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"Fifty years ago it would have seemed shocking for a public company not to pay dividends. Now many tech companies don't. The markets seem to have figured out ho

"Fifty years ago it would have seemed shocking for a public company not to pay dividends. Now many tech companies don't. The markets seem to have figured out how to value potential dividends. Maybe that isn't the last step in this evolution. Maybe markets will eventually get comfortable with potential earnings. (VCs already are, and at least some of them consistently make money.)" Does this not worry anyone? It's basically a statement justifying investment based on confidence, not that an investor is able to reliably guess whether a company will be able to generate PROFIT or not, but that it will be able to generate EARNINGS at all! this is not investing in two birds in a bush (likely to be profitable). It's investing on the basis of four in the nest (potentially earning money at all!). that's astoundingly risky. Now, either you believe investors are stupid and risk-insensitive (or risk-blind! not uncommon in a bubble) and will keep investing the same sums of money as they ever have, or you believe they are clever, credit strapped and most certainly not risk insensitive. Option A means a world of pain up ahead for investors and their backers, because we're in a mighty bubble. Option B means PG is wrong (though doubtless he'd like to be right, because it makes flipping seedstage companies from the YC stable a hell of a lot easier) Based on the total inability of even the biggest players on the scene - e.g.YouTube, Facebook and Bebo - to monetise, I really don't see how the confidence to move to an earning-optimistic (from profit-optimistic) investing mode is at all justified. If anything, earnings are less certain than they ever have been, the slide should be the other way.

nostrademons 19y ago
I'm a little uncomfortable with it, because it's the same reasoning that led to the subprime-related derivatives debacle. People felt that securities should be worth something, even though nobody was actually paying for them, and so they marked to model instead of marking to market. The result's been a disaster so far. But remember - there's more than just blind hope at work here. These companies are delivering real value to customers, they just don't know how to capture that value. The whole field of finance is based on providing capital to people who deliver real value but do not yet have the means to capture that value. If that weren't a necessary function, we'd have no need for loans - every business would be able to finance itself from retained earnings. People pay back loans all the time, even though they don't have the money on hand at the time the loan is written. They just have to watch out for what happened with the subprime market. Statistically, this was a really solid bet: a certain proportion of mortgages default in any given year, that proportion is relatively constant, and so by dividing these mortgage pools into tranches, you could get predictable risk & reward streams. The problem was that by securitizing the mortgages, they changed the market. Since banks no longer had to live with the consequences of bad loans, they started writing loans to riskier borrowers, which threw all the statistical models out the window. Graham risks a similar problem if, by letting more marginal startups get funded, he changes the assumptions that let him be reasonably confident that any startup that builds things people want will be able to make money off it. BTW, this doesn't always end badly. Fractional reserve banking is based on a similar principle - it's statistically very improbable that all of a bank's customers will want their money back at once, and so it's fine to loan out 90% of the money. Or the logic behind retained earnings vs. dividends: if a firm is reinvesting its capital wisely into the business, then it should create just as much shareholder value as if it's been paid out in dividends.
jmzachary 19y ago
All I have to add to this excellent post is "a fool and his/her money are soon parted". It wasn't different back in the 1990's and it's not different now.
- flipbrad 19y ago
  have i not fucked up that comment - mistaking earnings and profits as two separate things?

nostrademons 19y ago

I'm a little uncomfortable with it, because it's the same reasoning that led to the subprime-related derivatives debacle. People felt that securities should be worth something, even though nobody was actually paying for them, and so they marked to model instead of marking to market. The result's been a disaster so far. But remember - there's more than just blind hope at work here. These companies are delivering real value to customers, they just don't know how to capture that value. The whole field of finance is based on providing capital to people who deliver real value but do not yet have the means to capture that value. If that weren't a necessary function, we'd have no need for loans - every business would be able to finance itself from retained earnings. People pay back loans all the time, even though they don't have the money on hand at the time the loan is written. They just have to watch out for what happened with the subprime market. Statistically, this was a really solid bet: a certain proportion of mortgages default in any given year, that proportion is relatively constant, and so by dividing these mortgage pools into tranches, you could get predictable risk & reward streams. The problem was that by securitizing the mortgages, they changed the market. Since banks no longer had to live with the consequences of bad loans, they started writing loans to riskier borrowers, which threw all the statistical models out the window. Graham risks a similar problem if, by letting more marginal startups get funded, he changes the assumptions that let him be reasonably confident that any startup that builds things people want will be able to make money off it. BTW, this doesn't always end badly. Fractional reserve banking is based on a similar principle - it's statistically very improbable that all of a bank's customers will want their money back at once, and so it's fine to loan out 90% of the money. Or the logic behind retained earnings vs. dividends: if a firm is reinvesting its capital wisely into the business, then it should create just as much shareholder value as if it's been paid out in dividends.

jmzachary 19y ago

All I have to add to this excellent post is "a fool and his/her money are soon parted". It wasn't different back in the 1990's and it's not different now.

flipbrad 19y ago
have i not fucked up that comment - mistaking earnings and profits as two separate things?