STOCKS, A Cautionary Note

The stock market is a great wealth builder. Still during volatile times, I am always reminded of what a professor (Dr. Wish) once cautioned me about stocks, “It’s important to know what stocks are and what they are not.”

He spent long school hours talking about how the market can drive speculation and that can move stocks beyond their original purpose and value.

What Stocks Are

The concept of selling shares in ventures dates back to Roman times. These early investments dealt with specific ventures, usually voyages to far off lands. The investors agreed upon the purpose of the voyage. Each investor would get a share of the riches brought back. If the voyage failed, they would get nothing. 

It was not until the Dutch East India Company of 1602 that investors were attracted to taking risks in on-going ventures versus a specific one. The Dutch were the first to create what amounts to the stock market today.

Today, the concept is much the same. Stock shares are issued by companies to raise money. That money theoretically goes into growing the business or purchasing new plant property and equipment. The buyer of the stock becomes a shareholder (part owner) in the company. 

What Stocks Are Not

The initial purity and purpose of stock changes over time. Once they become public, they can be bought and sold between investors. This leads to speculation on the future of the company. The more investors feel about the growth prospects of a company, the higher the price goes. They lose that $ for $ of the initial offering.

This appreciation is often measured by the PE (price earnings ratio). The PE ratio is price of the stock divided by the annual projected earnings of a firm. The average PE ratio for the S & P 500 reached 25 in 2018. This means investors were willing to accept the stock being bid up to a price 25 times the annual earnings. In simple terms, it rests on the faith that the company will continue to make and invest earnings wisely over that 25 years.

The real worth of your stocks is more tied to this speculation than to real asset protection. If the company fails, a stockholder might get a small amount of what’s left. However, they must stand behind direct lenders (banks), bond holders and preferred stock holders.

If you own a small number of shares (as most of us do), you have little say over management of the company. Earning may or may not go to grow the company. You have no guarantee that your investment will go for the right purpose.

  

Final Thoughts

There, of course, are many other considerations in stock investing like dividends and the book value of assets per share.

Stocks historically have proved to be a good investment. However, stocks rests on faith in the future and not their initial value or use as investments. 

I am sure I will hear from all my broker and investment advisor friends on this one. However, in these volatile market times, the cautionary stock tale from my long-ago college professor still rings true for me.

David Young