The stock market is fake

I slowly began to wonder how investing in a socially responsible manner actually helps the world. Seems an obvious question, right? I can't answer it. I keep putting money into an alternative energy ETF, because that seems better for the world than investing in a mutual fund that will invariably include Wal-Mart and Exxon Mobil. Why would I want to invest in them?

Here's where language tricked me. Most of the time, I, sitting at home, have no opportunity whatsoever to invest in a company. There is really no such thing as investing in Vestas Wind Systems or in Wal-Mart.

The relevant question here is, "What is stock?" Most sources will slyly answer that a share of stock is part ownership of a company, equal to the reciprocal of the number of shares. This is surely theoretically true, and much of our financial and tax system is based on it. But poke at this answer a little. What does it really mean? And most importantly for our purposes, how does my part ownership of Vestas Wind Systems affect that company?

Sometimes private companies, in an attempt to raise capital, will want to sell off a percentage of ownership in the company. They divide this percentage into discrete units of ownership, called shares. They publicize a pending sale of these shares and jump through many regulatory hoops. Then the big day comes for the Initial Public Offering. The share price starts low so as to attract interest. Then it rises, and rises, and rises, and then falls, and then levels off.

After the IPO, the company no longer owns the shares. The shares at this point are bits of paper -- or not even that -- that float around from investor to investor. When you buy stock in Vestas, you're buying it from another investor. Nothing, of course, goes to the company. The same number of windmills will continue to be built. They won't have any extra money for advertising. All that money comes from their earnings, not a cent from stock (except for the initial public offering).

Divesting from Wal-Mart might send the stock price down a tiny tiny bit, but it won't affect the company's earnings. Those are affected only by the consumer market, not the stock market. And the company's ability to pay back loans (and therefore its ability to borrow) is based on how much money they have in the bank -- earnings. Not stocks. Their ability to destroy another community by placing a SuperCenter outside the city limits -- earnings.

There is no such real, tangible thing as owning a part of a company. It's far more accurate to say you're investing in a company's stock, a largely disconnected piece of a company that passes around cyberspace at a price based on predictions of a future price. Earnings affect share price only because people think they do; there's no real connection there. The same thing is true of P/E ratios, Beta numbers, and every single one of those opaque figures that confuse us into believing that the stock market is more than a collective hallucination.

So why invest in Vestas? I'm going to think about it some more, but at the moment I think it's a worthless thing to do. Better to invest in a manner so as to make as much money as possible, and after 20 years buy a windmill.

In fact, it's best to invest in the companies with the absolute worst practices (social, environmental, labor), and become an "activist shareholder." Show up at shareholder meetings and introduce resolutions to improve the company's business practices. Gather enough shareholder support and you actually can do some good. There are coalitions already trying to do this; we have only to join them. This is true socially responsible investing.

Objections:

But what about an IPO? Then you're actually providing capital to the green-friendly business. That's true. But "retail investors" such as myself do not have an opportunity to purchase an IPO. These shares sell very fast, and the only ones who can buy the IPO directly from the company at the IPO price are the "underwriters" of the IPO, the institutional investors who worked on the offering. Once these brokers own the shares, the shares are already estranged from the issuing company.

Don't stocks have an intrinsic or true price value? Sometimes they may deviate from that value (which makes it a good time to buy or sell), but they're based mostly on the true worth of the company -- divide the company's true worth by the number of shares, and you'll have a good idea of what a share should or will be worth. And you'll hear just as often that the worth of the company is determined by the worth of a share, multiplied by the number of shares. It's circular. There's no anchor. A share price is only based on what people think it should cost. Whether in shareholders' minds they're basing their valuation on assets, revenue, P/E, Morningstar ratings, President Bush's gaffe frequency, perception of "true value", whatever -- there's no reason it should or would reflect any of those things. But because so many people invest on the basis of P/E ratios especially, you can bet that a rising P/E will cause a stock price to fall.

But doesn't the stock price multiplied by the number of stocks determine a company's worth? Isn't that important? It's circular, as I discussed above. But yes, when it comes time for this company I've invested in to sell itself or to merge, its share price is a large determinant in how many shares of the purchasing/merging company I'll get. This is still trading shares for shares, and I'll own new slips of paper that are just as intrinsically worthless as the ones I owned before.

What about dividends? If the company is paying part of its earnings back out to investors, than owning a share of stock has definite, quantifiable value. Less than you'd think. First, most companies don't pay out dividends. Second, the dividend payout (from a company that does pay one) is considerably less than a simple U.S. Treasury bond. Third, dividends are fixed and regular; that is, they do not reflect a company's earnings. Therefore, dividends don't change the fact that speculation about a company's earnings potential should not logically affect stock price.

How is this different from a dollar bill? Since we abandoned the gold standard, a dollar bill has no fixed worth. You just haven't accepted that concept for stocks like you have for money itself. The whole monetary system has no anchor! It's different. One: the value of a dollar is based on quantifiable things for logical reasons -- most notably, the ratio of imports to exports with any other given currency, a country's bond rates, and a country's debt. You can draw economic graphs that show why this makes sense. And when a central bank tries to manipulate an exchange rate to be out of tune with these factors, it has tangible consequences. The collapse of the Bretton Woods exchange system in 1973 is an example. Our diplomatic dispute with China over undervaluation of their currency is another. Two: there is no expectation that a dollar waiting in my wallet is doing anything philanthropic for the world. We socially responsible investors feel we're doing something good by investing in Vestas. We're not.

Who cares? It might not be as logical as you'd like, but the stock market works. It makes money. Why should I care whether it makes sense? You probably shouldn't.