Thinking out of the box about corporate finances

Machine Design, Editorial Comment
March 22, 2001

In fact, my thinking is so far out of the box it might be off the planet. If it is, blame The Wall Street Journal. I enjoy reading that publication, but I may have overdosed on it. Specifically, I have developed a severe distaste for the mindset that permeates some of its articles. Many of the sources and people who are quoted project attitudes of an unconscionably avaricious nature, and perhaps that explains my backlash against conventional financial thinking.

For openers, The Journal frequently quotes CEOs who say their main mission in life is to increase the price of their stock. But these guys have the cart before the horse. Unless a firm is on the verge of bankruptcy, the overriding mission of every CEO should be to put out attractive products at competitive prices. The rest -- satisfied customers, hefty profits and, finally, an increase in stock price -- are supposed to follow in that order.

Reporters at The Journal also assume everyone plays the market like a drunk at a roulette table. Some of us don't, so we didn't have to gnash our teeth when the Nasdaq dropped 39% last year. I don't have any money in the Nasdaq, and I rather enjoyed seeing the New Economy speculators get their heads handed to them. In fact, most stocks in general are still overpriced by any rational standard of evaluation.

So how much should a stock cost? Well, as a kid, I was taught that people buy stocks because stock dividends are supposed to pay more than interest on a savings account. And the reason dividends are supposed to pay more than bank interest is that the price of a stock can fall as well as rise. Currently, it is easy to get more than 5% interest from a bank, so a stock priced at $100 per share should pay no less than $6.00 in annual dividends. But few of them do. If by magic corporations were able to pay out all earnings as dividends (and they aren't), you would get only a 4% return from all stocks in the S&P 500 taken collectively.

Now let's turn to the problem of investors being disappointed and stocks falling when corporations issue earnings forecasts saying they will not hit their profit projections. There is a simple way to avoid all the anguish this causes. Just make it illegal to issue an earnings forecast. Of course, when a quarter ends and earnings prove to be disappointing, the price of a stock will still fall. But at least there won't be all the hyperventilating before the fact.

Also, there is the matter of the "wealth effect" generated by the stock market. Some people think the nation is wealthier when stocks rise and poorer when stocks fall. In truth, the stock market neither generates nor destroys wealth. It is a zero-sum game. Nobody can make a dollar in the stock market unless someone loses a dollar, and for every dollar lost, somebody makes a dollar. This is explained by what is called the Greater Fool Theory.

Finally, sophisticated investors tell me I could earn a higher income if I took time to learn more about the stock market. But I tell them there is a rule anybody can apply to save themselves the trouble. When money becomes that important, stop spending it.