A side note, and I'm really hoping someone can explain this. What benefit does the stock market provide to us?
I understand investing in companies, but for me, and I'll admit a completely naive person to this whole system, it seems to have taken an 'inbest in company with money to help them succeed', to a 'who cares let's just cut and run to make the best profit'.
I'm perfectly willing to take a link to a great explanation at this point btw.
The "explain like I'm 5" version, partly to answer you, and partly as a clarifying exercise for myself.
In a market, you trade dollars for other valuable things.
In a stock market, you trade dollars for stocks.
Why is a stock valuable?
It represents a small piece of a company. If you bought up all the pieces of a company, you would own the entire company. But most people can't buy an entire company, so they buy small pieces of a company instead.
Why would you want to trade dollars for a small piece of a company?
A few reasons:
1. Because a company owns valuable assets, and if you own part of a company, then you own a part of those valuable assets.
2. Because a company earns money, and if you own part of a company, then you get some of that money. (Either directly as a dividend, or indirectly as more your shares gain in value.) Think about it: if you own part of a company, then for some small fraction of the day, every single person in that company is working for YOU. YOU get the fruits of their labors for that fraction of the day. If you do this with enough companies, then you can quit your job.
3. Because a company makes decisions, and if you own part of the company, then you get to vote on how those decisions are made.
4. Because dollars become less valuable over time, by about 2% per year, assuming that the economy is operating as planned. (Inflation.)
> What benefit does the stock market provide to us ?
Direct benefit: liquidity - whether you need to buy or to sell, you have a place where you'll find a counterpart quickly.
Indirect benefit: information - just watching the bets lets you have an idea about how much people with skin in the game value things, letting you take better decisions about resources allocation.
And the benefit of liquidity is to reduce your risk. If you change your mind, need some cash quickly, or even simply want to know what the market thinks your stock is worth, you need liquidity. If you don't have observable and executable prices, you may struggle to find a buyer for that stock when you need it (delaying a home purchase or exposing you to future changes in market sentiment / health of the company) and will have no idea who to trust to tell you how much you should ask when you sell your position.
Liquidity, I'm sorry didn't you invest in that company? If you can find a buyer for that percentage, okay cool, but nothing about investing should revolve around if you need liquidity all of a sudden.
nothing about investing should revolve around if you need liquidity
The knowledge that I can get out of my investment any time I want at the current market price makes me much more willing to invest in the first place. If I know that it can take several month to get out of an investment or that I have to sell at a discount to get a fast deal then I'm more likely to sit on more of my money in case I need it quickly.
In theory that's a big deal. In practice most people are looking at days to weeks to liquidate stock and that's not a big deal. As your holdings go up, into the billions, it can take months to years to unwind major investments without tanking the price. Further, having ~six months of living expenses outside of the market is considered prudent anyway.
However, the reality is if the market disappeared today informal markets would quickly take it's place consider what happens to pre IPO stock.
Months to years to liquidate stock? For most people?
I can't imagine selling a position would have any influence on price until it's a significant percentage of the market cap. The median cap of the Russell 2000 (an american small cap index) is 809 M [0].
Do most people really have multi-million positions in a single small cap company?
No not most people. But, if you own 60% of a company it can take a long time to unwind without impacting the price. Further the transion is smooth as selling 1 million in most stocks in a second would change the price.
Anyway, my point is simply that trades are the mechanism that changes price. So, you can't expect to sell arbitrary amounts of stock at the current clearing price.
Worldwide probability less than 20. But again that's just the extreme that demonstrates what's gong on. If you ever watch a stock ticker and calculate the volume of sales needed to change the price it's less than most people assume.
+/- a few cents might not seem like much but drops can spiral with relatively small initial sales.
Even if liquidity in the stock market doesn't matter to you personally, it also allows for others build new 'products' on top of it that you might benefit from. ETFs and Index funds, for example, provide far more benefits to the average investor than access to a liquid stock market. However they wouldn't really exists in their current form (or at the very least be a lot more expensive) without a liquid marked underneath them.
I hope one to one day have enough wealth that it takes months to liquidate my stocks. The number that can’t be liquidated almost instantly is very large.
Additionally, IPOs are almost priced incorrrectly, and show the problems with the informal market.
