Jim notes:

Smith wrote in his original post that:

On the one hand you can buy Apple stock for $375 a share and pay $7 to ScottTrade. On the other hand I also have a trash can in which you can deposit your $375, pay me $5 and I will set it on fire for you.

Clearly, I am offering the better deal as in both cases you have approximately zero probability of getting your money back and I am willing to burn it for $5 whereas you have to pay ScottTrade $7.

He wasn’t saying that there is a risk that Apple will never pay out enough cash to shareholders to justify the price of the stock, but that there is “approximately zero probability” of this happening. If a share of Apple stock has the same value as a pile of ashes, then it is not only worth less $375, it’s worth less than $1. That sure sounded to me like he was arguing that Apple’s stock price of $375 is “too high.”

I do have a long thesis about what looks like an increasing principle-agent problem in American business, though it could simply be an unaccounted for increase in the wages of skilled labor. In either case, however, it represents an immeseration of capital that I think may be under-appreciated.

The above statement though was primarily me being an ass. More formerly one might say I was engaging in hyperbole to stress a point.

That point is that the underlying value of owning stock doesn’t come owning the underlying company, its assets, or its profit stream. It comes from being able to extract real goods and services from that company.

Because we live in an economy where things are usually easily bought and sold, nationwide liquidity is typically not in short supply, and markets and the court system function well, people begin to forget this.

They use accounting methods for valuation. However, valuation always comes from your ability to take. Or more completely, to impose your will on the structure of the universe.

In our much more narrow case this means a couple of related things

  • If no owner of Apple stock is actually in a position to force Apple to transfer command over goods and services to the owner then the stock certificate is just a sheet of paper.
  • To that end, if the management of Apple take steps that lessen your ability to extract real goods and services from them then they make your stock certificate more paper-like.
  • Possession caries enormous power. If I already have command over goods and services ceteris paribus this greatly increases the probability of me having command over goods and services in the future relative to someone’s promise or in this case intimation that they will give me command at a later date.

Now I don’t think these principles are lost on people but they are not at the forefront of their minds. Which is why I think people become so easily confused in a credit crisis or a wholesale collapse in equity values or some other event. And, they speak and act as if things are going “wrong.”

Nothing is going wrong. This is the way things always were.

It also contributes to folks getting tripped up by adding-up constraints and possessing what is generally a greatly overinflated sense of the importance of moral hazard, sustainability and related issues. However, I’ll leave it there for now.

Advertisements