6 ms·

Not necessarily. If a company makes a profit, then theoretically so do your shares, whether in terms of share price increase or dividends.

hiddencost 10y ago
So, actually, fun fact, this is false! The stock price doesn't just reflect the amount of money the company has. The stock price reflects the "fully loaded" expected value of that stock. That means it prices in ALL expectations. If the company you buy performs exactly as expected, then you don't actually make any money because you paid the price that reflected those expectations, so whatever dividends the company issues will only compensate you for the premium you paid. So the stock has to outperform expectations before it's worth buying. The "expected value" of the company actually discounts dividends and the like, because the value of money in the future is less than the value of money today. There's an amusing side point to this, which is that a perpetual annuity actually has a finite value [1]. [1] https://en.wikipedia.org/wiki/Perpetuity https://en.wikipedia.org/wiki/Perpetuity
- encoderer 10y ago
  I think you're mis-applying the theory here and confusing Return on Risk? No matter what you say, if I buy a stock that expects to earn dividends, and I do earn those dividends, and I've realized a 5% dividend yield, I certainly have made a profit. Now, whether I'm getting return on risk is another thing and very well the answer may be no.
  - hiddencost 10y ago
    Don't think -so- that I've made a mistake. I can eliminate risk and make the same point: Suppose you buy a perpetuity, granting $X every year. After 100 years, you'll have 100 times $X more dollars, but you will be worth exactly the same as you were worth before the perpetuity. (This assumes that the market correctly prices the perpetuity so that the expected value of purchasing it is $0). EDIT: I'm not talking about "profit" because it's not really a super useful concept here. Having a larger quantity of dollar bills after a period of time does not mean that I've got more value. Trivially, if I have $100 in 1950, and $101 in 2016, I have made a "profit" of $1 but lost a substantial amount in real terms. I should cite sources and use correct terminology. Wikipedia provides the following [0] > The dividend discount model (DDM) is a method of valuing a company's stock price based on the theory that its stock is worth the sum of all of its future dividend payments, discounted back to their present value.[1] In other words, it is used to value stocks based on the net present value of the future dividends. [0] https://en.wikipedia.org/wiki/Dividend_discount_model https://en.wikipedia.org/wiki/Dividend_discount_model
    - encoderer 10y ago
      I still think you may be misapplying some theory. The points of discounted future cash flows, time value of money, and ev are not lost on me. But pointing out that an arbitrary profit figure irrespective of inflation is a "profit" is meaningless. It's a nice Econ lecture but markets do not actually behave by a manner of collective estimate of dfcf. I would say it's more accurately described as a random walk with an upward inflationary bias.
- marshray 10y ago
  Well there's also the effect that new money flowing into the stock market as a whole ends up chasing a finite set of stocks thus tending to raise prices.
- reddytowns 10y ago
  I concede, however what I was mainly getting at was that this meme of "you only make money when the company grows" is also false. I believe you would agree with me that a company could exceed expectations while at the same time not growing (by giving out a bigger dividend, or buying up its own shares with its profits).
  - tptacek 10y ago
    I'm not saying that you only make money when the company grows. Obviously, you can make money from a consistent dividend, as well. But that's not really what you're doing when you invest in an S&P index fund, right?
- lmm 10y ago
  Using that logic you could say it's never worth buying anything. A loaf of bread costs the fully-loaded expected value of that loaf, so it's never worth buying a loaf of bread because it's always going to be worth exactly what you paid for it. But actually trade is a wealth creation mechanism because different people put different value on things: to you the loaf is worth more than the money you paid for it, while to the shopkeeper the money is worth more than the loaf. The stock will cost a fair market-clearing price for its expected return, risk-adjusted. But often a stock, or a perpetuity, is a good purchase for one or other market participant - no different from a loaf of bread bought at a fair market-clearing price.
- kgwgk 10y ago
  You are missing something: the discount rate used in a DCF model is not the "risk free" rate so if everything goes "as expected" you are still making more money than you would buying government bonds. One can say that this "risk premium" actually reflects the expectation that things don't go as well as expected. But the fact is that in the aggregate and in the long term equity investors are still doing "better than expected" and there is no agreement on why it is so (this has been called the "equity premium puzzle").

