How does the sharemarket work?

Carried over from another thread: Perth Market

 

Cool, this is going to be interesting. Perthguy vs wogitalia.

Place your bets ladies and gents.

 

So if I buy an existing share in BHP from an existing private shareholder, how much of that money goes to BHP? Perhaps instead of claming I don't understand the function of the sharemarket, and implying that you do, you could explain this to me.

How is buying an existing share from a private shareholder, holding it and reaping the dividends not passive investment? How does it benefit the economy?

I buy existing shares in BHP from a private shareholder, I hold those shares for a number of years reaping the dividends, I later sell them to another private investor. I consider this to be passive investing. Are you able to articulate why my position is wrong?

Here is what I would say about passive share investing. Passive share investment provides very little benefit to the economy, very few jobs, it actively takes money out of the economy by raising the price of shares, it's just a bad asset class.

 

I am hoping to get something more from wogitalia than 'you don't get it', which is all I have got so far. It's easy to say to someone, oh, you don't get it. It's much harder to articulate why. I'm looking forward to a considered response.

 

And for the record I am not referring to investing in IPOs or buying shares issued by a company to raise capital. Obviously these put money into a company to fund existing operations or expand the business with flow on economic benefits.

I am specifically referring to speculative trading on the secondary market, which has been argued to be productive.

 

I think that sums up the share market.
...
Thread closed.

 

Not really. This is an argument that has been circulating for a long time on this forum. Property investing is unproductive, investing in shares is productive. It was argued out in this thread (TL;DR)

Banks have treated our housing market like a Ponzi scheme, and it's about to bust

So, I put it to the forum: speculative trading of shares on the secondary market: productive or unproductive?

 

All investing is speculation, Property and shares. Both are productive, gives man and woman somewhere to gamble our money, then talk about them at bbq's. Without em, we would talk about sausages. And I only like talking about my sausage. So yes, both are productive.

 

Ultimately, the shareholder has equity in the company (it doesn't matter if it is productive or not). If the company wants that share back, you are an unsecured creditor and will have to buy it back from you.

Share trading may be speculative (if you expect the value of the company to increase through profitability or increasing asset values). It may be also be considered as long term investment looking at the cashflow generated from the profit generatedby the business.

It can also be investment to purchase cum dividend then take the dividend & sell ex-dividend taking the capital loss against other capital gains.

 

@Fullysickbro, lol. If only it was that straightforward

I don't really see all investing as speculation though. Of course when I buy shares through an IPO, I hope they increase in value, pay good dividends and I can sell them for a profit down the track. However, when I invest in an IPO, the money goes to the company, they use the money to hire staff and expand their business. This is productive. Sure, there is an element of speculation by the investor but the money is used by the company and the economy benefits.

 

The argument is that this is productive and benefits the economy although no one has explained exactly how. I don't see it.

 

@Perthguy - Only the IPO & subsequent capital raisings can be productive IF the capital raised is applied to investment within the business eg through dividend reinvestment scheme and the dividend applied to productive uses.

If the IPO is purely a release of value to the founders of the company, then it is not productive within the business but it may be applied to other investments or consumption by the founders.

 

this discussion rings a bell, haven't we done this before?

 

In any case I'd like to respond to this later but the subject deserves a bit of time, it's a good one and I think could be illuminating. Unfort I'm very short on time at the moment (moving office into the CBD tomorrow ) Maybe next week unless someone beats me to it

 

Good point. Dick Smith IPO. Productive or unproductive? lol

 

The short answer is yes, the argument was started. However I never got an answer to my question:

I buy BHP shares and hold them for a number of years before selling them for a profit. Productive or unproductive?

This time around the claim is this: investing in property is incredibly unproductive and property should not even exist as an asset class. Big call. Naturally, I don't agree.

 

Further to the above, I find the whole argument, that investing in property is unproductive and investing in shares is productive, inaccurate and intellectually lazy.

I am interested to see your take when you have the time.

 

Just as unproductive as a range trader. Purely speculative and taking profits daily.

 

Do you understand the concept of equity and what it represents to a business? At it's absolute most basic level it is an alternate method of funding for a business, a cheaper and generally more flexible method than debt, this is a gross oversimplification but it will do to illustrate the purpose of the equity market.

The stock market operates as the equity market and allows owners to enter and exit the ownership of a business with relative freedom. This is essential to attracting investors in the first place and allows businesses to access equity rather than being reliant on debt as their only funding method. If you don't have the share market then you have no way for owners to exit without the company having to use its funds to buy back the shares. If owners are locked into a business and have no way to exit then the cost of that capital would increase exponentially, heck it probably wouldn't exist at all for most companies. Forcing companies to buy back the equity at the beck and call or whim of the owners would annihilate the whole point of equity as a source of finance.

Enter the share market and secondary trades between the current owners and prospective owners. It allows that equity to remain in place for the business to use and expand, the same as how you would access the equity in a property to expand your property portfolio. It also allows owners to exit the ownership of the business when they want, an incentive that is behind the very reason that they will invest in the first place, capital growth of shares would be pointless if you couldn't sell them.

It's passive at the shareholder level but it's an investment in an active asset, being the business that the share is in. You're directly investing your money into that company. That company can then use that money to continue it's enterprise and further expand. Equity in a business works the same as in property, it's what allows a business to achieve exponential growth because they can compound the return without the massive expense linked with debt.

Not all businesses use those funds well but on a whole businesses add a **** ton more to the economy than a rental property could ever hope to. A 500k business might hire say 3 people at $150k and return the owner another 50k. A 500k property returns the owner 50k (hell of a property, I know!) and maybe employs another 5-10k in tradies, rental agents and the like.

You aren't a passive investor at that point, you've taken a holding in an active asset. Now you might then choose to be a passive owner who doesn't do anything and more than likely with someone like BHP you wont even have the choice, but it's still an investment in an active asset.

No different to the silent partner in the local cafe, just because they're passive doesn't mean the asset class, being a business, is.

This is where the fundamental lack of understanding comes in. If shares were a piece of paper being traded around, then yes, that would be correct, but shares represent the equity in a company, they are the funds that companies use to generate growth, which generates jobs, which creates money in the economy at an exponential rate. That piece of paper entitles you to your share of that equity when the business is wound up.

Hopefully it's clearer now.

For example... You and a friend have a business, let's say it's property development... The business has generated 500k (250k each) of equity and has say 250k in the bank. You believe that right now you could develop a property the business holds with that 250k and generate 500k in profit but your partner in this business is going through divorce and wants to cash out his 250k of equity. As a result your business has to use it's 250k in cash to buy back his shares and has to forego that development. Now if a secondary market were to exist, he could sell those shares for 250k to another party who would allow the business to retain it's cash and go ahead with the development. This is obviously a gross simplification because there are a ton of other options that are also possible but hopefully it illustrates the basic concept of the share market and why money invested in it, and thus businesses, is a far more productive investment vehicle for the economy as a whole.

 

The two key aspects of the stock market are fear and greed.
Much like the rest of life, really