Shares are bought, sold, split, reverse split and can be transacted by a market-maker, who, in-essence, is a buyer. Do you not believe that a company isn’t savvy enough to split the price of it’s stock (making each holder the bearer of many more shares, i.e. 2:1, 4:1 splits) in order to facilitate the opportunity to attract BOTH profit takers and new buyers. This re-invents incentive and assists in the potential trading opportunities of an enterprise’s stock. As well, companies frequently and willfully buy back their own outstanding shares when they are flush with cash and no longer wish to meet their obligations to those shareholders. During a buyback, the price of shares will typically rise because the company has exhibited greater cash flow, price/sales, and thus (thru share buyback) lowers the debt obligation of the enterprise to the shareholders.
I believe some of your statements represent thoughts that can be made only in theory, but really don’t hold merit in practice. However, the case you bring up regarding ‘money’ for your shares can be addressed through shareholder preference for dividends, or simply re-investing profits for the potential of higher future gains. Remember, just as you bought the non-dividend paying shares in your ‘hypothetical’ situation, so too, there will be another person wishing to buy your shares because dividends may not be an issue to them-- did you think you bought your shares in isolation…??
Did I miss your point, or does this address the issue of the stock market, gambling, and free-market economics?
Dividends are when companies pay out to people who hold shares. Many companies don’t do dividends. Sun Microsystems (JAVA), AMD and Nvidia (NVDA) are 3 examples off the top of my head of companies that don’t pay dividends.
So people don’t expect dividends, necessarily. They expect to profit.
A more apt analogy would be a case where many Rolls Royce’s are being traded at price X. The company decides to produce several more. The fact that some people may be willing to pay 2X for the cars is meaningless as long as the market price is X, and they can therefore pick up a car for this price (assuming the cars are perfectly homogenous to fit in with the share example).
Yes, but that is not speculation on which you can make some extra profit.
That is just uncertainty as you called it.
But, I make difference between this kind of “speculation” and “gambling type speculation” like when you invest on stock market. I have some small amount of shares in one company and I did not profit from it for two years because the company does not pay dividend in this crisis. When I bought that shares I knew I was gambling, and now I prefer to invest in my business and my knowledge then in stock market.
Well, you better give up. It’s an empirical fact that despite no dividends or very low dividends stocks are traded. Dividend yields are very low. What’s more, you potential profit is much bigger buying shares of companies that do not pay substantial dividends. As well as potential for loss, of course.
XYZ sells at $10/share. The quarterly report comes in, and they profit. Their share price is adjusted for “earnings per share” (EPS).
If the EPS is $0.10, the share price then increases by 10 cents. Owners of XYZ are now $0.10/share richer. This is why people want to hold shares of companies that profit.
If there was no incentive to buy shares, why would they?
This argument basically renders all forms of trade useless as well as all forms of savings except for direct personal use. It is also completely ignores the assumptions I have based my argument on. If the book value of the company will become $300m it means per definition that there are buyers who will pay $300m for the companies assets, or there books are wrong and need to make value adjustments in there books to compensate.
If a company buys a computer for instance and decide to write it of during 10 years and then the next year the market indicates that computer that are more then 1 year old are worthless they need to make adjustments to there initial assumption and write it of faster.
To get cash in the you can always use your shares to liquidate the company. As long as there are real assets behind the investment it will be worth something in the marketplace.
Dividends only serve to adjust the degree of liquidity. All things are more or less liquid.
What could happen is that there could be a discount to the price on something cause the liquidity is poor. But as long as we are speaking personal investment that isn’t really relevant. There are plenty of buyers who care alot less about liquidity then the regular private investor. Capital can be utilized better if there are no restrictions for liquidity on it, so very wealthy investors and institutions will want such assets as a portion of there portfolio cause they give a higher yield and because they have no desire to be able to turn them into cash in the foreseeable future.
And also dividends are not there for the benefit of the investor. Dividends are a tool for the company to get rid of excess capital. It is a part of corporate finance planning to keep the return on the investment up by not binding more capital in the company then they can use.
