I love when people say that putting money in stock market is like gambling. It’s amusing when you know the person in front has very little knowledge about what he is talking about and yet there is so much confidence and conviction. That is way it is rightly said "Little knowledge is dangerous". Well I will present before you the truest picture and it will be up to you to go ahead or drop the idea.
We start with an analogy.
Let’s look at the game of poker. What can be a better example of gambling than poker? I won’t go into trivialities of the game and probability and all the deep stuff. All I will touch is that the fact is poker is a Zero sum game. By Zero sum game I mean that whatever someone wins, someone somewhere loses. So it is a pure competition. Either you are a sucker or either you are a winner. So if a poker game begins where there are 8 players with 1000 each. So there is 8000 rupees on the table. That means there is 8000 rupees to be lost and 8000 to be won. So far it is good. Now let’s introduce a game and we call it “magic poker”. In this game we introduce a magical rule. There will be a magical pot in the centre which will create money somehow and that will be distributed in each round which is played. So say 100 rupees is created in each round. If 40 rounds are played we get 4000 more. One more thing to notice is that this money goes into the center pool where bets are placed. If you are not playing the game and taking the risk, you can’t lay your hands on this created money. Savvy. In this magical wonderful game the longer you stay (i.e. more rounds are played) the more money is created and you can walk out with more of it. There will be 12000 to be won and 8000 of people’s money to be lost. Clearly this is not a zero sum game because there can be a scenario where everyone is a winner. But you will always win more than you lose in the long term. Yeah I know you certainly want to play a game like this. Sadly this type of game doesn’t exist. But that is what most people think, but if you have read my past 3 money posts, you must have figured out what I am talking. This is why I laid so much stress to explain how money is created. Because when I will tell you Stock Market is kind of a magic poker game you won’t raise the eyebrow and shout “Hey! Money is never created”.
Now the question arises how stock market has a central money creation pot. Answer is The Companies. I don’t know that someone has told you this or not but the Companies create money more than anything else. All the companies together form that magical pot which creates the money. The amount of money created is profit which the companies earn. Gross profit or net profit? Answer is somewhere between them. You cannot calculate depreciation of the infrastructure used to produce. So you cannot find the exact figure because depreciation is always estimated based on theory. (We will talk more about this as we go on, role of debt creation, banking and all but right know this is all you need to know). Now another question how this money created in random manner comes back to the central table where bets are placed? Now that is the right question and answer is Savings, Investment and Dividends. A company can do these 3 major things with their profit.
First they can save and put that money in banks. These banks can invest this money back in the stock market(Or the central pool at table of magic poker) and at the same time issue loans equivalent to this amount to people, earning interest from it and returns from the stock market at the same time. (That’s why I love banking stocks).
Secondly, company re-invests this money into Greenfield projects which creates demand for jobs and products. The people earning through these projects save their money in banks, mutual funds, insurance companies, real estate and these in turn invest that money into stock market. You can see real estate and stock market are competitors in drawing the money from people and have their own cycles. We will see that later.
Thirdly, dividends are distributed to people who save those in banks or reinvest in stock market. Thus again the money is driven to stock market.
One important thing you will see that the money saved goes into the stock market. But what about the money spent. Money spending also has a very important role. When this created money is spent on different products, this increases the demand for the companies that are producing it. This additional demand ensures that the profit growth is there so that there is more money created the next year. If this money is not spent through investment and spending on buying products, there will be no profit growth and magical compounding effect will not take place. So you see the role of spending is also very important for the sustainability of the companies that comprises of stock market.
We start with an analogy.
Let’s look at the game of poker. What can be a better example of gambling than poker? I won’t go into trivialities of the game and probability and all the deep stuff. All I will touch is that the fact is poker is a Zero sum game. By Zero sum game I mean that whatever someone wins, someone somewhere loses. So it is a pure competition. Either you are a sucker or either you are a winner. So if a poker game begins where there are 8 players with 1000 each. So there is 8000 rupees on the table. That means there is 8000 rupees to be lost and 8000 to be won. So far it is good. Now let’s introduce a game and we call it “magic poker”. In this game we introduce a magical rule. There will be a magical pot in the centre which will create money somehow and that will be distributed in each round which is played. So say 100 rupees is created in each round. If 40 rounds are played we get 4000 more. One more thing to notice is that this money goes into the center pool where bets are placed. If you are not playing the game and taking the risk, you can’t lay your hands on this created money. Savvy. In this magical wonderful game the longer you stay (i.e. more rounds are played) the more money is created and you can walk out with more of it. There will be 12000 to be won and 8000 of people’s money to be lost. Clearly this is not a zero sum game because there can be a scenario where everyone is a winner. But you will always win more than you lose in the long term. Yeah I know you certainly want to play a game like this. Sadly this type of game doesn’t exist. But that is what most people think, but if you have read my past 3 money posts, you must have figured out what I am talking. This is why I laid so much stress to explain how money is created. Because when I will tell you Stock Market is kind of a magic poker game you won’t raise the eyebrow and shout “Hey! Money is never created”.
Now the question arises how stock market has a central money creation pot. Answer is The Companies. I don’t know that someone has told you this or not but the Companies create money more than anything else. All the companies together form that magical pot which creates the money. The amount of money created is profit which the companies earn. Gross profit or net profit? Answer is somewhere between them. You cannot calculate depreciation of the infrastructure used to produce. So you cannot find the exact figure because depreciation is always estimated based on theory. (We will talk more about this as we go on, role of debt creation, banking and all but right know this is all you need to know). Now another question how this money created in random manner comes back to the central table where bets are placed? Now that is the right question and answer is Savings, Investment and Dividends. A company can do these 3 major things with their profit.
First they can save and put that money in banks. These banks can invest this money back in the stock market(Or the central pool at table of magic poker) and at the same time issue loans equivalent to this amount to people, earning interest from it and returns from the stock market at the same time. (That’s why I love banking stocks).
Secondly, company re-invests this money into Greenfield projects which creates demand for jobs and products. The people earning through these projects save their money in banks, mutual funds, insurance companies, real estate and these in turn invest that money into stock market. You can see real estate and stock market are competitors in drawing the money from people and have their own cycles. We will see that later.
Thirdly, dividends are distributed to people who save those in banks or reinvest in stock market. Thus again the money is driven to stock market.
One important thing you will see that the money saved goes into the stock market. But what about the money spent. Money spending also has a very important role. When this created money is spent on different products, this increases the demand for the companies that are producing it. This additional demand ensures that the profit growth is there so that there is more money created the next year. If this money is not spent through investment and spending on buying products, there will be no profit growth and magical compounding effect will not take place. So you see the role of spending is also very important for the sustainability of the companies that comprises of stock market.
In short the profits (money creation) are life blood of Stock Markets. To be continued……
I hope it was useful. Any questions are most welcome.
I hope it was useful. Any questions are most welcome.
1 comment:
sir, please come back and write more....
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