Wednesday, April 8, 2009

Why Few Will Make Money with stocks

In my February blog article on 'The Real Ponzi Scheme', I noted a number of unsavory and disturbing points to do with purchasing stocks and stock ownership, and especially reaping the rewards of such. The example given was for Company "XYZ" which goes public and issues 10 million shares of stock to 2 million people, for $50 a share. The market capitalization here is therefore $500 million.

What I went on to note is that this total capitalization is what determines payouts in the end. If all the people want out with their redemptions at once, then the payout for each is the minimal value per share. A simple principle is at work, the more redemptions (sales, sellers) the less the payout per share. If all wanted out at once, though the stock price might originally be $50 per share, the payout for 2 million people would amount to no more than $1,243 each on average.

The entire assumption of stock ownership is predicated on the gamble that not all will cash out at once, and in fact, there will be many more "buy and hold" investors than stock share redeemers. As long as say, ten times as many buy and hold, others can use the inevitable stock gyrations and a knack for timing, to get the most bang for the buck on a cashout. On the average, only about 0.01% of the total number of investors can do this without penalty.

Say, for example, the original stock share plummets after ten years to 50 cents a share. The market capitalization has now decreased a factor of 100 ($50/ $0.5 = 100) to $5 million. If there are no 10 million investors, the share price can be no more than 50 cents a share and that is the maximal cashout (redemption) amount. Thus if all ten million stock holders cash out at once they will (theoretically) get 50 cents a share. However, since stock managers do demand to take profits, commissions, and don't intend to part with all the money, they use a formula pegged to the volume of selling such that the share value is inversely proportional to the volume.

Thus, what theoretically might look like 50 cents per share on paper, for a mass redemption, will really end up as probably only ten cents per share.

If all the buyers (of company XYZ stock) initially bought stock at $50 per share, then watched it collapse to $1 a share, where did the money go? (A clue can be found by reading the 'Real Ponzi Scheme' piece! )

The (Duh!) answer (see also the recent 'Ask Marilyn' column in PARADE, April 5) is that the sellers (redeemers) got it. Well, who else would? The other aspect is that this scenario only accounts for a tiny fraction of the total money "lost".

Remember, as per my example in the earlier blog article, that when all the 2 million purchasers of XYZ stock bought it (at $50 per share) they actually artificially inflated the worth of all the shareholders. Obviously, they also inflated the worth-value for all those who bought it at $48, $24, $15 and $1! The reason? Everyone's stock is valued at the last share price times the number of shared owned. Thus, at any time in that transition interim, IF one of those lower purchase owners had the prescience or good fortune to cash out in time, they would have reaped a relative reward. This, despite not having bought the stock at a lower value.

In like manner, Janus World Wide Fund sold shares at one time for as high as $75. When I bought in (in 1997) they were still high but not as high as the inital offering rate. As they began a down swing I cashed out (in 1998) at least 100 shares for $70 a share- enough to finance a holiday to Yellowstone National park. Eventually the shares crashed to below $30 a share, by which time almost all share holders were selling (which was why the share price was being driven lower).

Back now to what I noted in the previous piece: Joe Schmoe similarly, may be elated at beholding a $174,000 balance after his 10th year of holding XYZ stock, but he needs to understand that the bulk of this:

$174,000 - $35,000 = $139, 000

is phantom money.

By the same token, if the following month the share prices collapses back to $5, Joe has not lost $174, 000 but only the money he actually put in up to THAT point, or $35,250.

It is this larger value, based on a "misleading multiple" of inflated share value x shares, that leads many to believe they have lost money they never owned in the first place. It only appears they did. Such is the stuff of stock hocus pocus which has nearly every modern day "investor" bamboozled and starry -eyed.

What if all sellers sold at once, does that make their losses real? Never in a million years! As I noted earlier, if all sold at once they'd all be victimized since as sellers outnumber buyers the share price drops according to inbuilt formulas used by the companies to correct for diminishing share volume. Diminishing (held) share volume = diminishing returns. Zero sum game anyone? The true and hard fact, again, is that only the prescient or early sellers, are able to obtain the top share price. This is possible because there are many times more "buy and hold" investors to support those sales.

Bottom line: If you own stocks you either better: a) be sure you receive regular dividends so you can collect at least something over time, or b) develop mind-reading powers tuned into the optimum time to cashout, so you are among the few who do when the share price is highest!

1 comment:

Unknown said...

It's no wonder more young people are abandoning finance as a career. It must eventually have sunk in that it's all a royal shell game! I myself knew stocks were a pyramid scheme from 2002 when the (then) 'Phil Donahue' sow on MSNBC (before Keith Olbermann's time) featured econ professors who dunned stocks as the much bigger pyramid scheme. This was when a lot of talk of Social Security privatization was going on.

Imagine how many more millions would be left to live off Alpo had Social Security been privatized in 2005 as Bush wanted to do!