Why is this stock worth anything?
November 13, 2015 9:23 AM Subscribe
Not really about a specific stock but I'll use NWPX as an example. To clarify what I'm asking I should say I understand the concepts of discounting earnings, voting rights, common stock, diversification etc. but fundamentally I have always scratched my head over what the point of owning this sort of stock is.
NWPX is not a penny or tech/growth stock but a small coherent industrial company that makes pipes. It has never paid a dividend in 20 years and its price has gone up and down over the years. What I don't really understand is why, (beyond the notion that in the future it will be worth more, which seems like a tautology if thats the right word,) it is worth buying. Is it that there is an expectation that in the future it will be bought? Is it that it might start paying a dividend sometime? I wish I could have a 7 minute Q and A with a fund manager as I just don't get it.
NWPX is not a penny or tech/growth stock but a small coherent industrial company that makes pipes. It has never paid a dividend in 20 years and its price has gone up and down over the years. What I don't really understand is why, (beyond the notion that in the future it will be worth more, which seems like a tautology if thats the right word,) it is worth buying. Is it that there is an expectation that in the future it will be bought? Is it that it might start paying a dividend sometime? I wish I could have a 7 minute Q and A with a fund manager as I just don't get it.
Speculation.
Stocks are worth what other people think that they're worth.
See: "Pump and Dump" as one of the more egregious examples of what stocks really are.
posted by porpoise at 9:40 AM on November 13, 2015
Stocks are worth what other people think that they're worth.
See: "Pump and Dump" as one of the more egregious examples of what stocks really are.
posted by porpoise at 9:40 AM on November 13, 2015
To make sure I'm clear - you're not asking why stock exists in the first place or what stock is, but rather why own stock in a relatively stable small company the value of which is not expected to change dramatically, correct?
Aside from wanting to gain control of the company by buying stock, which is larger scale than you mean, I think the point of owning it is that you do think it will increase in value over time. If you had bought NWPX in November of 2000 when it was around $10 bucks a share you were doing pretty well this past summer when it was around $35. Certainly more than tripling your investment is better than parking the money in a savings account where you'd be lucky to earn a couple percent/year.
posted by Wretch729 at 9:43 AM on November 13, 2015 [1 favorite]
Aside from wanting to gain control of the company by buying stock, which is larger scale than you mean, I think the point of owning it is that you do think it will increase in value over time. If you had bought NWPX in November of 2000 when it was around $10 bucks a share you were doing pretty well this past summer when it was around $35. Certainly more than tripling your investment is better than parking the money in a savings account where you'd be lucky to earn a couple percent/year.
posted by Wretch729 at 9:43 AM on November 13, 2015 [1 favorite]
Don't think of it as a way to make money, think of it as a relatively safe and inflation-resistant way to store the money you have.
posted by contraption at 9:57 AM on November 13, 2015 [1 favorite]
posted by contraption at 9:57 AM on November 13, 2015 [1 favorite]
In theory, the funds that might be used to pay dividends aree being put back into the company to help it grow. If successful, the shared price will rise.
In practice, that might be true, or the company might be closely held by management who use the funds to pay themselves more. You would have to research the financials to find out.
posted by SemiSalt at 10:00 AM on November 13, 2015 [1 favorite]
In practice, that might be true, or the company might be closely held by management who use the funds to pay themselves more. You would have to research the financials to find out.
posted by SemiSalt at 10:00 AM on November 13, 2015 [1 favorite]
This digs into the economic concept that price == information.
On the consumer side, basic supply and demand states that price should equal the cost of production. Obviously we see that is rarely the case. The variance between that price and the final price is an aggregate of the market's known information about that item. If it is well known that there is high demand for that item, the price will increase. If it is thought they might be stuck with excess inventory, it will decrease.
On the investment side, you make money by hedging on where you think the market is wrong. The price increases because people buying the stock think the company will do better than people selling the stock. This is correlated but slightly removed from genuine health of the company. That's what creates an incredible amount of volatility even for small stable companies.
posted by politikitty at 10:16 AM on November 13, 2015
On the consumer side, basic supply and demand states that price should equal the cost of production. Obviously we see that is rarely the case. The variance between that price and the final price is an aggregate of the market's known information about that item. If it is well known that there is high demand for that item, the price will increase. If it is thought they might be stuck with excess inventory, it will decrease.
