Stock market a present value machine
SETH JACKSON 297-4751
>Someone mentioned that the stock market is just a present value machine
>This can't be totally true, because then every stock with a given P/E
>ratio would sell at exactly the same price, right? A quick glance
>at the stock listings shows this not to be the case. Comments?
>
> Jeff Percival ...!uwvax!uwmacc!jwp
Wrong. The price of a share of stock is the net present value of the
company divided by the number of shares outstanding. Even if two
companies had the same net present value (highly unlikely), their
share prices would differ if they had a different number of shares
outstanding.
--
Seth Jackson
David Fox
>Wrong. The price of a share of stock is the net present value of the
If this were the case stock prices could not jump on good rumors nor
plummet on bad rumors. Actually, the price of a share of stock is
always whatever price one person is willing to buy at and and another is
willing to sell at. This is to say that the stock market is a perceived
value machine. The present value of the company only influences the
price of the stock insofar as it influences the buyer's and seller's
awareness. Other factors which influence the price of a stock are:
- The prospects of the company
- The prospects of the economy
- The health of the president (of the United States)
- The adjectives used most recently in news articles about the company
- The opinion of Adam Smith
- The weather
- The phase of the moon
- ...
Well, that's my opinion, anyway.
Rich Strebendt @ AT&T Information Systems - Indian Hill West; formerly
> >Someone mentioned that the stock market is just a present value machine
> >This can't be totally true, because then every stock with a given P/E
> >ratio would sell at exactly the same price, right? A quick glance
> >at the stock listings shows this not to be the case. Comments?
>
> company divided by the number of shares outstanding. Even if two
> companies had the same net present value (highly unlikely), their
> share prices would differ if they had a different number of shares
> outstanding.
WRONG WRONG WRONG !!!
The price of a share of stock reflects the OPINION of the most recent
buyer of the stock as to a lower bound on the FUTURE value of the
stock. This price has little (if any) relationship to the value of the
company (hence the Grahame strategy of buying undervalued companies) or
of any other RATIONAL attribute of the company. The value of a stock
is set by EMOTION, not rationality.
As an example, General Public Utilities of Pennsylvania stock dropped
from something like 24 to 4 at the time of the Three Mile Island
incident. Did the value of the company's assets (less its liabilities)
really drop to 1/6th of what they were the day before? Not really. Did
the incident have an EMOTIONAL impact? You betcha! I do not know what
the stock is selling for today, but I expect that it has recovered a
good bit, but is not yet up to the pre-incident price. The emotional
reaction is wearing off, but is not yet gone. [This arguement is, of
course, grossly oversimplified, but the basic thrust I think is valid.]
This also explains (at least in part) why the market reacts to the
changes in the economic indicators, the price of oil, and the direction
of flatus outflow of Congressional Committee Chairpersons. There is
no link between the number of housing starts in the month of March to
the net asset value of General Motors. There is an emotional
expectation that the future price of GM stock will increase if the
number of houses being built has increased. Hence, when the Leading
Economic Indicators rise, the price of GM stock rises, unless there is
another contravening emotional issue that forces that particular price
down. Consider also the "market's resistance" to cross certain values
(say, 1800 recently) -- purely emotional reactions of the stock buyers.
So, when you hear someone speak of the market as a rational entity, you
should be thinking "AHA -- Another sucker donating money to MY
brokerage account!!!"
Rich Strebendt
...!ihnp4!iwsl6!res
Paul R Markowitz
> >>This can't be totally true...
> >Wrong. The price of a share of stock is the net present value of the
> >company divided by the number of shares outstanding...
>
>
> - The prospects of the company
> - The prospects of the economy
> - The health of the president (of the United States)
> - The adjectives used most recently in news articles about the company
> - The opinion of Adam Smith
> - The weather
> - The phase of the moon
> - ...
>
> Well, that's my opinion, anyway.