hiddencost 10y ago

So, actually, fun fact, this is false! The stock price doesn't just reflect the amount of money the company has. The stock price reflects the "fully loaded" expected value of that stock. That means it prices in ALL expectations. If the company you buy performs exactly as expected, then you don't actually make any money because you paid the price that reflected those expectations, so whatever dividends the company issues will only compensate you for the premium you paid. So the stock has to outperform expectations before it's worth buying. The "expected value" of the company actually discounts dividends and the like, because the value of money in the future is less than the value of money today. There's an amusing side point to this, which is that a perpetual annuity actually has a finite value [1]. [1] https://en.wikipedia.org/wiki/Perpetuity https://en.wikipedia.org/wiki/Perpetuity

encoderer 10y ago
I think you're mis-applying the theory here and confusing Return on Risk? No matter what you say, if I buy a stock that expects to earn dividends, and I do earn those dividends, and I've realized a 5% dividend yield, I certainly have made a profit. Now, whether I'm getting return on risk is another thing and very well the answer may be no.
- hiddencost 10y ago
  Don't think -so- that I've made a mistake. I can eliminate risk and make the same point: Suppose you buy a perpetuity, granting $X every year. After 100 years, you'll have 100 times $X more dollars, but you will be worth exactly the same as you were worth before the perpetuity. (This assumes that the market correctly prices the perpetuity so that the expected value of purchasing it is $0). EDIT: I'm not talking about "profit" because it's not really a super useful concept here. Having a larger quantity of dollar bills after a period of time does not mean that I've got more value. Trivially, if I have $100 in 1950, and $101 in 2016, I have made a "profit" of $1 but lost a substantial amount in real terms. I should cite sources and use correct terminology. Wikipedia provides the following [0] > The dividend discount model (DDM) is a method of valuing a company's stock price based on the theory that its stock is worth the sum of all of its future dividend payments, discounted back to their present value.[1] In other words, it is used to value stocks based on the net present value of the future dividends. [0] https://en.wikipedia.org/wiki/Dividend_discount_model https://en.wikipedia.org/wiki/Dividend_discount_model
  - encoderer 10y ago
    I still think you may be misapplying some theory. The points of discounted future cash flows, time value of money, and ev are not lost on me. But pointing out that an arbitrary profit figure irrespective of inflation is a "profit" is meaningless. It's a nice Econ lecture but markets do not actually behave by a manner of collective estimate of dfcf. I would say it's more accurately described as a random walk with an upward inflationary bias.
marshray 10y ago
Well there's also the effect that new money flowing into the stock market as a whole ends up chasing a finite set of stocks thus tending to raise prices.
reddytowns 10y ago
I concede, however what I was mainly getting at was that this meme of "you only make money when the company grows" is also false. I believe you would agree with me that a company could exceed expectations while at the same time not growing (by giving out a bigger dividend, or buying up its own shares with its profits).
- tptacek 10y ago
  I'm not saying that you only make money when the company grows. Obviously, you can make money from a consistent dividend, as well. But that's not really what you're doing when you invest in an S&P index fund, right?
lmm 10y ago
Using that logic you could say it's never worth buying anything. A loaf of bread costs the fully-loaded expected value of that loaf, so it's never worth buying a loaf of bread because it's always going to be worth exactly what you paid for it. But actually trade is a wealth creation mechanism because different people put different value on things: to you the loaf is worth more than the money you paid for it, while to the shopkeeper the money is worth more than the loaf. The stock will cost a fair market-clearing price for its expected return, risk-adjusted. But often a stock, or a perpetuity, is a good purchase for one or other market participant - no different from a loaf of bread bought at a fair market-clearing price.
kgwgk 10y ago
You are missing something: the discount rate used in a DCF model is not the "risk free" rate so if everything goes "as expected" you are still making more money than you would buying government bonds. One can say that this "risk premium" actually reflects the expectation that things don't go as well as expected. But the fact is that in the aggregate and in the long term equity investors are still doing "better than expected" and there is no agreement on why it is so (this has been called the "equity premium puzzle").