Wednesday, June 14, 2006

Securitizing yellow-top taxis and workings of the stock market

The stock market is, in its original and actual intention, a place for business owners to "borrow money". The difference is that the borrower, instead of paying interest to the lender, agrees to sell a part of his ownership of the business (i.e. his stock) to the lender. The lender can hope to receive dividends from the borrower when the business do well, or sell his ownership to yet another person.

This ability to transfer ownership from one person to another, for better or for worse, leads to the creation of something that humbles even the most intelligent, Nobel Prize-winning monkeys: the stock market.

To make things simpler, let's try to understand the stock market with an analogy. Imaging a yellow-top taxi driver one day decides to sell his ownership of the taxi to 10 other people. (Yellow-top taxi drivers own their taxis, other drivers rent their taxis from companies like ComfortDelgro, SMRT etc). The 10 new owners can also sell their 10% ownership (i.e. their stock) to other people.

Now imagine another 9 yellow-top taxi drivers do the same, selling 10% of their taxi ownership to 10 people, we have just created a "stock market" for yellow-top taxis with 10 x 10 = 100 investors/traders. Depending on the ability of the different drivers, the stock of some taxis will sell at a higher price than others. Some stocks will fall and some will rise, driven by people's perception of the ability of the different taxi drivers and, well, almost anything else one can think of. Like the no. of monkeys taking taxis, or the weather forecast in Ang Mo Kio, or increase in taxi prices relative to decrease in air-con temperature in shopping centres etc.

So, how would you choose which taxi stock to buy? Based on the driver's ability? Or analysts' forecast of the no. of monkeys taking taxis next week? Or listening to the weather forecast? Or by looking at how the stock have traded in the past hour?

Buying a stock on some positive news hoping to earn a profit in one day or one week completely misses the point. To buy a stock is, in effect, to become the owner of the company (or the taxi). Surely this decision should be based on solid fundamentals of the company (or the driver) and also the stockholder's long-term conviction that the company will continue to perform in the future.

Post a Comment