Shareholders want RoE. RoE = Net Income/Shareholder’s Equity = Net Income/(Total Assets - Loans). It is because shareholders want high RoE that the company pay dividends in the first place, paying dividends lower the shareholder’s equity and increase the part of net income applied to there stock in the company.
If you don’t want non liquid assets you shouldn’t be buying stocks in the first place you should be investing in bonds or something more suitable. Stocks are made liquid today thanks to advanced global stock markets but they are really have very low liquidity. Which is why before the emergence of such markets much more external investment in companies was in the form of bonds.
Ohkay, theres something that you missed here that will fix this up.
Assume Microsoft has two sellers in the secondary market (100 shares each), one willing to sell at $100.1 the other willing to sell at $100.2, The rich and clever man for whatever reasons believes Microsoft is going to have a great 2010, so he buys up all shares (200) at $100.1 and $100.2, the stock now goes from 100.1 to 100.2. The clever mans new Demand drives the price up, in the same way that any new demand would drive the price of any good up.
The company now can dilute there shares, essentialy printing 200 new shares, this new supply (ceteris paribus) takes the market price back towards the original $100.1 mark.
What this example shows, is that companies benefit just as much from secondary sales as they do from primary sales.
Essentialy buy buying a secondary you give the company a ticket to offer a primary without diluting their stock price.
If i owned a company whos stock price in the secondary market consistently appreciated 300% due to new demand (bubble like or due to great growth), I could issue as many primaries as I want, because I know new demand in the secondary market will keep the price high.
-= Everything here is ceteris paribus, assuming people dont get scared of further dilution etc etc, or that inbetween exchanges new people enter the market etc etc=-
Emitting new shares does not “dilute” the price in this manner. What your example illustrates is counter-fitting of shares in the secondary market by a third party.
Which I really don’t see how it could be done in practice since companies keep track of there own owners or at least which broker there shares are held with.
If there is say 500 shares in this company and the stock price is now $100.2 there total stock value is $50 100. If they issue 200 more shares at $100.2 they will increase there stock value with $20 040. However they also increase there asset sheet with the same amount $20 040 that they received in payment for the new shares so this should not affect the share value. At least not downward. It would if anything drive the share price up further because the companies book value/share will increase (assuming there stock value is higher then there book value to start with).
Say that there book value was $30 000 to start with. Before they issue shares the company is valuated at 167% of there book value (50 100 / 30 000 = 1.67). After they have issued the shares they will be valuated at only 140% of there book value (70 140 / 50 040) = 1.4.
The stock now trades at a lower inverted-discount (sorry I don’t know the proper English word). If the future expectation on the new capital is as good as on the old there is no reason why this ratio should change so the price should be now driven up so that the new capital trade at the same level as the old.
In the short-run there is dilusion. There is a “shock” the the supply and other key indicators like P/E will be broken until the new capital start generating some profits. There is a bit of lag. However this type of dillusion does not really benefit the company.
However these effects get elevated the fewer shares are issued and the higher the price is the fewer shares the company need to issue. But really it doesn’t matter to the company itself at what price the new shares are being issued and in the long run this alone should have no affect on price.
The main benefit of second hand trading is prices.
Without second-hand trading it would be pretty damn difficult to issue new shares though cause no-one would know what the price is supposed to be.
We had the government sell out part of a telecom company here which had never been traded before and they it by selling shares to the public. Fortunately for them people are stupid trusted the government had given a fair price. It dropped like a rock soon after it started to trade in the secondary market…
Trading something that doesn’t have a price in a reasonable way requires immense resources be allocated to finding out what it is worth before doing the trade. It is costly and most buyers aren’t willing to pay for a proper evaluation so it would be almost impossible to sell new shares (unless the government sais the price is fair ofc…)
The question Mickanomics asked about how stock trading benefits the company has not, in my opinion, been satisfactorily answered in the prior posts. I do not have more than a rudimentary understanding of the stock market, so I would appreciate if someone could please correct any of my misunderstandings.
The main answer given in reply to Mickanomics is that the higher price of shares allows a company to gain more capital when issuing new shares, ceritas peribus. But why does this really help? After all, if the company desires to get more capital it can simply continue to create and sell additional shares until market price of shares becomes zero (like certain paper monies). Doubtless a companies owners - the share holders - have every reason to impose the issue of new shares as their proportion of ownership of the company is diminished. I am not familiar with the mechanism by which a companies make the decision to issue new shares, or buy them back.
