On Shareholder Wealth
Bill of Absolutely No DooDahs, wrote this comment in response to my earlier post Google Price Target: $16,578.90:
Other than getting paid dividends, how does one extract wealth from a company one holds shares of?
Call me a cynic (I’ve been called worse), but with the exception of divs, what investors get from buying stocks is selling them at a higher price … meaning that we are not really extracting wealth from anyone except the buyer …
Here is my response:
I think the two of us may have encountered this difference of perspective before. So, you may disagree with some of what follows.
You do not extract cash from anyone but the buyer; however, the value of the security is derived from the value of the business you have an ownership interest in. A common stock represents an ownership interest, not merely a right to receive cash distributions. The fact that cash has not been distributed to the security holder does not mean that the holder’s wealth has not increased. Most public companies are primarily engaged in creating wealth through reinvestment in the business, not through distributing cash to shareholders. Some owners may do better than others in buying and selling their ownership interest; however, owners in the aggregate will only do as well as the underlying business.
I disagree with the idea that owners only extract wealth from the buyer. Although legally there is a separation between a corporation and its owners; economically, a corporation has no wealth that doesn’t belong to its owners. Owner’s earnings (whether distributed or retained) are wealth. Cash is extracted in the form of dividends. One form of wealth is converted into another (cash) at the time of the sale of the common stock. However, the owner’s wealth increases at the time the business earns the money (i.e., increases it net worth) not at the time of the sale. The stock sale does not create the wealth – it merely converts an undivided interest in the corporate assets into cash. Some of our laws (and accounting practices) may obscure this fact.
Although we (almost always) dispose of our ownership interests in corporations by selling them in the open market; they are more than mere pieces of paper that can be sold for ever higher amounts. Ultimately, shareholders have control over the assets of the business. They may choose to dispose of them (or encumber them) as they see fit. Distinct assets may be separated from the business as a going concern. Sale of the common stock is not the only way to transfer wealth into cash.
If your point is that to obtain cash a shareholder must either receive cash thrown off by the assets (i.e., dividends) or sell his interest in the assets, I agree. However, I think that’s true of the ownership of all assets.
If I want cash for any of my property, I must either sell the asset or collect a rent. In this respect, I can’t say there’s any real difference between an ownership interest in a corporation and an ownership interest in any other property, except for a very active market for the interest in the corporation.
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