I AM NOT AN investment expert. I am befuddled by such things as puts and calls. Who is putting what where?
I do know the difference between stocks and bonds. I know that bond prices go up when interest rates go down, and vice versa, and I eventually figured out why. I also know stock markets are used to raise capital and that shareholders are actually owners of a company, but with little power or influence, especially small individual investors. In addition, I know you can make money in the financial markets in two ways: increases in the price of a stock or bond, and through the payment of dividends or interest.
But then I get to the point where I don’t understand. What the heck is the yield curve and does it matter to me? And don’t even get me started on the VIX.
I have a relative who works in wealth management and we have interesting discussions about my failure to comprehend the difference between the stock market and a Las Vegas casino.
Here’s the thing: I’m told that what drives the price of a stock is earnings. Even outside factors, like the economy and political turmoil, all come down to their impact on earnings. But why do earnings drive the price of a stock? Because growing earnings create more value. Value for who? Shareholders. But how? Because they increase the stock price.
How much does this merry-go-round ride cost?
If I buy a stock that pays dividends, it seems to me that growing earnings should lead to higher dividends. That makes sense since, as an owner, I am supposed to share in the profits. Aren’t I?
But if a stock doesn’t pay a dividend, how do growing earnings create more value, except by people betting on something whose hoped-for higher price will be based on another person’s bet? See, we’re back in Las Vegas: We’re betting that there will always be some player willing to cover my bet with a raise.
Or are we betting that the stock will pay a nice dividend someday? If a company isn’t sharing its earnings with me—the shareholder—why should more supposed value by way of the stock price be created for me? Why should anyone be willing to pay more for the stock? Wait, I know: The company is reinvesting earnings in the business, to grow the business. To what end? Well, so people will pay more for each share.
Oh my! Just send me a dividend check, please. I’m an old retiree in need of an income stream.
Is there anyone else out there as confused and cynical as me? In the meantime, the casino—I mean, stock market—seems to be performing quite well. That’s a good thing, because one way or another most Americans are counting on it, even if they don’t realize it. I know I am. I don’t plan on getting off the merry-go-round. It may fund my next vacation. Want to guess where?
Richard Quinn blogs at QuinnsCommentary.com. Before retiring in 2010, Dick was a compensation and benefits executive. His previous articles include Running in Place, Tortoises Needed, That’s Rich and Sharing the Load. Follow Dick on Twitter @QuinnsComments.