Mickanomics pointed out that in the secondary market when share owner “A” sells his shares to “B” that the money given in exchange for the shares comes from B and goes to A. No portion of this money goes to the company to provide additional capital to fund its operations. Thus, it follows that investor B, regardless of how high a price he may have paid, has not brought about any increase in capital to the company. As such, it cannot be said that B has performed the entrepreneurial function of directing capital towards those lines of production where he judges the most urgent needs of consumers to be satisfied. Granted, shareholder B has gained the power to elect a board of directors that once had belonged to A. If he abstains from concerning himself with the affairs of the company and from voting, as many small investors do, then he does not appear fulfill any entrepreneurial function of directing scarce resources although the incidence of gain or loss of the companies operations will still fall on him. It is only in this latter sense that he can still warrant the title of an entrepreneur.
Therefore, it seems the only capital a company attains from the market is in the initial selling of any given share (whether IPO or the issuing of additional shares). The secondary market, as far as I can see, has no direct influence on the allocation of capital goods.
I’m sure there is an error in this line of thought, please correct.
Posters here keep making this mental switcheroo by stacking the company vs the shareholders. The company IS the shareholders. The company “gets” from the shareholders as much as the shareholders “get” from the company – they are one and the same thing!
If investor A owned 50% of a hot-dog stand and he sold it to person B, does the fact that B bought the shares on the “secondary” market make him any less of an entrepreneur, even if he reneged on any decision-making rights regarding the stand? Everybody wins (and no one loses) when there’s a liquid market for voluntary exchange of goods/services (company shares in this case). If I owned 100% of my hot-dog stand I’d be thrilled to know there are buyers willing to pay me for % ownership in my business. By selling 20% to someone else I can diversify my risk and use the proceeds to purchase 10% in the grocery store business nearby and 0.0002% of the IBM business at the stock exchange.
A priori awareness of a market’s existence makes it much more enticing and attractive for initial investors (entrepreneurs, venture capitalists) to start businesses from scratch. The existence of discerning buyers willing to own % of a promising enterprise is a major incentive for the original idea getting off the ground to begin with.
Indeed, but they keep separate bank accounts - and that is my point. When person B buys 50% of your hot dog stand then your personal bank account balance has gone up by some amount, whilst the balance sheet of the legal corporate entity known as the hot dog stand has no additions or deductions as a result of this transaction.
I am not challenging the point that is possible for the company owners - the shareholders - to transfer money into the corporate entity or out of the company. For example, they could elect for the corporate entity to create and sell additional shares. The shareholders may themselves be the purchasers of the shares. On the other hand, they can instruct the corporate entity to pay dividends to remove money from the corporation.
True, but this does not demonstrate the funds finding their way out of the bank accounts of the investors and over into the balance sheets of corporations. This simply moves shifts the matter over one step where all the same applies. Unless, of course, the new purchases referred to here are the first purchases of a shares wherein the corporation would be the seller of that share and thus receive the proceeds of the sale.
So when an initial investor sells 100% of the business he started from scratch to other investors, surely the company does not acquire capital as a result of this transaction. Would the initial investor give some portion of the proceeds of the sale over to the corporate for the benefit of that which he no longer owns? Surely not - the money the initial investor receives remains with him and does not enter the balance sheet of the corporation.
Yes, when I sell 100% of my car to you, none of the proceeds go toward the car, and they all go to me. Is this a problem which needs a solution of some sort? Is the fact that the car is not “benefiting” from our transaction in any way suggesting that “secondary” car markets are not helpful or beneficial?
Yes, although we must strain the analogy a bit. As none of the proceeds benefit the car, we cannot say that a high selling price helps the car, or a low selling price hinder the car. The car remains the car as is. Likewise goes for the corporation. A high or low selling price of shares of ownership does not benefit or hinder the corporations operations. It does not diminish or increase the capital on its books. Thus, we cannot say the act of purchasing shares in the secondary market at various prices affects in any direct way the allocation of capital goods of that business for which shares were bought and sold.