On the investment side, you make money by hedging on where you think the market is wrong. The price increases because people buying the stock think the company will do better than people selling the stock. This is correlated but slightly removed from genuine health of the company. That's what creates an incredible amount of volatility even for small stable companies.
posted by politikitty at 10:16 AM on November 13, 2015
The stock is worth something for (at least) two reasons: (a) the stock represents a share of the company's future earnings, which one day will be paid out in the form of a dividend or as a distribution in connection with an acquisition or wind-up of the company; and (b) the stock has speculative value in the sense that if you buy it you might be able to sell it to someone else for more money.
I think what you are getting at in your question is - if there are no dividends and no reason to think that the company is going to be acquired in the foreseeable future, why is point (a) worth anything at all? I think the answer is probably the same as why a dollar bill in your pocket has value - because everyone in the marketplace agrees that it has value and is willing to trade other things of value for it. It is somewhat circular, as you say in your question. The thing that keeps it from being totally detached from any underlying concept of value is the point (a) stuff, although, as you suggest, the point (a) stuff is often very hypothetical/remote.
posted by Mid at 10:37 AM on November 13, 2015 [5 favorites]
I think what you are getting at in your question is - if there are no dividends and no reason to think that the company is going to be acquired in the foreseeable future, why is point (a) worth anything at all? I think the answer is probably the same as why a dollar bill in your pocket has value - because everyone in the marketplace agrees that it has value and is willing to trade other things of value for it. It is somewhat circular, as you say in your question. The thing that keeps it from being totally detached from any underlying concept of value is the point (a) stuff, although, as you suggest, the point (a) stuff is often very hypothetical/remote.
posted by Mid at 10:37 AM on November 13, 2015 [5 favorites]
Also, I don't have any empirical data (though I bet you could look it up), but the chance that Random Company X might one day get cashed out in a merger or in a private equity buy-out isn't that unlikely. The private equity types buy-out all kinds of random small companies all the time and cash-out the common stock with a premium -- i.e., they take away your share that was worth $5 and they give you $7 in cash. It is the possibility of this type of event, among many other types of events, that gives common stock a form of "underlying value" -- i.e., someone might come along and buy the company and cash you out with a premium.
posted by Mid at 10:41 AM on November 13, 2015 [1 favorite]
posted by Mid at 10:41 AM on November 13, 2015 [1 favorite]
pure speculation, but i suspect one way that point (a) is made more concrete is by trading in groups of companies. that company doesn't exist alone, but also as one of a group of, say, small engineering companies based in the north west of the usa. it's possible that someone thinks that those companies in that region are going to benefit from, say, some improvement to regional infrastructure, and so there is a demand for shares of all companies in that class. so some of the value in a share comes from its perceived closeness to other companies. and that means that no one particular company has to be closed (for example) for there to be some expected payout.
posted by andrewcooke at 10:56 AM on November 13, 2015
posted by andrewcooke at 10:56 AM on November 13, 2015
Companies that don't issue dividends may be reinvesting their profits in the firm, but they can also return the money to investors through stock buybacks.
posted by Mr.Know-it-some at 11:22 AM on November 13, 2015 [2 favorites]
posted by Mr.Know-it-some at 11:22 AM on November 13, 2015 [2 favorites]
Basically if it generates cash, that cash has some value. The price someone is willing to pay for that cash is a function of how fast that cash can grow if you consider growth is essentially a function of the return that cash earns.
In theoretical framework at least.
posted by JPD at 12:32 PM on November 13, 2015
In theoretical framework at least.
posted by JPD at 12:32 PM on November 13, 2015
Stock gives you partial ownership in a company, and thus partial ownership of its profits. Some companies give you your share of profits in the form of a dividend, while some choose to reinvest those profits in the company. This decision is ultimately made by senior management, and, by extension, the board of directors, which is directly accountable to shareholders.
Whether a company pays a dividend or not is not material to its stock price; think of a company choosing to pay a $10 dividend for each of two years, or to reinvest the year 1 profit with the expectation of doubling year 2 profit (meaning a $20 year 2 dividend).
The reason stocks have value is because they give you a claim to a company's future profits. Stock prices go up when a company's expected profits increase.
