Does the stock market really matter?

[Random]

Does the stock market really matter?

Giving the stock market some thought lately, and it occurred to me that unless a company was selling shares of itself for the purposes of expansion, the stock market really doesn’t seem to matter to the rest of the economy.

Once a share of stock is in public circulation, does it really matter who holds it? Does it really matter to the economy what the “price” of a stock is? Is there any point to it all, or could all those stock brokers achieve the same goals by trading baseball cards?

Maybe I’m wrong, but it just seems like we spend too much attention to the stock market and not enough to the economy overall.

 

[roger]

Yes. And no. Hope that helped.

Obviously the second-to-second prices are pretty irrelevant. However, there are second order effects that are anything but subtle or unimportant.

First, within broad limits current prices influence the price of selling/buying a company. I say broad, because VC or such will routinely offer, say, 10% under or over the current stock price to buy out a company. If you stock price is way out of whack, this can limit your saleability.

Second, the ability to issue stock is part of your 'line of credit', so to speak. The accounting principles are too complicated to go into here, but often it turns out that the cheapest way to raise money is to issue new stock. If your stock is out of whack then your ability to do this is limited, increasing the cost of doing business. On the flip side, if you have a strong cash position and your stock tanks for no good reason, it is often sound practice to buy back your own stock. Stocks are also sometimes used in transactions with other companies in lieu of cash.

Third, low stock prices make selling unappealing, which means the nation as a whole is less liquid, which means that less spending goes on, which means an encumbered economy.

Forth, most major corporations and many smaller corporations have significant investment into the stock market for various reasons. They might have too much free cash to deploy in their own business, they may be hedging against a risk their own business faces, or whatever. A low market renders those investments insolvent at best

In other words, it is entirely true that on any given day the stock market is rather disconnected from the underlying health of the economy. OTOH, over time, the stock market tracks the economy with near perfect matchup. It really couldn't be any other way - if it fell behind companies would be essentially on sale, and eventually buyers will swoop in and take advantage, and vice versa. So ya, I'm not worried about day-to-day or week to week performance, but long term trends are certainly worth observing. If you wanted to argue 'why not just track the economy instead' I'd agree, but the stock market gives us a very simple little number and graph to eyeball it quickly.

 

[Ziggurat]

Giving the stock market some thought lately, and it occurred to me that unless a company was selling shares of itself for the purposes of expansion, the stock market really doesn’t seem to matter to the rest of the economy.

Companies do that all the time. They also engage in stock buy-back: if they have extra cash on hand, rather than pay it out in dividends, they can use that cash to buy stock and thus concentrate the value of the remaining stock.

Once a share of stock is in public circulation, does it really matter who holds it?

Well, yes. Because stocks pay dividends, and who gets those dividends makes a difference. Maybe not a first-order effect to the economy as a whole, but still. Furthermore, the sale of stock is accompanied by the transfer of cash (in the other direction), and how that cash flows can also have a big (though indirect) economic effect.

Is there any point to it all, or could all those stock brokers achieve the same goals by trading baseball cards?

If baseball cards paid dividends, sure.

Maybe I’m wrong, but it just seems like we spend too much attention to the stock market and not enough to the economy overall.

That's quite possible. But 1) the economy is enormously complex, so it's hard to synthesize all the relevant information about it, 2) the stock market acts as a pretty good proxy for people's expectations for the economy, and since it factors in the opinions of millions of decision-makers with localized knowledge, it can provide a perspective that no single individual could, and 3) even if we're paying too much attention to it, that doesn't mean it isn't important.

 

[NewtonTrino]

It matters more if you actually have money invested in it. Which you probably do if you have an IRA or a 401k of some sort.

Also if DrKitten recommends a stock... BUY IT!

 

[lomiller]

In addition to some of the points made above, remember that going public is a common exit strategy for start-up companies. This is one of the main ways the financial backers of new companies make their money. Without a stock market investment in starting new companies would be much lower and the economy as a whole much smaller as a result.

