Stocks

A word of warning: I suspect that I may be completely off-base here. My understanding of this subject is a mix of antiquated theory and limited anecdote. I’m throwing this out as a snapshot of my current understanding and perceptions. Please contradict and help fill in the gaps.

I’ve been thinking about the stock market lately. Not in the sense of me making investments, but in terms of how it works, how it allocates money to commercial ventures. This is part of a general curiosity about what makes the world tick, but there’s also a specific self-interest in wanting to understand what motivates the companies I work for. My background coming into this is from historical reading and personal experience.

But first, why do I care about the stock market? Well, I don’t, really - not the day-to-day of it. I’m not one of those guys who keeps a stock ticker running on his desktop. But it’s important - these days, it’s responsible for a lot of what gets done in the world. Most of our food, clothing, shelter, medicine, transportation, entertainment, etc. comes from publicly traded companies. Also, the origins and theory of it are kinda cool. Essentially, it’s a mechanism that allows a whole mess of strangers to work together on a venture that’s far to big for any one of them to tackle. When you look at it this way, it’s a really elaborate form of human communication. And humans, I find fascinating. I’m really only interested in economics to the extent that it’s about people. I’m most interested in the microeconomic end of the scale, because it’s really the psychology of decision making. Why do people do what they do? How much is internal motivation, and how much is external constraints? Group behavior is also interesting, as in companies. But as economics gets more macro, it gets away from people and eventually ends up in a bad place full of aerodynamics-grade math.

The other reason for caring about the stock market is that a lot of the companies I might work for are motivated by the stock market. If they’re public companies, they end up making a lot of decisions based on how it will affect their stock. If they’re private, they’re probably thinking about becoming public companies, or getting acquired by public companies, which influences them in similar ways.

My limited understanding of stocks comes from reading about 17th century trading ventures. You want to build a ship, outfit it and crew it, and spend the better part of a year sailing it halfway round the world to bring back spices or silver or lumber or whatever. These are huge up-front expenses and there’s a very real chance that the ship will be lost to storms or pirates. The upside is that if all goes well, you’ll make a ton of money. Almost nobody has the kind of money you need for that initial investment. Even if they do, they can’t afford to lose it all. But if you get a big group of people together, then each can bet a share they can afford to lose. They buy shares, and they get a cut of the profits. Now if you get a really big group of people together, you can fund a bunch of ships and play the averages. Instead of feast or famine, you get a nice, predictable return on investment. Instead of shares in a one-time venture, you have an ongoing business, and the shareholders get yearly dividends. More importantly, without some mechanism like this, the happy consumers in your corner of the world will never know the joys of coffee, chocolate, or potatoes.

So stocks and dividends make sense. You invest in a company. You give them money up front, and they give you a piece of the action. It even makes sense to trade stocks. If you decide you’d rather have a chunk of money now, you sell your share to someone, and they get the dividend every year. It makes sense that the value of that share could go up, if the company prospers and grows, and the yearly dividend goes up. The important thing here is the company’s focus on profit. Profit is a measure of how useful the company is, how well it provides a good or service that people are willing to pay for.

But now we get to the point where I think it starts to peel loose from reality. If you think a company will be successful, and its shares will pay higher dividends in the future, it makes sense to buy them now and sell them for more later. It’s logical, but it’s a critically different way of valuing the stock. You’re buying shares based not on the dividend itself, on the profit from the venture, but on how much you expect to be able to resell the share for later. It’s the shift from investment to speculation. The value of the stock is no longer tied to the expected dividends, but to what people think they’ll be able to resell it for, what they think other people will think it’s worth, which is what they think they’ll be able to sell it for. Profitability, useful products, business value, all of that may still influence the stock price, but they’re secondary factors.

We got a prime example of this in the dot-com boom, where there was really no business justification for the value of stocks. There were companies with no product or customers. They didn’t own anything; they hardly had any employees. They didn’t do anything useful. But they’d go public with a lot of buzz and their stock would skyrocket just because people thought everyone else wanted to buy it. Once investors thought it had stopped going up, they scrambled to get out before it crashed, which ensured that it did. Then the cycle would start over with the next cool idea - there was no end of those.

The key is that the investors don’t actually care about the success of the business, as long as they can get out in time. They want the business to look promising, so others will want to invest and drive the price up, but it doesn’t have to deliver. The rewards for investors became largely detached from value creation, from profit. The fundamental promise of capitalism, that businesses are rewarded for doing useful stuff, is broken.

Something strange and bad also happens to the company’s motivations. Remember that they’re always competing with other companies for investment money. The things they should be focusing on - doing useful stuff - take a back seat to activities oriented around market perception. A lot of that seems to do with growth, or the perception of. If a company is doing useful stuff, making a profit, and plowing that back into the business (buying more ships), it will grow. It will have more equipment and people than it did last year. All well and good. But this gets turned around, and growth becomes the measure of success. So companies start doing stupid things in order to have good growth numbers.

Mostly, they go out and buy a bunch of smaller companies who have little to do with their core business. They end up being less than the sum of their parts. The guys at the little company are less motivated, because now they’re just working to make a bunch of strangers rich. That’s even if you haven’t demoralized them by laying off a bunch of their staff. Even if there are synergies to be leveraged (shudder), there are a lot of hurdles to overcome - cultural, political, technical, and organizational - and no guarantee that everyone will ever work effectively together.

So I don’t know what the answer is, or if I even understand the problem. A lot of this is idle curiosity: There’s a complex and important system that looks kinda broken, and I want to understand how it got that way. It’s not like I run a company, or even manage investments.

But the practical side is that my understanding of this will inform decisions about where I work. I’ve come to appreciate how much the business environment and priorities have a real impact on my day to day job. I’ve worked at the little company that got bought. I have friends who’ve worked for the big company doing the buying. I have friends who have worked for the company that’s hiring lots of useless people to make the numbers look good, and others at the one that’s laying off lots of useful people to make the numbers look good.

If I can go into an interview and ask the right questions about their business, I’ll end up a lot happier. I’m not job hunting now, but understanding this will also help me recognize if my company is going off the rails. Maybe the answer is to find a company that’s not playing this game, where the owners aren’t just looking to cash out, where they’re really engaged in the business. I’ve actually worked at a place like that years ago, a little boutique software shop. It was really nice in a lot of ways. I left it then because I had a lot to learn, but I might be happy going back to that kinda gig now.