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Q: Fundamental Structure of Stock Market ( No Answer,   4 Comments )
Question  
Subject: Fundamental Structure of Stock Market
Category: Business and Money > Economics
Asked by: johnjosephbachir-ga
List Price: $3.00
Posted: 28 Nov 2005 02:35 PST
Expires: 28 Dec 2005 02:35 PST
Question ID: 598441
Where is the "bottom" in the stock market? I realize that it is
basically all driven by hype, psychology, etc now, but in theory, what
is being traded? Why would/should a corporation's performance
theoretically affect the value of it's share? is it something to do
with what happens if the corporation dissolved?
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There is no answer at this time.

Comments  
Subject: Re: Fundamental Structure of Stock Market
From: elids-ga on 28 Nov 2005 10:24 PST
 
Without turning this into a long dissertation...  ;-)

The original idea was that you bought a piece of the company when you
bought a share of the stock, if a company had 100 shares and you owned
1 you owned 1% of the company. That was many moons/schemes ago.

Today if we were to follow rational thinking and a share of stock was
bought or sold at what is worth, you should start buying a company's
stock at a multiple of 8 times yearly earnings and keep buying it as
it goes down (assuming the underlying business model is still valid)
by the time it reaches 4 times yearly earnings you should own the
entirety of the company. The rational for that being; at 8 times
earnings you are buying at the same return you would get from
government backed/issued bonds and have the possibility of capital
gains if the stock goes up. You keep buying as it goes down because
the lower it is the higher your total accumulated dividends in 8 years
time. You will have bought the entirety of the company by the time it
reaches a P/E of 4 because at that price it is selling for half of
what is worth (highly unlikely anybody will sell to you at this
point).

However, that is all nonsense because in today's market very, very,
very few companies actually sell you company stock... HA! this I
love... you see they came up with this interesting concept of tracking
stock so that the not so afluent could 'play the market' as well. This
tracking stock is/was nothing really if you could buy a share of stock
XYZ for ten bucks you would be able to buy a share of it's tracking
stock for one, if the other went up ten percent you could sell your
for $1.10 so it tracked the company's stock at one tenth the value. As
more and more people 'played' these shares in the market eventually
these 'tracking stocks' became more profitable than the actual shares,
so they became the 'common stock' or what we today know as 'Class B
shares', and the actual company shares were/are known as 'Class A'.

So, since most companies in the US today trade in class B shares,
about 70% of the wealth in the stock market is in absolutely nothing.
For example you could check out Mr. Bill Gates selling records, he has
consistently sold class B shares for ever and a day, but it has been
well over 20 years since the last time he sold a single class A share.
If you were to apply the logic from the first paragraph to today's
stock market you could buy the entirety of the oustanding (class B)
stock for Microsoft a company worth over 200 billion and if the
company was to close the next day you would own nothing.

So you see, the stock market is simply 'perceived' value. What you
think others may think it will someday be worth.

Eli
Subject: Re: Fundamental Structure of Stock Market
From: johnjosephbachir-ga on 28 Nov 2005 11:47 PST
 
very interesting stuff, thanks.

so who benefits from the initial sale of the class A stock? does the
corporation get all the money from their sales?

also, how does the corporation continue to benefit from the shares being traded?
Subject: Re: Fundamental Structure of Stock Market
From: elids-ga on 28 Nov 2005 12:41 PST
 
That varies a lot depending on the initial sale (IPO), it is not
ussually a sale from the corporation to the public. Say Micheal Dell
starts a business by himself, a couple years later his company is
worth one million, he is doing just fine, but he figures if I had ten
million in cash right now my business would grow tenfold in a year
instead of ten years. So he seeks financing from wealthy individuals
who buy  40% of the company for ten mil. Mr Dell does the math and
figures it is best to own 60% of a ten million $ business than 100% of
a one mil. company. yeah 6mil > 1mil no doubt.

Eventually these investors want to get their money back and they go to
the public when the time is right (initial Public Offering). They
figure we need to get out of this X amount of bucks so they figure how
much is the company worth and how much of their ownership will each
throw in the bucket. Among those that are owners the ones that think
that's about as much as this will ever be worth sell their stock they
can first sell it to the underwriting company that will take the
company public, the Dell corporation gets it's cash up front and all
the stock is out of their hands, at this time they loose control of
that percentage of stock. The underwriter takes it to the market and
first sells it to a bunch of institutions in very large chuncks
hundredthou to millions of shares at a time. If there is anything left
that nobody wants on the day of the IPO they will sell them to the
public in the open market, if the institutional investors scooped up
all the shares because they thought this was a good buy and blah blah
blah then there is nothing left for the public to buy at the IPO
offering price. When the stock begins to be traded it is now bought by
the public from thes institutional investors at a much higher price
than what they paid for. They are the secondary buyers of the stock,
that's why it's known as the secondary market that's where you and I
buy.

Once the company got his money in that pre-IPO offering from the
underwriter the Dell corporation will never see another penny from the
sale of their stock, if they have promised to pay dividends and the
company is profitable they will pay to the owners of that stockholder
those dividends. Both, shares A and B get dividend payouts.
Subject: Re: Fundamental Structure of Stock Market
From: elwtee-ga on 03 Dec 2005 10:45 PST
 
dear john,

you might consider taking everything you have just read and forgetting
it forever. there is very little of it that is factual, true or makes
any sense. to begin with when you buy a share of stock exactly what
you get is a  proportional interest in the ownership of said
corporation. it doesn't matter who you got the stock from, you own
your little piece. if you understand that then understanding that most
everything else written to you is just wrong will be easier.

the section on tracking stocks is not factual as to what tracking
stocks are, why they were created or what they become. that entire
section is just plain old bad information. not even a
misinterpretation. just wrong. the statement that they all become b
shares is equally just plain old wrong. many companies create classes
of stock. they all represent ownership. while there are different
reasons for creating stock classes the most common is voting rights.
creating unequal voting rights in stock classes yields greater
corporate control.

the entire section on bill gates is equally useless. gates has
consistently divested himself of microsoft stock to diversify his
holdings. so what? the concept that b share holders have no
shareholder equity on liquidation of a corporation is just plain old
and simply wrong.

the entire second response about how and why companies go public and
the process by which that happens is so completely incorrect that it
will be easier to offer a few paragraphs reviewing how the process
really works than to attempt to address and correct every mistatement
found therein. for example while it is true that after the ipo, market
traded shares do not involve the underlying corporation, everything in
that paragraph after that statement is wrong too. i.e. companies don't
promise dividends, they are declared on an ongoing basis. companies do
not have to be profitable to pay dividends. it is very possible to pay
dividends well in excess of stated earnings and/or in the face of
stated losses. it is not true that all classes of stock be paid the
same dividend or any dividend.

as to your initial question, the bottom in theory is zero. the shares
of any company can go to a zero valuation if and when no one is
willing to pay anything for them. your premise that the market is all
"hype and psychology" has some defendable merit but you should be
aware when making that argument that the longer the time frame being
studied the less true the statement becomes. eventually corporate
performance will always carry the day and that performance is what the
market pays for. the value of the shares is a reflection of the
collective assumption of future performance and how much the
collective is willing to pay for that future performance in the
present. dissolution value can be, in certain cases, a consideration
but for the most part is not a significant adjustment to market
pricing of equity.

now that i have told you that you have gotten no useful information
and should disregard everything you received prior to this date, i
should by all rights address all the statements and correct them and i
will. unfortunately i am not able to offer you that time at this
moment. i will try to return and do you some good soon. sorry about
that.

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