. Some will though.

http://paulgraham.com/wealth.html

Q:How do you value a house with starving neonazi cannibals climbing through the windows? A:With a 12 gauge and buckshot.

This is a very naive view of stock valuation. First of all, all value is subjective, there is nothing like a "true" value for anything. How much is a glass of water worth to you at home? How about when dehydrated in the desert?

Anyhow, stock prices represent a partial ownership of a physical entity. It's not worth zero. If the company stopped doing business instantly, sold all its assets, you would own a share of that. Stock valuations are also set based on dividends. If a stock pays out a dividend at a certain rate, it's got a certain value given the risk level of owning the stock, and that's not zero either, since the stock is an income source. On top of those ways of pricing a stock, you price in future expectations. When a company misses numbers even a little bit, the future expectations can drastically change, which is why you can see huge price swings. If a company is a "sure bet", its stock price is much more stable.

This is no ponzi scheme, but it is true that the "wealth" is kind of imaginary until cashed out. However, as with everything else in the economy, we choose alternatives, and if a share of a company is a good thing to have compared to other things to do with the money, it does create a valuation.

myob says

Anyhow, stock prices represent a partial ownership of a physical entity. It's not worth zero. If the company stopped doing business instantly, sold all its assets, you would own a share of that

When company stocks go to Zero - you have Zero as well. The only company BOND holders share profit from sold asset.

“ blah blah blah ZERO… blah blah blah NEGATIVE”

You need to cheer up, don’t worry, be happy! Buy a condo, heck buy several and rent them out. Then you could be a savvy landlord like me rolling in dough. Honestly, the world can be molded by positive financial fantasies. TAKE IT!

bmwman91 says

People that make large put- & call-option bets can end up owing money

Thats called gambling. Its why you cant borrow money for that activity.

lwog says

You bastard... You stole my picture!

He sounds just like you too.

rooemoore says

Lol, I'm a moron who laughs at stupid things!

Haha. You like my penguin?

A stock is not like fiat money. Why not?
There are usually a fininte number of shares outstanding. AAPL today for example has 900 million or something close to 1 billion shares.
Money? Well, they can increase that so much that the money you are holding loses value.
Stocks are not usually bought with debt, but with cash. Sure, you can have now a 50% margin so you can't be using too much debt to buy stocks.
A stock can pay dividends. A house cannot, unless you rent out a room to someone.
A stock is virtual. There is no case of someone's brokerage account burning down, being eaten by termites, or being blown up by PG&E. I don't need to insure my stock account.
But, I can actually buy instruments that try to insure the value of my stocks come to think of it.
A stock can become more valuable because the company can grow its sales and profits and assets.
Cash cannot do that, and there is not yet any house that is able to grow an extra room by itself.

The only way for a particular companies stock to go to zero is for no one to want to buy it. That almost sounds possibly, until you realize that someone will always want to buy it as long as it is making money.

The only way that the whole stock market goes to zero is if the whole economy freezes, and all companies stop making money. Because companies have debt and obligations, in many cases their profits can go to zero without the economy grinding to a complete halt. So, in a crisis of confidence, people will stop spending, the economy freezes up, stocks go to zero. In normal times, stocks are perfectly easy to value.

You cannot say that stocks are purchased with cash and houses are purchased with borrowed money. It is the individual person or company who is leveraged, not each asset they own.

Here's an obvious example:
Let's say you have $200K in stocks, and you decide to buy a house. You sell the stocks and buy the house. All is well, as you have no debt, but you decide that you are getting left behind as stock are going up, and houses are flat or decreasing. To add insult to injury, the gov't is subsidizing house loans. So, you take out a loan and use the house for collateral. The bank gives you $160K, and you buy some stocks back. Now you are happy, because the gov't is subsidizing your stock purchase and allowing you to deduct the interest, and you are back in the green. Is the house a leveraged purchase or are the stocks? Overall, you have $360K in assets and have $200K net worth, so your personal leverage is 1.8:1. That much is clear.

Here is a more typical example that most people struggle with. Let's say that you have $100K in stocks and choose to buy a $200K house. If you wanted to minimize your leverage as an individual, you would sell the stocks and buy the house. Your personal leverage ratio would be 2:1, b/c you used $1 in cash to buy $2 in assets. You might feel that this is more safe, because you are minimizing your debt and leverage, but you are now invested 100% in housing and 0% in stocks This is not very balanced.
As an alternative, you could sell $20K in stocks to put down on the house and borrow the rest. Now, you have $280K in assets, and have $100K invested. Now, your overall leverage is 2.8:1, your stake in the house is somewhat tenuous, and the $20K is at risk of going to zero. On the other hand, you have $200K in housing assets and 80K in stocks, which is more balanced. You now have less stake in the relative price of stocks and housing. To me, although the overall leverage is higher, this is the safer bet. In addition to balancing investments, you would have limited my housing risk to $20K in some states.

Facebook is not a "ponzi scheme".
It's an asset that was vastly overvalued in its IPO.
The company's actual earnings are in the neighborhood
of 60 cents for each share that they issued.
Therefore, an offering price of $6 per share
would've been reasonable.
Yes, the stock "could go to zero," but it would not go to zero so long as there are actual earnings from advertisers.
Even an offering price of $10 per share might've been reasonable, if people expected the company's earnings to grow at something like 10% per year.
The $38 price was wacky, and although the stock price is rising this morning, I do expect it to go down to $15 in the not-too-distant future.

Interesting last 2 posts.
AAPL also cannot go to zero, since the cash on hand is equal to about $118 per share ;)

clambo says

Interesting last 2 posts.

AAPL also cannot go to zero, since the cash on hand is equal to about $118 per share ;)

you need to factor in debt.

if apple leverages themselves into debt it could go to zero - just ask the banks about the effects of leverage.

of course i'm not suggesting apple will go to zero. just that it's hypothetically possible even when they are sitting on a big pile of cash.

Yes, stocks are intrinsically worthless...but so is the paper money that Zuck got in return. Yes, we could all walk away from pieces of paper and declare anarchy, but it's likely not going to happen.

The part that's the scheme is banks artificially propping up the stock price, and then alerting its friends there's going to be a huge sell off.

It is true that stocks are a bet but some stocks are also about how well someone does there home work.For example,years ago I purchased some stock on a bit of home work I did about samples of mud that had come up on a oil rig in the Beaufort Sea off the coast of Alaska.Now my money goes to the owners of the claim and they pay a drilling company to drill on those claims and even though they may or may not hit oil the price of the stock can go up and down on price of energy,the fact that the company I have stock in has purchased some other claims that show good readings or bad readings which affect the price of the stock.Just by leaving it with them and forgeting about it one day I wanted to purchase some silver so I decided to look up the stocks I had purchased of that oil campany on the Beaufort Sea and WaLa I had trippled my investment without even knowing and they had not hit oil but the price of oil was up and oil was found in that area but not the stock I owned.What would I have made if it did?

Does anyone see a similarity with Facebook's IPO and GM's IPO a few months ago. Both stocks were over priced and both stocks value dropped the next day.

There is a "true" valuation of stock, if there is no investment bankers and stock brokers in between.

For example, investment bankers/stock brokers want you believe, and preach, that you should buy based on forward eranings. Are you stupid? If I were to buy, I want to buy based on the valuation what it is earning now. If there is a better profit in the future, it is what make me actually part with my cash, that's the upside.