 

[The_Animus]

Initial public offerings (IPO) as well as future sale of additional stock is useful in generating large cash flow so that a company can quickly expand.

However, I was under the impression that trading of stock that has already been issued is less useful. If people believe the company is doing well or will do well in the future, then they believe they can earn higher dividends or be able to sell the stock later at a higher price. This drives up the price of the stock. However, after the the stock is first offered, the company doesn't generate any more money by a rising stock price. It essentially becomes a game of outside winners and losers betting against one another as to who can guess where the stock will be after X time period.

If this is incorrect please set the record straight

 

[respect]

Initial public offerings (IPO) as well as future sale of additional stock is useful in generating large cash flow so that a company can quickly expand.

However, I was under the impression that trading of stock that has already been issued is less useful. If people believe the company is doing well or will do well in the future, then they believe they can earn higher dividends or be able to sell the stock later at a higher price. This drives up the price of the stock. However, after the the stock is first offered, the company doesn't generate any more money by a rising stock price. It essentially becomes a game of outside winners and losers betting against one another as to who can guess where the stock will be after X time period.

If this is incorrect please set the record straight

Who would buy the stock initially if they expected it to be worthless? If a company's stock is tanking it limits their ability to raise new capital. It is very much in the interest of a company for its stock to be valuable even if they are no longer gaining from it.

 

[The_Animus]

Who would buy the stock initially if they expected it to be worthless? If a company's stock is tanking it limits their ability to raise new capital. It is very much in the interest of a company for its stock to be valuable even if they are no longer gaining from it.

Yes assuming they were going to issue additional stocks or bonds then having a high stock price would be good for the company as it would allow them to raise capital more easily as well as a greater total amount of capital.

However, if the company is not going to raise additional capital, then the trading of already issued stocks and bonds does nothing for the company.

You have a whole slew of day traders or groups using sophisticated software to makes trades within seconds. These stock purchasers do not retain stock in any particular company for long, thus there is no investment in the company by them in any real sense. Nonetheless they can glean large amounts of money by buying in massive volume at differentials of just a few pennies. Do you feel that this type of trading is beneficial for companies or the economy in general?

 

[respect]

Yes assuming they were going to issue additional stocks or bonds then having a high stock price would be good for the company as it would allow them to raise capital more easily as well as a greater total amount of capital.

However, if the company is not going to raise additional capital, then the trading of already issued stocks and bonds does nothing for the company.

You have a whole slew of day traders or groups using sophisticated software to makes trades within seconds. These stock purchasers do not retain stock in any particular company for long, thus there is no investment in the company by them in any real sense. Nonetheless they can glean large amounts of money by buying in massive volume at differentials of just a few pennies. Do you feel that this type of trading is beneficial for companies or the economy in general?

Perhaps I wasn't clear enough. Whether or not the company is planning to issue stock to raise capital tomorrow is irrelevant. They may want to in the future even if they have no plans of doing so now. I know of no real company that flat out does not want to expand ever (this may apply to your kid's lemonade stand). And even in the unlikely event that such a company exists, they probably wouldn't be publicly traded to begin with. A company with worthless stock is severely limited at raising capital. A worthless stock market limits all companies.

A vibrant stock market is very beneficial to publicly traded companies and the economy as a whole. It may seem irrelevant to you that a day trader can make money by buying a stake in a company at the right time, but the fact that investors can make money by doing so helps businesses raise money. Essentially, without a stock market there wouldn't be stock.

 

[geni]

A vibrant stock market is very beneficial to publicly traded companies and the economy as a whole. It may seem irrelevant to you that a day trader can make money by buying a stake in a company at the right time, but the fact that investors can make money by doing so helps businesses raise money. Essentially, without a stock market there wouldn't be stock.

Doubtful. Stock can exist quite happily without an exchange that allows much in the way of day trading. Indeed for a company looking to raise cash a stock exchange isn't actualy required. If your company is worth investing in people and funds with money to invest can be found.

