Do you have any idea what happens to your money that you have lost on a stock? Say, if you purchased ABC Ltd for Rs.2,000 and sold it for Rs.1,500, you lost Rs.500. It may feel like that money went to someone else, but it didn’t go to the person buying the stock; ABC Ltd didn’t get it and your broker also didn’t get it. Then, where did the money go?
It actually disappeared into thin air, along with the decrease in demand for the stock, or, more specifically, the decrease in investors’ favorable perception of it. This capacity of money to dissolve into the unknown demonstrates the complex and somewhat contradictory nature of money. Money is a teaser, at one end intangible, flirting with our dreams and fantasies, and at the other end tangible, the thing with which we satisfy our needs and luxuries. More precisely, this duplicity of money represents the two parts that make up a stock’s market value: the implicit and explicit value.
On the one hand, money can be created or dissolved with the change in a stock’s implicit value, which is determined by the personal perceptions and research of investors and analysts. For example, a pharmaceutical company holding a patent for the cure of a so-far incurable disease may have a much higher implicit value than that of a finance company. Depending on investors’ perceptions and expectations of the stock, implicit value is based on revenues and earnings forecasts. If the implicit value undergoes a change, which really is generated by abstract things like faith and emotion, the stock price follows. A decrease in implicit value, for instance, leaves the owners of the stock with a loss because their asset is now worth less than its original price. Again, no one else necessarily received the money; it has been lost to investors’ perceptions.
Money also represents explicit value, which is the concrete worth of a company. Explicit value is calculated by subtracting liabilities from assets. This represents the amount of money that would be left over if a company were to sell all of its assets at fair market value and then pay off all its liabilities. Without explicit value, implicit value would not exist: investors’ interpretation of how well a company will make use of its explicit value is the force behind implicit value.
A company’s explicit value doesn’t really change on a day-to-day basis, but a stock’s implicit value changes frequently throughout the day. A drop of Rs.100 in a stock is equivalent to losing a significant amount in (implicit) value. Because a company has a significant amount in concrete assets, we know that the change occurs not in explicit value, so the idea of money disappearing into thin air ironically becomes much more “tangible.” In essence, what’s happening is that investors are declaring that their “value” for the company has been lowered. Investors are therefore not willing to pay as much for the stock as they were before.
So, faith and expectations can translate into cold hard cash, but only because of something very real: the capacity of a company to create something, whether it is a product people can use or a service people need. The better a company is at creating something, the higher the company’s earnings will be and the more faith investors will have in the company.
Now you know what happens when you lose in the markets: Its not that someone else gained, your money simply disappeared!
Milan is a veteran stock market investor and educator on equity investing. Connect with him on firstname.lastname@example.org