On Shareholder Wealth
Bill of Absolutely No DooDahs, wrote this comment in response to my earlier post Google Price Target: $16,578.90:
Other than getting paid dividends, how does one extract wealth from a company one holds shares of?
Call me a cynic (I've been called worse), but with the exception of divs, what investors get from buying stocks is selling them at a higher price ... meaning that we are not really extracting wealth from anyone except the buyer ...
Here is my response:
I think the two of us may have encountered this difference of perspective before. So, you may disagree with some of what follows.
You do not extract cash from anyone but the buyer; however, the value of the security is derived from the value of the business you have an ownership interest in. A common stock represents an ownership interest, not merely a right to receive cash distributions. The fact that cash has not been distributed to the security holder does not mean that the holder's wealth has not increased. Most public companies are primarily engaged in creating wealth through reinvestment in the business, not through distributing cash to shareholders. Some owners may do better than others in buying and selling their ownership interest; however, owners in the aggregate will only do as well as the underlying business.
I disagree with the idea that owners only extract wealth from the buyer. Although legally there is a separation between a corporation and its owners; economically, a corporation has no wealth that doesn't belong to its owners. Owner's earnings (whether distributed or retained) are wealth. Cash is extracted in the form of dividends. One form of wealth is converted into another (cash) at the time of the sale of the common stock. However, the owner's wealth increases at the time the business earns the money (i.e., increases it net worth) not at the time of the sale. The stock sale does not create the wealth – it merely converts an undivided interest in the corporate assets into cash. Some of our laws (and accounting practices) may obscure this fact.
Although we (almost always) dispose of our ownership interests in corporations by selling them in the open market; they are more than mere pieces of paper that can be sold for ever higher amounts. Ultimately, shareholders have control over the assets of the business. They may choose to dispose of them (or encumber them) as they see fit. Distinct assets may be separated from the business as a going concern. Sale of the common stock is not the only way to transfer wealth into cash.
If your point is that to obtain cash a shareholder must either receive cash thrown off by the assets (i.e., dividends) or sell his interest in the assets, I agree. However, I think that’s true of the ownership of all assets.
If I want cash for any of my property, I must either sell the asset or collect a rent. In this respect, I can’t say there’s any real difference between an ownership interest in a corporation and an ownership interest in any other property, except for a very active market for the interest in the corporation.
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I think our disagreements coalesce around three points, shareholder control, the value of the security, and how wealth/value/cash is transferred and/or created through the stock market.
Is a stock really just a piece of paper representing a claim on “assets” or do shareholders have ultimate control of the business? When I buy a stock, I have no control or power over the assets or cash flows involved, all I have is a paper claim on those things. If I *own* a funeral home, I have outright control. I can plan the product, carefully decide what features I need to extract more payment per “event” to offset the increasing trend towards cremation and away from burial. I have perfect control over whether to lease or buy the flower cars and hearses. If I enjoy the process of watching an embalming, I can do so at my leisure. Should I grow the business organically or through acquisition? Etcetera. My benefit includes basically unlimited use of the assets, such as having family members cremated for free, selling caskets at cost to valued friends, or just driving around in the limousine. I also get the benefit of 100% of the cash flow, i.e. a 100% dividend payout ratio where I control the quarterly dividend amount. Forgive me for using so coarse an example, but (1) I enjoy it, and (2) several such homes have come across my value screener over the past year. Now, if I *own part of* a funeral home, I abdicate much of the control. If the funeral home is a stock company, my control of the asset diminishes with the proportion of outstanding that I own, as well as with the class of the stock. At the levels at which you and I (or I, at least) would be an owner, we have effectively zero control over what the company does, whether its assets are used wisely, the dividend payout, etc. I’ve been in a few boardrooms, and trust me, *directors* of companies have little individual control of companies, and what they do have is in large part political – management has the control, with few exceptions and with rare penalties for misusing it.
Is the value of the security derived from the value of the business you have an ownership interest in? Value is subjective. However, the current market price per share is set at the margin, on an open bourse, by a variety of actors whose interests typically have little to do with the underlying business. Just because you, I (when wearing my “value hat”), and some others attempt to ascertain the prospects of the business, and just because we are speculating that “Mr. Market” will eventually have the business trading at close to what perceive to be its “intrinsic value,” doesn’t mean that the market price per share does now, or will ever in actuality, be equal to or greater than our perceived value.