I would not nessisarily say they are priced incorrectly, there is a liquidity premium. Also, post IPO there is often a tiny slice of the company on the market combined with a lot of speculation.
You clearly haven't invested much then. Investing in the public markets is different to investing in private equity -- the former is generally highly liquid, the latter illiquid.
Illiquid investments need to generate higher returns to make up for the fact they're illiquid, in comparison to liquid ones.
Same reason that a $100 bill is worth more than a $100 gift card to a specific store.
The presence of the secondary market makes the initial offering (sales) of shares easier.
Imagine company A is making a primary offering (direct sales of shares from the company to an investor), but that those shares do not have a ready secondary market.
Imagine company B is making the same primary offering, but there is a deeply liquid secondary market.
Company A and Company B are otherwise identical (line of business, revenue, profit, outlook for the future, etc). Investors will much more readily invest in company B.
Liquidity is correlated to trading volumes - so the more people exchange shares of your company, the quicker you can find a counterpart. Investors accept lower returns if they can get their money back whenever they please, so a liquid investment vehicle is advantaged.
Ceteris paribus, volatility is negatively correlated to trading volumes: if your shares are only exchanged twice a week (actual trading volumes for a small company on some exotic exchange) the price variations will inevitably happen in large steps, which does not reassure investors. And if the company is not publicly traded, who knows what the price of the next transaction will be ?
A lively market for an investment vehicle opens the possibility of derivatives, which are valuable to investors interested in the company but whose appetite for risk is limited. So if your company's shares trade has derivatives, it makes them more attractive.
> Why would gambling on a companies future ever help anyone
Most transactions in the market are not gambling. Trades happen, yes, but that is because the prospects of companies are continually changing. When it became apparent pretty much everyone would move to Netflix and streaming video, would you want to continue holding Blockbuster stock? No; you would want to sell it.
People who simply "gamble" in the market lose money about as often as they gain it, and soon stop. Hedge funds and mutual funds generally try to invest in shares on a longer-term basis rather than continually trading them; trading incurs transaction costs, and if an investment was correct and is generating better-than-benchmark returns there is no reason to sell it.
The "day trading" books you might see at your local Barnes and Noble are get-rich-quick books and are not representative of the actual professional investment industry.
> [...] would you want to continue holding Blockbuster stock? No; you would want to sell it.
For every seller, there's a buyer. The market will settle on a price at which those are evenly matched---even if that's close to zero.
You have to offer a good enough price on your Blockbuster stock to find a buyer who thinks it's a good idea. (Unless it's someone who has to cover a short position, those guys are basically forced to buy. But they'll still buy from the seller with the best price.)
> Why would gambling on a companies future ever help anyone(except the lucky?).
Prediction markets are the most efficient way to make societal decisions; they allow everyone to combine their information and predictions without having to directly coordinate with each other. There's academic literature arguing they'd be the best way to do politics etc. At the moment all we do with them is capital allocation, but that has real-world effects: ultimately the idea is to give more money to companies that can use it better (so that they then e.g. build more factories, hire more people, make relevant buyouts) and less money to companies that will make less good use of it.
Sorry but I have to make the precision: market optimized for monetary output and not necesarily social good. Companies doing well in the stock market might be exploiting workers, unnecessarily exposing consumers to different dangers, destroying the environment or a plethora of any other bad things and the stock market would not care as long as it does not create a PR problem that could affect sales of the company.
Similarly, a company that does well socially (e.g, a public hospital) but not economically would get obliterated in the stock market.
> Companies doing well in the stock market might be exploiting workers, unnecessarily exposing consumers to different dangers, destroying the environment or a plethora of any other bad things and the stock market would not care
That would be regulatory failure - it is not the market's fault if the government is weak... Fix the government, get decent labor laws, let companies internalize externalities, regulate environmental impact !
> Similarly, a company that does well socially (e.g, a public hospital) but not economically would get obliterated in the stock market
Which is why, in civilized countries, public services are provided by the government or on behalf of the government.
Foisting government responsibilities upon the market is bound to create disappointment...
I can understand your point. We are so many layers removed these days with trading platforms and online brokerages that it's easy to forget that when you buy an equity, you are actually holding shares of a real company that produces real products, employs real people, and maybe most importantly, holds real assets. One of these assets is future cash flows and this is pretty much where the value of shares in a company come from.
