Wednesday, December 17, 2008

Forward Looking Stock Market

I've got to keep this short as my wife is at the casino, and thus I need to pick up my son. Ever wonder why pundits say the stock market is forward looking? Here is my explanation.

A stock's value is, by business school definition, the present value of all future dividends. What if the stock doesn't pay dividends (e.g. Google)? Then it's the present value of all expected future dividends. A well respected business school professor of mine is very adamant that this definition is sound.

When experts say the market is forward looking, they mean, the value of the market today is what investors think the dividends will pay out, or are expected to pay out, until the end of time.

Please challenge me if you think I'm wrong.


Droidtrader said...

By "dividends", are you referring strictly to a quarterly or annual dividend that a company pays its stock holders, or do you also mean potential appreciation of share value?

If you mean strictly quarterly dividends paid out while owning a stock, I would disagree. I think the vast majority of investors have too short of a timeframe in mind when investing, and dividends are of little concern. I think most investors are more concerned with short term price appreciation balanced with risk (beta).

In my opinion, this short term focus on stock value appreciation drives companies to take actions geared towards short term results at the expense of long term results. Actions such as buying unneeded capital just to match the plan they created 15 months previous. Actions that if you owned the company, and were spending money out of your own pocket, you would never take.

Mac Noland said...

Only dividends. The potential appreciation of the stock is simply the market's reaction to anticipated larger dividends in the future.

You're right, short-term investors don't think of holding the stock in perpetuity. They are hoping that "good news" drives up the price so they can dump it. Which I think you'd agree with me, is stupid. Just ask Warren Buffett.

I would agree 100% with the over emphasis on short-term gains. Eventually these sacrifices will damage a company.

The problem is, while most of us have a ownership of the companies we work for, we don't hold enough to be influential. So we all bounce along with each other and execute upper management's vision, even if deep down, we think it's not a wise decision. In a way, collectively we make each other less intelligent.