In the last two years, one assertion I’ve heard over and over is that the stock market a giant Ponzi scheme — it only works if everybody continues to feed it money, and it collapses when people take their money out.
A similar assertion is that the stock market is just a “greater fool game,” in which stocks’ only value lies in the hope that you can sell them at a higher price to a greater fool at some point in the future.
Both claims are nonsense.
Stocks Have Inherent Value
If the public at large decided that they wanted nothing to do with stocks, and they all pulled out (and this is, to a lesser extent, what goes on in severe bear markets), stocks wouldn’t become worthless. Yes, they’d be worth less, but not worthless.
For the value of a stock to go to zero, the company itself has to be worthless. As long as a company has intrinsic earning potential, a share of ownership in that company has value as well.
A Worthless, Profitable Company?
For example, imagine if the price of Verizon’s stock declined all the way to $0.01 and that this decline was caused purely by investor panic. That is, it had nothing to do with any fundamental change in the profitability of the company. With a share price of $0.01, the company’s dividend yield (based on its most recent dividend) would be 4750%! Even if the price never went back above $0.01, you could get an obscenely high return from buying at such a low price.
Of course, such a scenario would never occur. The price of a company doesn’t ever go that low unless there’s a fundamental decline in the company’s profitability. At some point, investors would step in to snatch up the high dividend yield, thereby keeping the price from falling further.
Owning, Not Just Selling
Yes, companies’ earning potential can decline, or even go to zero. But it’s not caused by people getting scared.
Unlike a Ponzi scheme or a “greater fool” game, stocks have an inherent value. And they have that value even if there’s no “greater fool” to sell to, and even without investors continually pumping money into the system.
Now, to be fair, stocks do have a ponzi-ish aspect to them, in that their market value does go down when other people pull their money out. But to assert that stocks’ only value lies in their ability to be sold is simply not true. You can receive value by owning stocks, not just by selling them.