There are some confused responses above.
posted by deadweightloss at 6:23 PM on November 13, 2015 [4 favorites]
Whether a company pays a dividend or not is not material to its stock price; think of a company choosing to pay a $10 dividend for each of two years, or to reinvest the year 1 profit with the expectation of doubling year 2 profit (meaning a $20 year 2 dividend).
The reason stocks have value is because they give you a claim to a company's future profits. Stock prices go up when a company's expected profits increase.
There are some confused responses above.
posted by deadweightloss at 6:23 PM on November 13, 2015 [4 favorites]
+1 to deadweightloss.
There are 2 ways you would cash in your stocks:
i) if the company goes bankrupt or is dissolved. You then have a claim to the company's assets proportionate to how much stock you own, once the creditors and preferred shareholders have been paid off.
ii) you sell it anytime before the company is dissolved/goes bankrupt. so what are pipes worth?
the stock market doesn't reflect what a company is truly worth (as in, there's not a direct relationship between the two). but oftentimes, the two are tied, especially if the majority of shareholders are reading the financial statements of the company. so, if the company has a good management team/board of directors/shareholders AND a good business, stock prices should be going up gradually if the product is not volatile. for instance, the shares in a company that sells commodities like gas is volatile because it's tied to the entire industry's supply and demand and there's not much the company can do to control the supply/demand of the product, no matter how good of a business model and management team it has going on.
but when it comes to pipes, i guess the supply/demand should be pretty stable.
posted by kinoeye at 8:18 PM on November 13, 2015
There are 2 ways you would cash in your stocks:
i) if the company goes bankrupt or is dissolved. You then have a claim to the company's assets proportionate to how much stock you own, once the creditors and preferred shareholders have been paid off.
ii) you sell it anytime before the company is dissolved/goes bankrupt. so what are pipes worth?
the stock market doesn't reflect what a company is truly worth (as in, there's not a direct relationship between the two). but oftentimes, the two are tied, especially if the majority of shareholders are reading the financial statements of the company. so, if the company has a good management team/board of directors/shareholders AND a good business, stock prices should be going up gradually if the product is not volatile. for instance, the shares in a company that sells commodities like gas is volatile because it's tied to the entire industry's supply and demand and there's not much the company can do to control the supply/demand of the product, no matter how good of a business model and management team it has going on.
but when it comes to pipes, i guess the supply/demand should be pretty stable.
posted by kinoeye at 8:18 PM on November 13, 2015
It has never paid a dividend in 20 years and its price has gone up and down over the years. What I don't really understand is why, (beyond the notion that in the future it will be worth more, which seems like a tautology if thats the right word,) it is worth buying.
You pretty much nailed why in your post. Imagine a company that earned 5 percent annual, but never paid a dividend (or share buyback) or invested in expansion, etc. Their lack of dividend doesn't negate the value of that cash stream. In fact, if the price doesn't track the accumulated piles of cash, an activist investor or corporate raider might come in, buy the company, and announce a one time dividend of all the cash hoarded and come out richer for it. And this is not hypothetical -- there are people out there rich enough to buy and sell entire companies, and use their voting rights to enact sweeping changes. Carl Icahn is notorious for getting into fights with management about strategy, policies, and such.
So even stocks with boards and management who don't return money to shareholders should be trading as if that policy could change at any moment, and if prices start to stray too far from that, it's incentive for folks like Icahn to prove them wrong.
posted by pwnguin at 2:56 PM on November 14, 2015
You pretty much nailed why in your post. Imagine a company that earned 5 percent annual, but never paid a dividend (or share buyback) or invested in expansion, etc. Their lack of dividend doesn't negate the value of that cash stream. In fact, if the price doesn't track the accumulated piles of cash, an activist investor or corporate raider might come in, buy the company, and announce a one time dividend of all the cash hoarded and come out richer for it. And this is not hypothetical -- there are people out there rich enough to buy and sell entire companies, and use their voting rights to enact sweeping changes. Carl Icahn is notorious for getting into fights with management about strategy, policies, and such.
So even stocks with boards and management who don't return money to shareholders should be trading as if that policy could change at any moment, and if prices start to stray too far from that, it's incentive for folks like Icahn to prove them wrong.
posted by pwnguin at 2:56 PM on November 14, 2015
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(People do this. I bought Irish bank shares when they dropped to pennies on the dollar. My 9 cent shares are likely to tank completely, but they could one day return to their 30.95 high...)
posted by DarlingBri at 9:39 AM on November 13, 2015