On Tue, 9 Aug 2005, Alex wrote:
> Something I've never been able to figure out is how stocks prices are
> supposed to be related to the performance of the company. The only
> explanation I've heard that makes any sense is that stocks are essentially
> claims on future dividends and hence their value is the discounted value
> of those future dividends. It seems to me that there are several problems
> with this explanation. First, many companies pay no dividends and have no
> announced plan to do so.
I think the problem is that you're thinking dividends where you should be thinking earnings, as in the price/earnings ratios.
Earnings can be paid out in dividends or invested in the company, in which case they represent capital growth. On the face of it, it seems to make perfect sense to say the growth in the value of your stock is proportional to the growth in the value of what you own (the piece of the company represented by the stock) plus the direct payments to you. A no dividend situation presents no real problem theoretically -- if a company is earning but not paying dividends it must by definition have grown by precisely the amount they didn't pay out.
Of course, the assumed proportion between the rate of growth earnings and price assumes that the base price is correct. And supposedly the rightsness of that can be appraised independently by looking at the ratio of the market capitalization to the value of the underlying assets.
In theory it seems to make sense. In the reality the basic valuations and the P/E proportion that is considered reasonable both seem to be set by crowd behavior.
Michael