Originally Posted by
newb411breaker19
Is the Stock Market a zero Sum game?
The short answer is yes and no.
The stock market itself is nothing more than an exchange where people trade cash for partial ownership of some conglomeration of capital (you can think of capital as "that which aids in the production of goods or the delivery of services" -- examples of such might include items as diverse as computer hardware or software, farming implements, hammers, office space, mops, microscopes, trademarks, or patents). The amount of cash required to purchase said conglomeration is solely determined through its supply and demand as well as by the infrastructure of the market itself. The stock market is what's known as a
secondary market in that buyers or seller of capital do not transact directly with the company itself (with the exception of share buyback programs) but rather with other members of the public (where a member may be either an individual or a conglomeration of individuals such as hedge funds, mutual funds, or pension funds).
As such the stock market
is a zero sum game. If (agents for) you buy a share of IBM from (agents for) me at $80 on the floor of the New York Stock Exchange and the share price later rises by $1, then you've made $1 and I have lost $1 (of potential profit – this is known as “opportunity cost”). There's
no way to make (or lose) money buying or selling a stock on a secondary exchange without it costing (or benefiting) some one else an equal amount
(putting aside the dead weight loss of commissions and exchange fees).
Now comes the
however. The stock market is not the only place to way to purchase stock. There’s also a mechanism for purchasing stock in the United States (and every country has an equivalent) called the public offering market. Broadly speaking, there are two types of public offerings: initial public offerings (known as IPO’s) and secondary public offerings (which I suppose might be known as SPO’s, although I can’t honestly recall if I’ve ever heard that acronym used). The essential difference between an IPO and an SPO is that the former represents a public offering of a stock which
had not previously been publicly traded while the latter represents a public offering of stock which
had previously been publicly traded. But what exactly is a “public offering”?
The term “public offering” is itself a bit of a misnomer. Public offerings are really not all that public. In general, it’s much harder to purchase stock through a public offering than it is to purchase stock on a stock exchange. I won’t go in to the gory details of how public offerings work either in theory or in practice, but the defining characteristic of all public offerings is that they represent the mechanism by which companies may sell previously unissued shares of stock to (certain elements of) the public.
Now it’s my contention that public offerings in general are
not zero sum games but are in fact
positive sum games. To best explain we first need to get away from the abstraction of a publicly traded corporation and consider a hypothetical company. Typically, when microeconomists discuss hypothetical firms they use the term “widgets” as an abstraction for the generic goods produced. However, because this is a sportsbook review site let’s consider a small bookmaking operation.
When this hypothetical operation first begins the company is just a single person – the owner/operator -- let’s call his Bill. Bill has no equipment and no money. All Bill owns is the shirt on his back and the shoes on his feet (if you like you can also assume Bill owns a pair of pants and some underwear). Because he has no money the only way he can operate is as the agent of another larger bookie. Bill books bets at -109 and then lays them off on the other bookie at -110. Because he doesn’t even own a pen he can only book as many bets as he can remember. He doesn’t make very much money doing but at least he’s able to survive. Now after doing this for several weeks he’s able to sock away enough extra cash to buy a few pens and some paper. (This is an example of “capital”.) After Bill does this he finds he’s able to book significantly more bets per week and increase his profits substantially. Then it further dawn on Bill that he can start making
much more money by buying or renting office space, telephones, computers, software, and by having access to a credit line so that can operate independently of the larger bookmaker. Unfortunately, Bill realizes that it might take him years to generate enough profits to allow him to grow his burgeoning company as he might wish.
So what’s Bill to do? Big dreams but small pockets and all that. So Bill thinks for a while and decides to hit the pavement and find some investors. He tells his potential investors that for every $10 they invest with him they can own 0.01% of the company. (By doing this Bill has implicitly valued the entire concern at $100,000.) Because a lot of people believe in Bill’s business plan and because Bill’s such a top-notch salesperson, he’s quickly able to sell off 10% of his holdings and come up with $10,000 of operating capital.
This is the equivalent of a public offering. If Bill’s company is successful then he’ll be able to generate good returns for his investor while increasing his own profits all because of the equipment he can purchase by virtue of the cash infusion. In short this is a win/win scenario. Bill makes money and the investors make money. Without the investors Bill could not so much money and without Bill the investors couldn’t make money.
So now let’s relate this back to the original concept of a stock market. Remember that Bill’s investors were able to purchase “0.01% of the company” for every $10 they invested. But what exactly does this concept of “owning 0.01% of a company” actually mean? As company operator Bill is certainly entitled to pay himself a fair salary, and as 90% owner Bill is certainly entitled to 90% of profits net of capital expenditures. But what if there are no profits net of capital expenditures? In other words, what if Bill as operator decides to reinvest all the profits back into the company (perhaps establishing or setting up a health plan so as to attract better employees)? If this occurs then Bill’s investors won’t be able to get paid. Certainly, the value of their holdings within the company might well increase but if they themselves were concerned about liquidity they would be unable to extract any cash from their investment and potentially unable to pay their own bills or fund what they might consider ultimately a superior investment. But enter the stock exchange. If Bill’s stock were publicly traded then any of Bill’s investors could sell his ownership in the company at the secondary market
even if Bill could neither pay out dividends nor could he repurchase his company shares.
So therein lies the interplay. The very
existence of stock exchanges make it easier for companies to raise money from the public. Companies don’t raise money
on stock exchanges but the exchanges do give potential investors the security of knowing that they can readily translate their ownership in a company into hard currency if the need should ever arise. This security translates into greater in fundraising. Ask yourself this question: With whom would you rather invest money -- a company from which you can only cash out your investment on their terms, or a company from which you can cash out your investment at any time any without any interference?
So is a stock market a zero sum game? Yes and no.
Yes, it is a zero sum game insofar as an exchange devoid of any new issues does not present any opportunities for market participants to generate income in excess of that lost by other market participants.
And no, it’s not a zero sum game in that stock markets allow corporations the opportunity to more easily raise capital from the public. And, as lakerfan writes, if these companies can use this capital to create value, then ultimately everyone wins.
Sports betting v. Playing the stock market
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