'The Ponzi Factor' is a short book which is written to rationalise and justify the author's assertion that the stock market, as currently operated is really a gigantic ponzi. He bases this on the fact that an equities value is usually only a reflection of what another investor will pay for it and has no relation to the performance of the underlying business. The only caveat is that if a share pays a dividend, then this is less true as money from the business is introduced into total returns.
Tan is based in the US so his benchmark S&P is much less likely to pay dividends than the FTSE. Currently the yield on the S&P is around half that of London as many of the stars of the American stock market don't pay a dividend, indeed for many this is explicit policy. Tan uses the performance of Google and Tesla to illustrate the ponzi nature of stock investing. Google has made huge sums of money that it keeps in it's company accounts but will not pay to stock holders. He points out that between 2007 and 2011 where the company reported profits of $28bn, the stock price started and ended this period the same where as Tesla over the period from 2010 and 2017 reported losses of $4.3bn but the share price went up by nearly 20 times. It is difficult therefore to justify any direct, demonstrable correlation between business performance and stock price, we have to concede that the price is more based on emotions like 'expectation'.
Logically speaking, investing should be based on rational and sensible expectations of a return on that investment. If someone approached you to borrow money for their new business but all you get, and were ever going to get was a piece of paper saying the value of that paper was £0.01, I think most sane 'investors' would walk away from that deal. Tan makes the point that if an investments value is only determined by future investors and not the performance of the underlying company it can be thought of as a ponzi and not investing in the more honest sense.
Raising capital through equities means initial investors give money through brokers and banks to the company accounts for expansion or other capital needs. This money is then spent or held within the companies own accounts…
Thanks for sharing that Julian, interesting.
I have not read the book so I am only going on your précis, but at first sight it seemed to me that the argument is :
I cannot personally rationalise stock market prices, ergo they must be manipulated and fraudulent.
This is not a sound argument.
There are two truisms about share prices, one covered directly in your précis and one alluded to :
- A shares value at any point in time is dictated by what another investor will pay for it.
- A shares value is equal to the discounted value of all future cashflows (DCF) over the term of its ownership.
The latter is true in retrospect, but almost entirely useless as a predictor. It is true that many analysts deploy DCF models as part of their valuation, but the fact is that tiny variations in the assumptions generate large variations in the derived value.
What is interesting about these two truisms however is that the former is always indirectly a result of expectations of the latter.
Whilst it is true that some will buy stocks solely on the hope/expectation of being able to sell at a later date for a higher price to a greater fool.
But somewhere down the chain of future owners will be a potential owner effectively valuing the share on their expectation of the DCF.
However, this is where there is I believe an element of truth in the use of the term Ponzi (Although not I would argue in the sense of suggesting anything corrupt)
One of the key facets of a Ponzi scheme is that early investors make their fantastic returns by taking the assets of later investors.
This is actually not a bad description of the stock market (although as it is not a zero sum game, there does not necessarily have to be loser – although of course in practise there are.)
Take a typical ‘story stock’ whose share price soars to great heights based on the rosy future foreseen for the business, that then crashes and burns for whatever reason.
The investors that make money here are those that see the potential early and buy at a very low price and manage to sell at a later date at a much higher price when the market starts to get excited about the prospects.
If that still sounds a little seedy, consider this.
As an investor, unless you are following a ‘never sell’ strategy of the like promoted by Buffet or Bland (you can pay me later for that alliteration Stephen!), then you are implicitly targeting BLASH (Buy Low and Sell Higher) . Once you sell though, whether the price continues to rise and the buyer also gains or not should be matter of indifference (unless you can determine that you systematically sell too soon and can adapt your behaviour).
So whilst I started off being (possibly unfairly) critical of the idea the reference to Ponzi does actually have some merits in considering how the market works.
If you are generally going to hold forever, then I would agree that future dividends are a very important consideration.
Otherwise, however, where you perhaps be focussing thoughts is on what will cause a buyer to pay more for the shares in the future than you are paying today.
