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It is a common mistake, but stocks don't have a positive return because GDP increases over time. They have a positive expected return over time because they hav

by HFguy 4y ago

It is a common mistake, but stocks don't have a positive return because GDP increases over time. They have a positive expected return over time because they have a risk premium. That is, to invest and take on risk, an investor will demand a return above and beyond the expected value of the cash flows the business generates. Whatever path of GDP and/or population is expected to be is already factored into the discounted valuation of the cashflows. That is, you aren't getting a positive expected return because population growth is increasing over time (i.e., everyone knows that, it is already baked into the price). Now, if the expected population growth changes...then the price would change. You have an expected return because you are taking on risk.

JumpCrisscross 4y ago
> stocks don't have a positive return because GDP increases over time. They have a positive expected return over time because they have a risk premium You’re both right. The equity risk premium [1] is real. But it’s a premium over something. That something is, approximately, production. (It’s precisely the risk-free rate of return. Which, in the long run, is base-rate production.) [1] https://www.investopedia.com/terms/e/equityriskpremium.asp https://www.investopedia.com/terms/e/equityriskpremium.asp
- HFguy 4y ago
  Yes, all assets are priced relative to the risk free rate. As the assets all compete with each other and they all compete with cash rates. So that rate can be thought of as being baked into other assets already (including equities). Having said that, if you wanted a return strictly on base-rate production, then you'd invest then in risk free assets (vs equities).
  - RC_ITR 4y ago
    > Yes, all assets are priced relative to the risk free rate. Based on your name I bet you work in research at a hedge fund. I hate to break it to you but ask most people who are price setters what their discount is and they’ll say 10% regardless of 10Y treasury yields (since you know, TINA) As a result securities are increasingly priced on liquidity more than cash flows and that’s a function of the credit cycle way more than it’s a function of productivity. It’s a weird post modern approach to the economy, but hey that’s showbiz baby.
paulpauper 4y ago
agree. GDP does not mean stock market gains. In fact, you can have strong shareholder returns even if the economy is not growing at all. If $1 billion company generates $100 million in net profit annually, this is $ that must go to shareholders regardless of GDP. This is the situation right now with the US...major companies are generating huge profits annually even if real GDP, productivity, and population growth is sluggish, which is why the stock market has done so well in spite of so many things seeming to be wrong..
- slv77 4y ago
  Long term corporate profit growth overall can’t exceed demographic growth + productivity growth unless you assume that corporate profits will eventually consume all of GDP with labor and taxes going to zero. A large amount of corporate profit growth since the 80s has been due to a declining share of labor compensation vs capital and declining effective tax rates. Productivity gains are the only real “free lunch” which is what capital investment is supposed to provide to justify the gains. Productivity growth has been stagnating for a couple of decades.
MuffinFlavored 4y ago
> They have a positive expected return over time because they have a risk premium It feels very weird that the same: 1. US government (which bailed out some big banks when they did all of that corrupt greedy stuffy during the '07 housing collapse) 2. the predatory banks themselves 3. institutions like Vanguard, Blackrock, UBS really let "the small guy" win in the "retail investor" by allowing us to just click "buy" on things like index funds. it all seems too good to be true. when does the little guy ever actually win?
MuffinFlavored 4y ago
> You have an expected return because you are taking on risk. I have a dumb question. Most publicly traded companies rarely issue new shares. Why does a company care about its share price? If we are being rewarded for buying and holding their shares based on the growth a company makes quarterly, how does the company benefit from their share price going up? They don't commonly take loans against their shares or issue new shares. I know they have a duty to shareholders but... take Facebook for example. Who cares if their stock is down 60%? How does it affect the companies financials?
- snake_doc 4y ago
  > Most publicly traded companies rarely issue new shares. False, most public companies have stock based compensation plans, which are ways of issuing new shares. Without them, they would need to substitute stock compensation with cash to acquire talent. Facebook issues shares every time they approve a new stock based compensation plan.
  - MuffinFlavored 4y ago
    https://finance.yahoo.com/quote/FB/key-statistics?p=FB https://finance.yahoo.com/quote/FB/key-statistics?p=FB FB has 2.3b shares outstanding. How much has that number grown past 12 months, 24 months, 36 months so I can put what you are discussing into perspective?
    - snake_doc 4y ago
      It's not as simple as looking at the stock of outstanding shares to determine issuance, as it's a net figure. In terms of new issuance, FB spends billions in stock based compensation each year since 2012, all of these are new issuance under the equity incentive plan. It was ~$9.164B for FY2021 alone. In terms of buybacks, FB started buying back stocks in 2017 and has continued since. In FY2021, they spent ~$55.47B to buy back stocks. Therefore, outstanding shares have been decreasing since around 2020. But this doesn't mean the company stops issuing shares. The more stock prices fall, the more equity they would need to issue to compete for talent, or alternatively supplement with cash. Long term, stock prices is one of many measures of how the company would be able to raise capital (stock based compensation is an indirect way of raising capital). Data from Bloomberg: https://postimg.cc/Lq0sNCJV https://postimg.cc/Lq0sNCJV
ChrisLomont 4y ago
Risk doesn't add value. Production does. Stocks rise as the company is perceived as more valuable, generally due to productive gain. People don't want to risk investing without expected gain. But the risk is not causing growth.