The expected future earnings of a company are a random variable subject
to changes based on "states of nature". Each state of nature occurs with
some probability. However, due to uncertainty and various other facts of
life, we don't know what those probabilities are. Also, the expected earnings
under each state of nature are constantly changing. The present value
is the value in current dollars that an investor expects the earnings of
the company to be worth. This is a personal decision based on a variety
of factors that include all the things (no matter how little they have to
do with it) listed above. That means that all those things are part of
present value. The stock market is a big present value machine in which
investors tell each other what they expect the value of a company to be. Each
investor bases his decision to buy or sell based on whether he thinks his
view of the information about a company is better than the other investors.
--
------------------------------------------------------------------------
Paul Markowitz
"A pessimist is someone who won't call on G-d because he is certain he will
get an answering machine."
--My sister
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rex ballard
>>>Someone mentioned that the stock market is just a present value machine
>>>This can't be totally true...
>>Wrong. The price of a share of stock is the net present value of the
>>company divided by the number of shares outstanding...
>
>If this were the case stock prices could not jump on good rumors nor
>plummet on bad rumors. Actually, the price of a share of stock is
>always whatever price one person is willing to buy at and and another is
>willing to sell at.
Is there any reason why, for whatever reason, I couldn't buy say, 100 shares
of stock that is normally selling for around $10/share for about $15/share
and effect the daily "high". Or sell it for $7 to effect the daily low?
Some companies' employee stock purchase (ESP) plans take the high and low on a
particular day, split the difference and discount that price by say 5-15%.
If the company did as described above, for a couple of days, they could
raise the "high" enough to reduce the number of stocks actually issued
by the company. Later, the price would drop to "normal" or slightly below
because of dissappointed speculators. Effectively, the company could insure
that the value was at it's highest when the ESP was made. The employee
could effectively loose a hefy percentage of his discount couldn't he?
Is this done? Is it legal? Are ESP's good investments?
Jeffrey W Percival
>Each investor bases his decision to buy or sell based on whether he thinks his
>view of the information about a company is better than the other investors.
Not always. What about the people who buy a stock because they think they
can sell it next week for twice the price? No fundamental analysis here.
I'm making a pretty obvious and trivial point, but I was just
reacting to the people who were, in my opinion, attaching too much logic
to the market ("present value machine"). The Dow dropped 40 points
yesterday, and the NPV folks would have me believe that a readjustment of
the projected earnings stream of the underlying companies caused the
market to react downward. I would claim that the market moved in a way
that was independent of the valuation of the underlying companies and
earnings streams, therefore the market is at best a profoundly defective
PV machine.
Another way to phrase it: The Dow dropped 40 points yesterday. Will
the NPV adherents please name the companies whose earnings projections
changed so dramatically between 3:30 and 4:00 EST?
--
Jeff Percival ...!uwvax!uwmacc!jwp
jbt
----------
Just a couple of points:
1- Friday's sharp drop was due to arbitrage selling related to the
expiration of stock and stock futures options. It had nothing to do
with the value of any stock, perceived or real, present or future.
I have heard several experts say that prices recover/return to
normal very soon after a sell or buy program is exercised.
2- When we consider the effect of perceived value on the price of stock
keep in mind that *the* buyer of stock is a professional-- usually
the manager of a retirement fund, manager of a mutual fund or
someone of similar training and experience. Thus, it is reasonable
to assume that s(he) has full control of emotions! The majority of stock
is purchased in blocks of 10,000 or more shares-- probably not
triggered by deep emotions.
3- There can be instantaneous events that could easily change the
present value of a stock or the entire stock market. Such events
might include Paul Volker's resignation, heating up of hostilities
in the Middle East that involves us, or a sharp drop in oil prices ;-)
Enough, I stop for now. Hope it makes some sense.
---------------------------------------
<<I speak only for myself and the thoughts(?) are mine--my wife says so>>
Jack B. Turner, Planning Engineer
EMSP Project, AT&T Federal Systems Division
Burlington, NC
Phone - 919/228-4321 (Cornet 291)
Usenet- ![ ihnp4 ulysses cbosgd mgnetp ]!burl!jbt
--
----------
<<I speak only for myself and the thoughts(?) are mine--my wife says so>>
Jack B. Turner, Planning Engineer
EMSP Project, AT&T Federal Systems Division
Burlington, NC
Phone - 919/228-4321 (Cornet 291)
Usenet- ![ ihnp4 ulysses cbosgd mgnetp ]!burl!jbt