Wolfstan wrote:From previous
GW financial posts I see there are plenty oDakka members who have a good grasp of financial matters, so hopefully one of them maybe able to clear up my economic query
The news has been full of stories about the amount of money wiped off the value of shares and everyone has been running around like headless chickens. Obviously not being an econimic guru i'm having difficulty understanding why, the reason being -
The Acme Corporation has 100 mil wiped off the value of their shares, why does that affect the rest of us? I mean Acme has had the money for those shares, they don't lose out there do they? As a member of Joe public, I'm not affected, as I have no shares or pension that are connected to the company. Ok, if you have a pension linked to their shares and it's about to mature, then there is a problem for you, otherwise the shares will recover at some point. Even if the share value of Acme dropped to 1p / 1c, does Acme actually lose money? I'm assuming that it would affect future sales of shares, but again if the loss of value isn't down to the performance of the company, then it will rise again.
Acme itself doesn't lose money regardless of what it's share price is. The effects of a lower share price are more indirect.
Basically, if Acme were interested in expanding, the share price is more or less the price they'd be able to sell new shares for. If that price is quite low they would likely delay further expansion until the share price recovered. But that's only relevant if the company was planning to expand, and wanted to do so through an issue of more shares rather than through internal financing or a loan, so it isn't that big of a deal.
The bigger impact of a lower share price is to do with how much people are willing to invest. If the share market is dropping, other assets are generally likely to follow (outside of unique contrary assets like gold, almost all of which are static and do not generate economic activity). People are going to invest a lot less in a market with dropping asset values, as the profit has to be much larger to offset the declining asset value.
The biggest connection between the stock market and the economy as a whole is as a predictor. The point isn't that a stock market crash drags the rest of the economy down, but that the same poor economic performance that is first seen dragging down the stock market is soon to be seen out there in the real world. For instance, the GFC saw an almost immediate response in the stock market, but it took much longer for the liquidity squeeze to move through to tighter lending practices, leading to reduced investments and finally to lost jobs.
To me, as Mr Joe Average, it would appear that alot of noise and panic is made over things that really have no substance. It reminds me of the early days of the recession where there was all this noise over profits and shares dropped. Nothing to do with the fact that a company was in the red, but just because it didn't make the forcasted profit. They where forcasted to make 250mil, but only make 190mil and because of this the financial markets have a fit, the company cost cuts by laying off staff. You times that by "x" amount and you have a shed load of people out of work, self fueling the recession.
I must be missing something?
No, that's pretty much it. Thing is though, a dropping share price makes perfect sense in that situation. Consider, for instance, if you were looking at buying a laundromat bought a laundromat business that brought in $5,000 in profit every month. You'd likely pay about half a million for that business. But then something happened, such as a competitor opening up across the road, so that the business is now only expected to bring in about $4,000 per month. You're not going to be willing to pay as much for that business, probably somewhere closer to $400,000.
The stock market is much the same. People will pay less for a company that makes less. So if it was expected that the company was generating $250 million in profit, but they only delivered $190 million, the share price will likely drop*.
*Well, sort of. Accounting profit isn't really much of anything. The market doesn't care about how much you've valued your bottling plant at, so if the reason for the reduced profit is because you've devalued it by $60 million, that shouldn't affect the share price. What the market cares about is the cash flow the company can bring through - how much money it can bring in and either distribute or re-invest. This is why it's kind of weird they keep talking about profit to earning ratios with shares, but the profit is just a number accountants get to make up, and doesn't really mean anything. And I say that as an accountant.