by HFguy 4y ago

JumpCrisscross 4y ago

> stocks don't have a positive return because GDP increases over time. They have a positive expected return over time because they have a risk premium You’re both right. The equity risk premium [1] is real. But it’s a premium over something. That something is, approximately, production. (It’s precisely the risk-free rate of return. Which, in the long run, is base-rate production.) [1] https://www.investopedia.com/terms/e/equityriskpremium.asp https://www.investopedia.com/terms/e/equityriskpremium.asp

HFguy 4y ago
Yes, all assets are priced relative to the risk free rate. As the assets all compete with each other and they all compete with cash rates. So that rate can be thought of as being baked into other assets already (including equities). Having said that, if you wanted a return strictly on base-rate production, then you'd invest then in risk free assets (vs equities).
- RC_ITR 4y ago
  > Yes, all assets are priced relative to the risk free rate. Based on your name I bet you work in research at a hedge fund. I hate to break it to you but ask most people who are price setters what their discount is and they’ll say 10% regardless of 10Y treasury yields (since you know, TINA) As a result securities are increasingly priced on liquidity more than cash flows and that’s a function of the credit cycle way more than it’s a function of productivity. It’s a weird post modern approach to the economy, but hey that’s showbiz baby.

paulpauper 4y ago

agree. GDP does not mean stock market gains. In fact, you can have strong shareholder returns even if the economy is not growing at all. If $1 billion company generates $100 million in net profit annually, this is $ that must go to shareholders regardless of GDP. This is the situation right now with the US...major companies are generating huge profits annually even if real GDP, productivity, and population growth is sluggish, which is why the stock market has done so well in spite of so many things seeming to be wrong..

slv77 4y ago
Long term corporate profit growth overall can’t exceed demographic growth + productivity growth unless you assume that corporate profits will eventually consume all of GDP with labor and taxes going to zero. A large amount of corporate profit growth since the 80s has been due to a declining share of labor compensation vs capital and declining effective tax rates. Productivity gains are the only real “free lunch” which is what capital investment is supposed to provide to justify the gains. Productivity growth has been stagnating for a couple of decades.

MuffinFlavored 4y ago

> They have a positive expected return over time because they have a risk premium It feels very weird that the same: 1. US government (which bailed out some big banks when they did all of that corrupt greedy stuffy during the '07 housing collapse) 2. the predatory banks themselves 3. institutions like Vanguard, Blackrock, UBS really let "the small guy" win in the "retail investor" by allowing us to just click "buy" on things like index funds. it all seems too good to be true. when does the little guy ever actually win?

MuffinFlavored 4y ago

> You have an expected return because you are taking on risk. I have a dumb question. Most publicly traded companies rarely issue new shares. Why does a company care about its share price? If we are being rewarded for buying and holding their shares based on the growth a company makes quarterly, how does the company benefit from their share price going up? They don't commonly take loans against their shares or issue new shares. I know they have a duty to shareholders but... take Facebook for example. Who cares if their stock is down 60%? How does it affect the companies financials?

snake_doc 4y ago
> Most publicly traded companies rarely issue new shares. False, most public companies have stock based compensation plans, which are ways of issuing new shares. Without them, they would need to substitute stock compensation with cash to acquire talent. Facebook issues shares every time they approve a new stock based compensation plan.
- MuffinFlavored 4y ago
  https://finance.yahoo.com/quote/FB/key-statistics?p=FB https://finance.yahoo.com/quote/FB/key-statistics?p=FB FB has 2.3b shares outstanding. How much has that number grown past 12 months, 24 months, 36 months so I can put what you are discussing into perspective?
  - snake_doc 4y ago
    It's not as simple as looking at the stock of outstanding shares to determine issuance, as it's a net figure. In terms of new issuance, FB spends billions in stock based compensation each year since 2012, all of these are new issuance under the equity incentive plan. It was ~$9.164B for FY2021 alone. In terms of buybacks, FB started buying back stocks in 2017 and has continued since. In FY2021, they spent ~$55.47B to buy back stocks. Therefore, outstanding shares have been decreasing since around 2020. But this doesn't mean the company stops issuing shares. The more stock prices fall, the more equity they would need to issue to compete for talent, or alternatively supplement with cash. Long term, stock prices is one of many measures of how the company would be able to raise capital (stock based compensation is an indirect way of raising capital). Data from Bloomberg: https://postimg.cc/Lq0sNCJV https://postimg.cc/Lq0sNCJV

ChrisLomont 4y ago

Risk doesn't add value. Production does. Stocks rise as the company is perceived as more valuable, generally due to productive gain. People don't want to risk investing without expected gain. But the risk is not causing growth.