50% of my own company Stromberg Ltd is for sale for £500,000. Any takers, please give me a call.
After a young person I know almost put a fair chunk their money into GameStop (well after the initial price rise). I realised that some young people have not got a clue about what shares are or how stock markets work.
I thought I might share some advice and thoughts on shares and share trading.
It seems that people believe 'shares' are a game and that somehow gamification of shares can create value. However, shares in reality are (or at least should be) tangible assets and value. This post is aimed at the 'gamer generation of millennial investors'.
Share value is based on the current value or future value of the company. Pretty much, this value is profitability or future potential to make a profit.
To understand shares I will start with a very simple analogy, my own companies. I am the director of two companies and I hold 50% of one company and 33% of another company. So why do I hold shares? A share entitles me to a percentage of the company value. For small companies like mine what this means is, if I make a profit I am entitled to a dividend from those profits. In the simplest terms if I make an after-tax profit of £20,000 then with a 50% share I could take a dividend of £10,000 (subject to taxes) if all profits are paid out as a dividend. In actuality, the dividend depends on my company strategy. I might choose to reinvest some of those profits into developing the business or I may choose to pay a lower dividend to maintain cash in the business to ensure liquidity and cover future costs in the event of a downturn.
Lesson number 1. Share value is based on the ability to make a profit. Ultimately share value reflects confidence in the ability to make a profit.
I can choose to sell some of the shares in my company to someone else, or ask someone to invest in return for a share of the business. How much someone is prepared to pay me depends on the buyer's belief in my ability to make a profit, now or in the future. Now publically traded shares (or stocks) are similar, except anyone can go to the market to buy a share. How they get onto the market is simple, a company 'floats' the business publically, and uses the process to sell a number of shares in their company to raise money. That money is usually used to invest in the business for future growth. It also allows people who took the risk to set up the business to realize some value from their hard work.
However, in general terms, a floatation will only be successful if you have a convincing business plan that sets out how you can grow the size and profits of your business.
Lesson 2. Publically traded shares value businesses based on their ability to make profits and pay dividends, or their future potential to grow profits, or a bit of both.
Of course, a companies business plan may be flawed. It carries risk and a company may not do as well as it forecast or even fail. In which case the value of a share in a company may fall. Generally, people buy shares either because it offers a steady income on the dividends it pays from profits (a bit like rent from a house you own and rent out) or because people believe that the company will grow. For publicly traded stocks, you can buy them or sell them at any time, how much they are worth depends on investor confidence in the ability to make profits now or in the future.
If a company is not profitable, eventually it will run out of money, will not be able to pay its debts and will run out of cash. In this case, the shares are worthless. A share in a company that is unable to make profits now or in the future is worth nothing.
Lesson 3. If you continue to hold shares in a business that fails, you will lose whatever value you invested in those shares.
Now to GameStop. Gamestop was and still is a failing company. It has lost money for the last two years In 2019 is lost $750 million. It is likely to have lost millions more in 2020. If this continues a share in GameStop are worth nothing. If it goes bankrupt, the shareholders who hold the risk lose whatever they invested.
Lesson 4. Whoever holds the shares when a company fails, loses the value of those shares.
In the case of GameStop the value $350 a share completely overvalues the company by a factor of about 25, why, because today it is not a profitable business. At some point, the bubble bursts and whoever holds the shares will lose money. There are two perverse outcomes of this speculative bubble.
(1) The company can sell more shares at a vastly inflated price and take that money and reinvest it in the failing company. Unless the business model has changed, this is really just like burning money. It will stave of failure for a period, but eventually, the company will fail having wasted a bunch more money, mostly from people who have unwisely invested and hold the stock.
(2) The managers and directors who run the company will usually hold stock while they are running a failing company. They will sell their stock at a vastly inflated price and become very rich very quickly. They essentially get rewarded for running a failing business. Right now managers, directors and owners of failing companies are mightly relieved to get rich from their own failure to run a successful business.
Right now managers, directors and owners of failing companies are mightly relieved to get rich from their own failure to run a successful business.
Investing in GameStop you are rewarding people for failure. The outcome will be the same the company will fail, someone somewhere will lose money, but the directors get rich.
There are rules that are designed to protect investors. This because there are many investors who hold shares through things like pension funds, but do not monitor stock and shares or understand fully how their money is invested by the pension fund. The rules are designed to prevent market collusion where people try and distort the market for personal gain. essentially it is a fraud. Look at this way if I tell you lies about my business to get you to give me money for a share in my company, that is a fraud. Manipulating the market based on false value is illegal. The reason is that there are millions of people vested in stocks and shares through pension funds. Those people deserve some protections for there many years of saving. Technically if you take part in actions to knowingly distort the market and create false value, this is a crime in most countries with a large stock exchange.
Technically if you take part in actions or collusion to knowingly distort the market and create false value, this is a crime.
This is not about protecting the 'big investors' or the 'wolf of wall street' but protecting the trillions of dollars held by small investors in savings and pensions.
Your actions could rob a pensioner of their income when they need it most. Every failure of a publically traded business has casualties.
Lesson 5: Where there is no value, THERE IS NO VALUE. Everything unwinds in the end.
Finally, I am offering 50% of my company for £500,000. Any takers. No? So why then are you giving your money to GameStop, I am much more profitable than GameStop.
Just for information, my business made £20,000 profit in 2020 (£20,000 more than Gamestop) so £500,000 seems like a fair price to me based on current market conditions