In any moment it seems like you're just buying thin air for money and selling that air later for (hopefully) more money. But that's the short-term view of it. In the long run you are taking a stake in a company that you hope as a whole will be worth more in the future than it is today. That stake gives you legal right of ownership to a percentage of that company and its cashflows. If it's a dividend paying company you collect regular profits from it as well.
Markets aggregate information in a (usually) efficient way. Information is useful to different people in different ways. Just to take one example, if the stock price of a company falls and stays low for a whole, that could reflect some negative future prospects for the company, which traders know about. That could affect my decision to move across the country to work for that company. That is valuable to me. Since you asked for a source, I’ll give you one: pick up any introductory economics textbook.
Think about how something like, say, Heroku would look to someone outside the tech industry - so this is a company where people submit programs and they run them - not even on their own computers, but on Amazon's computers - and somehow that's something that makes a profit?
There are lots of small intermediaries in finance, like in any industry. They make money because they provide services that others find valuable.
I still don't understand. (this may be because I am not familiar with Heroku aside from hearing about it in passing).
Thanks for trying though.
Edit: I'm editing further to ask more
Edit2: so you said that they make money because they provide services. What services could you offer when (from what I can see):
Company A: wants investors. So promises them a portion of profit based on investment.
I can't see any value from any other provider there.
Now I may be wrong, and I'll admit straight off the bat I have * no idea * how it all works, but it seems to meet that there isn't any other value provided to the company, or to the initial investor aside from, buy these shares of the company, hold these shares, or I want to sell these shares.
It's worth emphasising that if you just want to invest in a company, modern markets let you do so in an unprecedentedly cheap way: you can usually buy or sell with a penny spread (not legally allowed to be tighter, which is a whole other rant) virtually instantly. If we're really talking about the pure "stock market" then at this point it's pretty much a commodified, low-margin utility business. I'll assume you meant the broader financial industry.
At a simple level: investors might want to invest in a given company at any point on the risk/return curve, rather than just the one their stock or a particular bond issue is set at. They might want to invest in a particular sector rather than having a view on specific companies. They might want to invest in a company whose stocks are priced in a different currency from their own, but without exposing themselves to the currency movements. They might believe a particular sector will outperform the market without wanting to take a view on how the overall market will perform. They might have a big chunk of a commodity to sell in six months and want to spread out the sale according to whenever gets the best price. And all of these views do, ultimately, filter down and translate into concrete capital allocation in the real world: maybe a particular sector ends up hiring more people or building more factories because they have more capital, and the economy does better for everyone when capital is spent in the best way. (Of course it's possible for everyone to be wrong, but the basic idea that averaging out everyone's buying and selling results in our best guess for where the money should go seems sound).
Of course mechanically you end up with a lot of intervening speculators - in between investor A who has a particular set of views about the market and company B that desires capital on particular terms, there might be dozens of intermediaries. But I see that as no different from the way that most real-world transactions are business-to-business - in between you buying a furniture cabinet and the people growing the wood or mining the metal there are dozens of intermediate suppliers, each with their own particular speciality, all adding a little bit of value.
What I see from this is a while bunch of hand waving to say that 'there are a whole bunch of people between you and x business', despite the fact you can directly purchase their shares(which they offered to gain temporary income to make purchases before their cash flow allowed).
I still don't see a reason why these people between you and the business have any useful reason to exist. Unless for gambling, Wich as far as I can tell is what it is. (And I'm not talking about initial investment, I'm talking about people gambling o weather the value will go up or down).
Ontop of all that, what benefit does it provide to the initial company if people are gambling if the value goes up or down by a few percent? That just seems like a different form of book making.
Edit:
You know upon second read, it seems there is so much hand waving to mitigate investor risk, that completely ignores the idea that you are purchasing a piece of a company, that really seems that the entire system is beibg rebuilt to keep certain people making money.
If I want an investor to purchase 20% of my company. For 20% profit, why should any sort of bonds, currency devaluation come into fact.
As far as I see it: you are directly purchasing a portion of my company. That is a share right? If the value goes up, assumably your dividend will increase. Otherwise it will decrease. What the value of my countries dollar happens, has no effect on the percentile of my company.
