Capitalism 101

I have some stocks. Not many, but I have some. A recent stock price change and the subsequent change in value of my investment made me realize there is something fundamental I don’t understand about capitalism and publicly traded corporations.

An old friend of mine started a company that went public. He’s very clever (like genius level) and based on that, and what little I know about what the company does, but not based on any great financial analysis of the company I decided to buy some shares this past spring following a sudden rapid drop in the share price.

Basically I was buying on (1) a hunch, because I know how smart my friend is; (2) a tiny bit of “Dow theory” – looking at the charts and seeing there have been ups and downs and (3) reading the take on the stock from a few analysts (lots of buy and hold recommendations, no sell recommendations). Even though the P/E ratio was through the roof, I decided to dive in and sold my YUM shares which had been stagnant for years and bought some of my friend’s company’s stock.

After that, to my disappointment the stock dropped rapidly in price again. But I decided to “double down” and bought an equal number of shares as my original purchase, thus substantially lowering my average purchase price. I still had confidence in the stock – based more on instinct than anything else. (My friend himself has never said a word to me about the stock value because nobody wants to get into any messy SEC considerations).

Since then, the stock has had its ups and downs, but all good financial news, and seems to be expanding in its field in an impressive way. Over the last few weeks the stock price has more than recovered, and I am about 10% ahead of my original investment now. So for now I’m pleased and intend to just hold onto the shares for the long run (I’m not the “day trader” type).

So what is it I don’t understand?

Last night I was checking the stock price and thinking, “I’m glad I’m investing in such a company with really good potential.”

Then I thought to myself: Wait a second. How am I investing in the company? The company didn’t get one red cent of my money. I bought the shares traded on the New York Stock Exchange, and they weren’t sold by the company. They were sold, presumably, by some other shareholder who owned them.

In fact, the company never gets any money from their own shares once they are originally sold, do they?

It’s like if I sell an old computer to someone. Apple doesn’t make any more money from the sale. An old item is just being traded around.

So how does this translate into “an investment in the company?”

I can see how the stock price rising can benefit shareholders. And presumably the founders of the company own lots of shares. And if there is ever a company share buyback that can reverse-dilute the share price and make them even more valuable. But it’s not like my purchase of the stock has put any extra investment capital into the company.

So I don’t see how I am investing directly in the company. Somebody invested in the company originally. And the company got a one-time cash infusion then. But all I did was buy their investment. The company didn’t get anything at all out of the transaction. So it’s not like I’m “helping the company” by owning these stocks, is it?

Anyway, it just seemed a bit strange to me when I thought about it this way.