It's for this reason that arguments about the benifits of day trading focus on liquidity. Now this argument is much sounder. A company looking to raise cash by selling shares generaly doesn't look to do so the next day so has time for advertising and the like that would be needed to sell them if there wasn't a stock exchange. However for an individual who might wake up in the morning and want to sell their shares a stock exchange is rather useful.

This breaks down when you run into high-frequency trading since it is unclear if anyone outside the high-frequency trading market who has the need for that level of liquidity.

 

[respect]

Doubtful. Stock can exist quite happily without an exchange that allows much in the way of day trading. Indeed for a company looking to raise cash a stock exchange isn't actualy required. If your company is worth investing in people and funds with money to invest can be found.

It's for this reason that arguments about the benifits of day trading focus on liquidity. Now this argument is much sounder. A company looking to raise cash by selling shares generaly doesn't look to do so the next day so has time for advertising and the like that would be needed to sell them if there wasn't a stock exchange. However for an individual who might wake up in the morning and want to sell their shares a stock exchange is rather useful.

This breaks down when you run into high-frequency trading since it is unclear if anyone outside the high-frequency trading market who has the need for that level of liquidity.

Aside from how wrong you are, I said nothing about liquidity.

 

[rjh01]

One other reason for the directors and senior employees of companies to want to keep the price high. Some of them own a number of shares.

 

[timhau]

Once a share of stock is in public circulation, does it really matter who holds it?

Yes. If I owned 50.00001% of the voting stock in Citigroup, I could call an emergency general meeting and install myself as the chairman of the board of directors and my 10 best buddies as board members. Then we could fire Vikram Pandit and hire my cat as the CEO.

 

[jazzmojo]

High stock prices make an LBO or hostile takeover much harder to pull off. Also, high stock price increases market capitalization which can lead to lower interest rates on collateralized loans.

 

[Francesca R]

Does the stock market really matter?

The stock market is the sum of ownership claims on the future cash flows of all quoted (publicly traded) businesses in an economy. In any specific sense it doesn't really matter who owns what or what its worth, but in aggregate it is rather central to those businesses, and the economy, being there at all. And if you run a business, who owns it now, and what their attitude is, matters to you more than whoever put the money up in the first place (if different)

Is there any point to it all, or could all those stock brokers achieve the same goals by trading baseball cards?

Stock brokers earn revenue by encouraging flows. They could do the same if people were happy to pay them a cut for finding someone to trade baseball cards with.

 

[Francesca R]

OTOH, over time, the stock market tracks the economy with near perfect matchup.

I don't think that's correct, because the quoted sector of an economy is not usually representative of the whole thing. Also there are dilution effects and valuation effects that drive offsetting wedges between the growth in EPS (which drives stock martket returns) and the growth of GDP.

This note (not gated) by MSCI Barra is a good summary of the issue.

 

[Francesca R]

However, if the company is not going to raise additional capital, then the trading of already issued stocks and bonds does nothing for the company.

Why not do a quick phone around of several listed companies and ask them if they would be at all bothered about having their shares suspended?

Then look up "going concern".

 

[Last of the Fraggles]

Does the stock market really matter?

Giving the stock market some thought lately, and it occurred to me that unless a company was selling shares of itself for the purposes of expansion, the stock market really doesn’t seem to matter to the rest of the economy.

Once a share of stock is in public circulation, does it really matter who holds it? Does it really matter to the economy what the “price” of a stock is? Is there any point to it all, or could all those stock brokers achieve the same goals by trading baseball cards?

Maybe I’m wrong, but it just seems like we spend too much attention to the stock market and not enough to the economy overall.

Well you already conceded that the stock market existing is good so companies can raise money. Now, who would invest in shares if there was no market to sell them in again?

 

[geni]

Aside from how wrong you are, I said nothing about liquidity.

By your argument the majority of canals would have been unable to raise money through the sale of shares since they predate the London stock exchange. This was clearly not the case.

 

[geni]

Well you already conceded that the stock market existing is good so companies can raise money. Now, who would invest in shares if there was no market to sell them in again?

You don't actualy need anything resembling a modern stock market to do that. Just look at the the trade in stamps if you want a modern example.