Defenestrating Thoughts from the Bivouac

I’ve been thinking about how to explain stocks to people who don’t know anything about them and I think I’ve come up with something.

Strictly speaking owning a stock is owning a small piece of a company. As a co-owner of the company, you technically get to help decide what the company does. But in reality, since a company like Google has around 315 million shares, and you own on the order of 10′s or 100′s, you don’t get any real power. Occasionally you may get to do something like vote things like who sits on the board.

Some stocks have a regular dividend they pay out. Take Microsoft, they have an annual dividend that’s about 50 cents per share. With the current share price, you’re looking at 2%. Not bad, but you can easily get a CD from 2.5 to 5% without any risk in your capital (after all a stock can lose value, but a CD can’t).

So the “ownership rights” and dividends are essentially worthless. So why do people hold stocks? Because they think they will appreciate.

And why would a stock appreciate? The ownership rights and dividends rarely change. The stock only goes up in value because people think it’s more valuable.

So, in a nutshell, here’s how you explain stocks: “Stocks are just like beanie babies.”

Why? Their value is based on market perception. Take the dot come bubble: everyone thought internet companies were great and their demand drove the price up and up. Then they realized that the internet companies were stupid. So demand fell, and prices fell.

Now, notice that you can replace the words “internet companies” with “beanie babies” and it reads the same. Both dot com companies and beanie babies were stupid in the first place, but popular perception said otherwise.

In the case of dot com companies, they had no business model and were losing tons of money. In the case of beanie babies, they were just stupid stuffed animals.

So, stocks are just like beanie babies. It sounds weird and oddly incorrect, but I can’t figure out why. Maybe it’s just the truth — no matter how uncomfortable it makes you feel. :-)