"The stock market is a device for transferring money from the impatient to the patient." - Warren Buffett.
So let’s discuss the stock market and how it actually works. A company can be privately owned or publicly owned. Companies start out as privately owned and then go public when they want to raise money. Going public means no single person owns the company anymore, the company will now have many owners known as shareholders (any person who buys a share of stock).
The company holds an IPO (Initial Public Offering), which is the first chance people have to buy stock in the company. A company may be divided into 1 million shares, each share representing an equal stake in the company. The current owners keep 700,000 shares for themselves, to make sure they retain the majority ownership and are still in charge. But then they sell the other 300,000 shares to the public to gain money. Those are the stock shares we are all trading amongst each other.
So when you buy stock, the goal is to sell that stock in the future to someone who’s willing to pay more for the stock than what you paid. But why would that person even buy it? He’s just trying to find someone else to pawn it off to later in life. We’re all just looking to sell our stock to the next greater-fool. Why are we all doing this? What’s keeping this system afloat? Why trade anything? Okay, let’s walk through it all.
First we need to establish what gives a stock value. Stock price is not directly determined by a company’s financials. Let me repeat that: stock price is not directly determined by a company’s financials. Yes, every fund manager in existence is constantly looking over a company’s financial documents to determine the state of the company. But that’s not what determines the stock price. A company doesn’t hand over their income statement to the New York Stock Exchange (NYSE), and then NYSE goes “oh okay, we’re gonna set your stock price today at $50.” Not how it works.
Stock price is determined by the trading among the people, supply and demand baby. The market itself sets the price. For a simple example: if you and I both own a stock in the same company currently valued at $50, and I sell my stock to someone who offered me $60 for it, guess what, your share is now worth $60, because that’s the going rate on the market. Whether or not that company was actually profitable is irrelevant, because that’s independent from the transaction of me selling my stock. Only buying, selling, and making offers on stock can physically change the stock price. This is very important, it establishes that value is technically in the eye of the beholder.
Imagine a corporation is a celebrity and their share of stock is an autograph. If you have a celebrity’s autograph, you want their fame to increase so the autograph becomes more valuable. And you want to sell that autograph one day for a lot of money to another fan. You want there to be lots of fans so they all have to outbid each other. But if the celebrity’s fame dwindles, then no one cares you have their autograph anymore.
So stocks are a popularity contest. You want the more popular stocks. But what determines popularity? Well a rich and successful company is popular, so in that way a company’s financials do influence your decision. But there are other influences. A famous CEO can sway the crowds. Everyone loves investing in Elon Musk, even though his companies have historically never made any profit. Advertising can influence you, seeing a lot of commercials. Plus simply your own personal interactions with these companies during your daily life.
Now most fund managers are still only looking into financials, instead of looking into the general population. This might be because my day job is directing movies and knowing my audience, but I would rather read people than financial statements. The shopping habits and the investing of average people are what determine those financial documents, so reading those documents already has the fund manager a step behind. Fund managers will argue that the bulk of all investing money is under their control, since most people just give their money to an investing firm instead of investing on their own. Fair point, but the invention of the internet has caused the decline of all middlemen. With all these basically free investing platforms like Schwab and Vanguard, and apps like Robinhood, I think the shift is coming sooner than later. Instead of thinking what will a hedge fund manager do, it’ll be more important to think what will average joe do? What company in the future will be so popular that all the average joes will want to invest?
So how is stock different than trading baseball cards? Pokemon cards? Beanie Babies? If the value only lies in the perception, won’t this fad end? Okay, well now you know why all your conspiracy theory friends say the market is an illusion and will spontaneously combust. But there’s a bit more going on….
The one main thing keeping the stock market afloat is that we, as a general population, all agree to it. You can think of stock as a sort of currency. We all agree it has value. I would put stocks somewhere in between cash and gold. It’s not quite as impervious as cash, but more than gold in my opinion. While we all agree gold is valuable for some archaic reason, all it would take is one generation of millennials to look at gold and go “Nah, we’re cool with the fake jewelry, we can’t tell the difference.”
Another thing keeping the market erect is that the human population is growing faster than the population of corporations. There are simply only so many stocks available to buy. So as more people come into this world, if they want to invest in the stock market, they have to keep paying higher prices to get in the game.
There are also slightly more tangible benefits to owning stock. For instance, some stocks give you voting rights, so you can help steer the direction of the company and make sure it remains popular. Granted, does anyone ever feel like their vote counts? Also you will hear a lot that you are technically an owner of the company, and for some reason that has value to people. Not sure why, I mean if I’m Warren Buffet who has the means to buy a large percentage of the company then cool. Otherwise I feel like it’s as if my neighbor asked me to invest in a Ferrari with him. He’ll pay 99% and I’ll pay the remaining 1%. All Ferraris appreciate over time, so I can sell my share for a higher price one day. But he gets to drive it, and it stays in his garage, and he gets all the ladies. So do I really own it?
At this point you’re probably agreeing with the conspiracy theorists, the stock market will in fact implode. But there is one truly tangible, crucial thing holding this ship together: dividends! Dividends are when a company splits some of their profits with their shareholders. If the company had a good year, they might go “for every share you own, we’ll give you $1.” And just like that you got some real income. Not only can you hopefully sell the stock later on in life for a profit, but it’s also earning you income along the way. So we finally have tangible value! Wahoo! Except that companies are not required to give dividends. Shit. One might argue that “hey, if I’m technically an owner, and there’s profit, then I’m entitled to my profit damnit!” Well it doesn’t work that way. Most companies reinvest their profits to expand and grow the business. And most greedy companies simply use the profits to give big bonuses to their executives.
I wonder if one day dividends will be required? Even if it’s just a penny. Or are we just hoping this is enough to keep the ship afloat? Whatever. But there is one more important thing I wish to impart. Since the stock market is basically public opinion, it does not represent the economy. I will repeat: the stock market does not represent the economy. Secondly, Many people (especially politicians) will say since the stock market is up, the economy is booming. As we’ve established, a company’s financials do not directly increase stock prices. Tesla’s stock skyrocketed because people think electric cars are the future, however Tesla actually had a minimal footprint in the economy, they sold like twelve cars. Their company was in the red, you made more money than Tesla that year. To the untrained eye, their stock price suggests they are a wildly successful company, but in fact they had a very rough year financially. High stock price does not represent the success of the company, it measures people’s faith in the company. People think things are going to get better, hence why they are investing. Thus the stock market measures people’s faith in the economy, not the economy itself. When the stock market is up, it means people have faith in the economy, nothing more. Plus, the stock market doesn't even include private companies so it neglects half the economy right there. So the next time you’re listening to a politician pat themselves on the back because the stock market is up, kindly remind them the economy is measured by the GDP (Gross Domestic Product), and that the stock market is all smoke and mirrors-- I mean perception.