All I can see is a lot of hand waving to make things different.
Side note: I'd really like to see a logical reason for any of this.
Edit to lostboys: I think the thread is too long and I can't directly respond, my apologies.
Once the business sells a portion to investors, those portions can be resold. This I get, where all the shorting and everything else comes from, makes me wonder about the entire stock system. At what point is it not about the investment about the business, and gambling about how it will go in the future(eg shorting). That and the whole system akin to it, is the part that is making me wonder how it was ever allowed.
> If I want an investor to purchase 20% of my company. For 20% profit, why should any sort of bonds, currency devaluation come into fact.
You'd have to find an investor who wanted to purchase 20% of your company, which is quite a big ask in a lot of respects: they'd be very heavily exposed to one single company, their risk requirements would have to align exactly with yours, they would have to be using the same currency as you. Bottom line is, you'd get a pretty poor price - which is why the institutions that end up buying 20% of companies are the big banks who can slice that exposure and find buyers for the different pieces. (Just like if you're trying to source a given component for manufacturing, you may well end up going through a broker and an importer rather than dealing directly with whoever makes that component). If the banks weren't able to give a better price, no-one would sell through them.
> What the value of my countries dollar happens, has no effect on the percentile of my company.
Sure, but if I'm a Japanese pension fund and the value of my investment drops by 5% because the dollar has weakened against the yen, my investors are going to ask me some awkward questions.
> At what point is it not about the investment about the business, and gambling about how it will go in the future(eg shorting).
It is investment: no-one's doing this for fun (well, maybe a few people are, but they're only hurting themselves if so), they're doing it to make money, which means figuring out what's actually valuable. At the end of the day the only money going into the system is business profits, so the only way to make money is to do something that makes more money for the economy (or, sure, you can do zero-sum bets - but that's not a profitable business to be in in the long term).
> That and the whole system akin to it, is the part that is making me wonder how it was ever allowed.
There's no "allow"; it's a free country, you can buy and sell stuff you own. But the reason the markets are active is because they're productive.
> despite the fact you can directly purchase their shares
Actually, most people could not directly purchase their shares if we didn't have a stock market. Companies in general would be owned only by relatively wealthy people or by other companies. Stock markets allow more ordinary people to share in the profits of companies. They democratize the ownership of the means of production in society.
> (which they offered to gain temporary income to make purchases before their cash flow allowed)
The income raised by stock offerings is not temporary; it is not a loan to be paid back. That capital becomes part of the company. The company might use that to purchase assets that stay part of the company or to buy inventory which it will then sell resulting in getting that money back plus profit.
> Once the business sells a portion to investors, those portions can be resold.
Without a stock market, they could not be resold without great difficulty. Investor A, who wanted to sell his share, perhaps after new management had taken over and was now driving the company into the ground, would have to find other another investor, Investor B, to buy it, and if Investor B didn't want to purchase the exact amount Investor A was selling at a mutually agreeable price, Investor A would have to begin a new search to sell the remainder of his share. This is one way liquity is such a big help.
> making me wonder how it was ever allowed.
The buying and selling of things has never needed to be explicitly allowed; in most modern nations, individuals are free to buy and sell things they own.
I wouldn't buy shares in your company unless I had the legal right to trade and sell those shares to others. When I invest, I'm not just supporting you, I'm supporting me.
>At what point is it not about the investment about the business, and gambling about how it will go in the future(eg shorting).
What, in your mind, is the difference? I think it's a reasonable viewpoint to say that all investment in a business is a speculative bet (ie. gambling) on its future. In that sense, shorting is no different than going long (you just believe it's going the opposite direction and want to express that viewpoint to the rest of the market).
I am not sure what you mean by "gambling" in relation to stockmarkets.
Third parties offer services like spreads CDO's and binary bets (which actually are gambling).
Stock markets act as a market i.e. introducing investors to companies that need capital for example my latest buy was an American Investment trust Tetragon with out a stock market how would I be able to invest in them ?
Gambling implies a truly random outcome which is why Poker is a game of skill as is arguably horse racing :-)
If you can identify an temporary overhang on a particular share you can make money as the discount narrows as I have done with Witan I also made a lot on Electra private equity as it was targeted by an activist investor and they realised some of their PE investments
If there's an IPO of two otherwise identical companies, which one would you pay more for:
- company A who's shares will be traded in a deep and liquid market, so you can get rid of them whenever you need money (eg for unforeseen circumstances)
- company B who's shares can not be sold easily afterwards?
