Thursday, November 20, 2008

Zero Sum Game : Debate Continues

My last blog on stock market was commented to remind me of the fundamentals of capitalism and that I was drifting to the dark side. Further I was reminded of the following


Stocks on the other hand represent ownership in a company. Value is created as the company's value increases. Yes there are speculative runs on stocks that are not based on the underlying company value, but they are always corrected. In the end the value of the company is reflected in the value of the stock. By investing in the company you are providing much needed capital to increase productivity and create more value.


Well stocks represent ownership. Correct! Organizations create value.  Correct! Stock market prices these organizations values. Correct! However the very fact that pricing the true value or judging the potential value becomes an issue. yes the market pundits say that the collective group wisdom establishes the right market price. Without getting into a debate on that the stock market in this process creates two parties. The first party who anticipates that the stock is over priced and the other who thinks otherwise. Subsequent to the initial IPO (for the most part), the subsequent trades and transactions are based on continuous betting on the potential movement of the stock market value. And there starts the zero sum game. Stock markets are definitely a mechanism to create a market of willing investors for the initial offering (may that's where it creates a value for the organization). However at that time and subsequent to the initial IPO event  the average investor is not aware of the information to adequately price a stock and subsequently follows biased set of information to make ill conceived decisions. I am sure that the market correction in the recent months (Dow now sitting below 7500) makes every one reassess that the theory of acceptable multiples of P/E. Regardless the average player in this market is definitely playing with odds stack against him or her and more than likely is working against a similarly handicapped investor on the other side.

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