The third point is probably worth a post on my blog, I was thinking about something similar to that before writing this comment …
Posted by: nodoodahs | March 8, 2006 02:31 PM
Bill and Geoff,
In the last 3-4 months, since I began investing, the information I have gather from your two websites has been perhaps the best information out there, professional or otherwise.
What makes your blogs unique is that both of you are unafraid to engage in a dialogue on a topic of discussion which you may disagree. In essence we as readers get two blogs for the price of one, so to speak.
I find myself often agreeing with both of you on most issues. Much like Fred Flinstone who had a devil and angel appear on his shoulders when he was torn between two choices, Geoff and Bill sit on my shouldes and shout "all value no TA" or "Value and TA can coexist without destroying the universe" as I ponder my investment choices (I make no assertion as too who is the devil or angel among the two).
I must say that I feel I fall somewhere in the middle of you two, but will admit that because of my lack of math skills, skills Bill has been blessed with, I lean more towards Geoff but embrace the TA analysis Bill provides.
With that said..this is what I have taken so far from the current discussion...as well ad both of your previous writings...
I am investing for a minimum of 24 years (thats when I can take disbursments from my various IRA's) so I understand what Geoff says about buying the business. I own PETM, when I go shopping for the dogs, I get a kick out of knowing that my "shares" represent an owneership interest in PETM. Even thought my actual interest may only equate to one bag of dog food or 5 rawhide bones, I know I "own" it as well as portions of future earnings.
So over the next 24 years (if i ere to keep it that long), whther PETM tades at 10 a share or 300 a share, as long as the value of the business itself grows at a sufficent rate, than when I choose to sell the future share price will take care of itself.
But I also get what Bill is saying. Gains are only gains when you can feel them in your hand. buying BUBL at 50 watching it go to 250 down to 25 and back to 50 means nothing to me because until I "swing" and sell I have lost or gained nothing.
So after reading both of you as well as others I have decided on the following course of action which includes a proposal to both of you as well as others which we can discuss either here or in the forum on marketocracy.
I am trying to develop a core group of companies/stocks which are great companies/stocks to own. how many? I dont know yet 20, 50, or 100 (maybe 5 or 10 per sector)..but what I hope to do is develop a list with what I belive to be fair value per share...and wait until I can buy at a discount...thats the Geoff in me..not that Bill is against that...
But the Bill in me knows that there will be times when these great stocks will be overvalued and the TA indicators will be whispering that the trend is about to turn...and i will sell.
so if i have 50 great companies..at any one time some will be undervalued by the market and I will buy...becuase even though the stock price may not go up..what geoff has shown me is that as long as a great company is increasing the value of the company I am gaining vlaue
and when they are overvalued i will sell and as Bill tells me I will realize my gain in value.
Now maybe I am too unsophisticated to know that my idea is foolish or too simple. But i think back to the old joke about the two hunters out shooting for some bears.
The hunters get suprised by a bear, drop thier guns, and start running for it..
one hunter says to the other hunter, "boy i hope WE can out run that bear"...and the other hunter smiles starts to run faster and says "I dont have to out run the bear, I just have to out run YOU."
and that's how I see investing. i dont have to out run the bear (or i guess the bull) I just have to outrun the other hunters. and in the short few months I have been reading I think I might be able to outrun a few wother investors (i mean do you really think the bird flu is going to wipe out every chicken in america, because that is how everyone is acting with chicken stocks, i am starting to get real greedy about SAFM by the way, thanks to Bill and Geoff)
So i will only buy good or great companies who internally grow my interest as an owner (thats Geoff talkign to me) but i will never love a company so much that i wont be afraid to dump it if some other person wants to give me more than i think it is worth knowing that I can take my profit move it into another great company and wait for that one to get cheap again (thats Bill talking to me).
Anyway i think you guys are both right in your analysis because you are ending up in th esame place..just taking different roads to get there.
i dont know if i added anything to this particular discussion but i just wanted to let you guys know that you have at least one very interested reader.
Steven
Posted by: Steven | March 9, 2006 01:48 AM