If the answer is A, you see how the secondary market can help the first issuer reap a higher price, thus helping the company succeed.
By the way, you are not alone. I was asking myself very similar questions a while ago. Mostly in the form of: "why would a company's management ever care about share price?" (Outside of when it's trying to raise more capital.)
A company's management cares about share price (and sometimes dividends) because that's what the owners of the company (shareholders) care about. If the directors of a publicly traded company don't care about share price, then the shareholders will vote in new management that does.
At the same time, share price isn't something management can directly change. They do so by running the business well so that it generates profits and growth.
So the question "why would a company's management ever care about share price?" can be answered "because it's usually an indicator of whether or not they're doing a good job and provides job security."
Keep in mind that the stock market is only one part of the financial markets. There’s treasury (Tbill),forex, bond, metals, and derivatives of all of these(futures/swaps etc) and then other instruments used for hedging. All of these markets directly affect the movement of money all around the world.
Also keep in mind that most trades are executed with a hedge in place to prevent losses. The market is rarely a case of bet a million on black trades. That said my knowledge is comes from knowing how energy and metals are traded.
At the very highest level, you have two groups of people: investors and businesses.
Investors have capital, and want to see somebody produce something extra with that capital. The main variables are the size of the capital, and the risk profile the investor is prepared to accept.
Businesses require funding to grow[1]. The main variables are the nature of the reparations, and the control they are willing to concede.
The scale of the four dimensions above means that there is no one size fits method to transfer capital from investors to businesses and vice versa. For instance, Capital: $2 to $2bn; Risk: I'm prepared to lose it all, to I want guaranteed, fixed returns; Reparations: I'll pay 20% interest, to you can have non-negotiable dividend; Control: you can own debt, or you can have a seat on my board.
The evolutionary nature of the finance industry has gone from age old future contracts ("I'll give you $100 next October for your crop of wheat") to other more exotic derivatives e.g. Snowball Swap. Even if you as an individual do not need complex options like that, you may invest in a 401k that does.
[1]not limited to pure funding. Consider a manufacturer that makes a product that takes a year to make. If they sell to a foreign market, they cannot risk working and consuming raw materials for a year in one currency to be paid in another currency at the end of the order that varies. Thus, an FX Future gives the manufacturer the confidence to agree a deal and concentrate on the business fundamentals, not global currency markets.
I see and almost understand what you are writing, but how does this help the original business.
Say I'm business A. I'll offer a portion of my business (say 40%) with the offer that you will reap 40% of my profit. (Assuming one person pays in for that whole value).(edit: I offer this as the income will allow me to expand where as otherwise I'd have to wait longer depending on profit)
At what point does almost anything else you mentioned help the business?
Everything else seems likes gambling, imho, and I still can't wrap my head around why it's allowed.
The more lively the capital market is, the more money is available and the better deal the company get when getting money from the market. This is why companies prefer to list themselves on the bigger, more famous exchanges.
If you need $100m, it matters whether you're giving up 10% or 20% of the business for that money.
(A major benefit to the public of financial markets is diversified pension funds with good returns, btw)
*At what point does almost anything else you mentioned help the business?*
Firstly, it's a market place. The business and investor need to find each other.
To create the market place, you must understand that different investors and different businesses have use cases that you don't need, such as "almost anything else" I mentioned.
*Everything else seems likes gambling, imho*
One of the dimensions is risk profile. Some investors want risky positions in highly leveraged trades e.g. buying a lottery ticket. Some though want a minimal return on an almost sure bet e.g. Italy won't be beaten by San Marino at football.
So we do admit the words bet and gambling apply to derivatives, at some point in these discussions. Fine.
The reason why folks must be confused is that, non Stock market gambling is seen as a vice and/or crime by much of human society. There are religious edicts and/or laws against this practice in most places. The Stock Market getting a free pass from this view - and most people (including myself) not knowing about the nature of this system until they dig a bit deeper - seems unfair.
Las Vegas is looked upon as lascivious even when some of the gambling requires skill (Poker / Blackjack) - derivates trading is instead marketed as a great career where the people doing are superheroes.
