Name a financial arrangement/system where current investors’ profits are dependent on cash from new investors.
If you said a Ponzi scheme, you would be correct, but if you said publicly traded stocks, you would also be correct.
Before I explain why stocks are a Ponzi, let me first make a distinction. I’m not saying all stocks are Ponzis, just the ones that perpetually don’t pay dividends. Why? Because there are two ways investors can make money in stocks. One is from dividends, and the other is through capital gains by selling the stock in the future for more than the purchase price.
If a company doesn’t pay dividends, the only way their investors can profit is from new investors willing to pay a higher price – sounds like a Ponzi scheme.
Companies that don’t pay dividends haven’t established a history of consistent profitability and frankly don’t have the confidence to make the dividend payments. Their stock prices rise and fall at the whim of investors.
Dividend-paying stocks, on the other hand, are not Ponzis because the companies paying them are legitimate businesses with a history of profitability. Their stock has an intrinsic value independent of the market price of the stock. In other words, the investor will still receive their dividends as long as they hold the stock no matter what the price is on the stock market.
Dividend stocks are rooted in profitable enterprises capable of paying those dividends. Delta Airlines, Intel, Walmart, Apple, and Coca Cola are examples of companies that pay dividends. They are all long-running businesses and have a history of profitability. Dividend-paying companies pay their investors from profits.
Dividend-less companies do not pay investors at all. Investors must rely on the greater fool theory to make money with these stocks – making them speculators – buying and trading in the hopes of picking up a bargain from one fool and turning it around and selling it for a profit to a greater fool down the road. This makes for a volatile stock market.
Because a substantial amount of the market capitalization of the stock market is not rooted in sound financial principles, but on speculation, the wealth in the stock market is “phantom wealth.” Investors are continually chasing the next Facebook and Amazon, frequently buying and dumping stocks in pursuit of the next best thing – usually a company that has never been profitable. I’m looking at you Snap, Inc.
Here’s a prime example of phantom wealth. Uber’s market cap currently sits around $56 billion, but it has yet to turn a profit and has no prospect of turning one any time soon. That market cap is based on hopes and dreams, and in a market downturn, those hopes and dreams will be dashed. This is the reason the market cap of the stock market vaporized during the last Financial Crisis, and it will do it again during the next financial crisis. It’s because cash is king during a financial crisis and investors in non-dividend paying stocks will be happy to unload mystical rainbows and unicorns for cold hard cash even if it’s for a lot less cash than they initially paid for the stock.
That’s why the Ponzi nature of stocks make the stock market dangerous and volatile.
The problem with the stock market is that dividend-less stocks are the ones that get all the attention. Dividend-paying companies are usually older and involved in unsexy businesses. The whole buy low/sell high gamble is the only game that’s talked about on Fox Business, CNBC, financial news networks, and is also the focus of a lot of financial analysis and research. The rise and fall of stocks are all these financial news sources talk about because they think that’s all investors want to hear.
It’s a fact that dividend-paying stocks are hit less hard than other stocks during downturns because of the intrinsic value of the dividend stream. However, dividend stocks are not entirely immune to distress. Even during the most significant crises, like the last one, some dividend-paying companies scaled back their dividends or suspended them altogether. My point is, the stock market is volatile, and much of its “wealth” (i.e., market cap) is phantom and can come and go in an instant.
Nothing’s really safe in the stock market in a downturn.
So why invest in something rooted in a shaky foundation? Investors like dividends for the fixed-type income they provide, so why not consider another type of investment offering consistent, periodic income distributions rooted in an established industry that is not tied to stock market volatility?
It’s not sexy or new or the next best thing, but why not consider an alternative investment like real estate?
Ultra-high-net-worth investors (“UHNWIs”) are always prepared for recessions. That’s because the vast majority of their investable assets aren’t tied to the stock market. They prefer alternative investments like real estate that offer consistent income distributions, are asset-backed, and resistant to market downturns. UHNWIs have long allocated more than 10% of their investable assets in commercial real estate for these reasons.
Some segments, such as affordable housing, are not only resistant to downturns, but actually thrive in them.
With the passage of the JOBS Act, secure, alternative investments are no longer exclusive to the wealthy. They are readily accessible to more qualified investors than ever before. There’s no excuse for serious investors not to break the vicious cycle of the Wall Street Ponzi and invest in something tangible and volatility-free like commercial real estate.