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From a friend who is a client:
Here are a couple of things I have been pondering.
- Market capitalization is pretty fictitious. It assumes that all the shares of a company are worth the price at which the last block sold. However, if you tried to sell all of the shares of a large company (hypothetically), the price would drop to almost zero.
- It seems to me the primary reason the stock market goes up over time is because the money supply increases. To put it another way, if the money supply did not increase the stock market could only increase in value by increasing the % percentage of the money supply spent on stocks, which is obviously limited.
My views here might be somewhat naive. Comments/criticism/feedback welcome.
Dear Friend,
Ben Graham used to talk about the stock market being a cross between a voting machine and a weighing machine. On any given day, economic actors vote by buying and selling shares, and in the short run, the trades happen at the levels dictated by whether the buyers or sellers are more aggressive. That is the voting machine of the market. In the short run, values can be pretty senseless if one side or the other decides to be aggressive in their buying or selling.
What arrests the behavior of the voting machine is the weighing machine. The price of a stock can't get too low, or it will get taken over by a competitor, a private equity firm, a conglomerate, etc. The price of a stock can't get too high, or valuation-sensitive investors will sell to buy cheaper shares of firms with better prospects. Also, corporate management will begin thinking of how they could buy up other firms, using their stock as a currency.
I've written more on this topic at the article The Stock Price Matters, Regardless. Within a certain range, the market capitalization of a company is arbitrary. Outside the range of reasonableness, financial forces take over to push the valuation to be more in line with the fundamentals of the company.