I’m not bitter about this even if the message sounds so. Just fascinated by the asymmetry of perception.
I remember when I learned how to day trade foreign exchange with a simple technical analysis strategy. When I started I was ready to have to learn all kinds of advanced maths and expected to "level up" analytical thought.
Then I learned it's all about risk management and absolutely technical analysis trading is gambling. I agree with you, blew my mind!
Because it is gambling with real world consequences. Stock markets influence company behavior which in turn have very real effects over people lives (layoffs, salary reductions, increased hours). So it is a conflict of interests between people that are gambling and people who are just going around with their lives but have no power to counter market gambler movements.
I think you're ascribing more market->company linkage than is actually present, possibly significantly more.
The market (in general) rewards companies who show a prospect of increasing profits. In other words, they reward healthy company behavior the same way that a calendar would reward an effectively competing company or a biological entity (with continued survival and thriving).
It's an imperfect mechanism for sure, but in general, healthy companies get rewarded and unhealthy companies get pressure to become healthy or to die. I don't see that the problems outweigh the benefits.
Temporary extra funds are exactly what you'd want if you saw that conditions were right to open a factory you couldn't afford, for example. Your shareholders are people who would like to take on the profit (and risk) of such an investment. This works in everyone's favor.
Liquidity. The fundamental problem with pre-financial markets is the inability of those with money (investors, both large and small) to connect effectively with those who need money (business owners, etc). Often, you needed some sort of personal connection in order to invest or seek investment from others. The financial markets provide a more efficient way to connect the two parties, based on mutually accepted standards (financial statements, public disclosures, etc), which forms the basis of public offerings.
Once the stock has been released to the public, the market remains a valuable tool for the market to determine price, both among investors and for the company (buybacks and additional offerings primarily).
And this is just a simplified model of the equity markets. Add debt, derivatives, FX and various futures, and it gets more complicated.
Stock markets exist to allow multiple people to invest in a company which allows for spreading risk for the venture. The price of the shares reflects the underlying view of the price of the risk in buying a stake in the company, in addition to the outright value of the firm / venture.
Clear, transparent information about these prices and the ability to buy and sell this risk reduces overall costs to the economy for operating these ventures, greatly increases overall liquidity in the market, and overall greatly lowers overall costs and provides much more ready access to capital for ventures.
If read fiction then I recommend reading 'Time will run back' by Henry Hazlitt[1]. It explains the emergence of consumer goods market and stock markets beautifully by starting from a 1984 style society without any private goods (and no memory of Capitalism) and an open-minded dictator.
I short, an asset (whether a stock, a house, or a bar of gold) only has any meaningful economic value if you can actually sell it in exchange for traditional currency.
Stock markets make it easy to sell your stocks- If you can't sell a stock it's just a useless piece of paper.
Further: before stock markets had a relatively clear bid-ask price range, everyday people would treat stocks as the same as paper currency (which was also relatively new at the time). This led to inflationary bubbles and crashes. The John Law Mississippi Company bubble in early 18th century France caused a significant economic crash, which exacerbated the economic situation leading up to the French Revolution a good 70 years later.
In addition to what others have said: an opportunity to invest. There are plenty of great investment opportunities around, but not all can be had at the click of a button.
It makes it easy for an investor living in France to invest in a US tech company.
1. It offers owners and/or founders of the company liquidity, which is essentially why they started the company in the first place.
Just because you own an amazing company doesn't mean you want to keep your entire net worth in a single stock.
2. I would buy Apple shares if I could sell them at a moments notice. I wouldn't if I couldn't.
3. A liquid investment is generally valued higher than an illiquid one.
4. A higher valuation means the company is able to raise funding from the market at a later stage, by selling additional equity (if required) -- this is relevant for the company.
We wouldn't have to call it an Initial Public Offering if companies never sold shares in subsequent Public Offerings. Most trades don't have the company in question on the selling side, but some do, even after the IPO.
I understand investing in companies, but for me, and I'll admit a completely naive person to this whole system, it seems to have taken an 'inbest in company with money to help them succeed', to a 'who cares let's just cut and run to make the best profit'.
I'm perfectly willing to take a link to a great explanation at this point btw.