google blogger on Monday, January 31, 2011
My opinion is that stock certificates are just another form of wealth, like gold, copper, wheat, pigs, a home, whiskey or a title to your car. A stock certificate is a "title" to a business, and business is an asset like any other. It is productive, creating wealth for owners, but that is not why it goes up in value. Imagine I own a hen that lays one golden egg per year. How much is the hen worth? It is valued in the same way as a stock and calculations would include:
1. How likely is the hen to die? How old is it? How long do other golden hens live?
2. How likely is the hen to give birth to other similar chickens (innovation, expansion).
3. Will the chicken lay less than one egg/yr? Smaller eggs? (loss of market share, lower profitability)
4. What kind of upkeep will be required to keep the chicken alive (overhead, inventory costs, cost of capital).
5. Will other people breed similar chickens? How many of these are in the world? (competition).
The chicken has a fixed value today, just like gold or copper. It is a more complex valuation, but it is still fixed. There are three basic reasons stocks go up in value:
1. Inflation creates higher prices (not higher real value).
2. The business re-invests profits (chicken keeps the egg and it hatches into a new golden egg-laying hen).
3. The outlook for the company changes (did the company breed a new strain of chickens? Did other golden hens die?)
The fundamental point remains: a business is an asset and has a current value like any other asset, and is not expected to rise in value (unless profits are re-invested). If the business is expected to rise in value, that information is used to value the business. If I know I have the only imortal golden hen on earth, I can value it by calculating the present value of all its future golden eggs.
A stock's value is determined primarily by the present value of all expected future earnings. The discount rate (the percentage used to reduce all future income to its current value) is determined by expected inflation, default risk, and the time value of money.
Currency can be backed by any asset, and US dollars are currently backed by homes, cars, businesses, and the US government (because it accepts them for tax debts). They are not imaginary, and are not produced from "thin air" (usually). They are produced when a bank takes an asset in trade for US dollars, which happens every time a home, auto, or business loan is generated.
Posted by google blogger at 9:58 PM