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The well-known economist, Paul Samuelson and also Eugene Fama, a University of Chicago economist, both held the view that attempting to pick the right stock was up to the Demon of Chance. Samuelson is thought to be among the first to discover, and be influenced by, the work of Louis Bachelier, a French economist, whose work in 1900 indicated that participating in the stock market is a zero-sum game. Samuelson published a paper in the 1960's that formed the basis for the Efficient Market Hypothesis and of the market being a random walk. His work, and that of many others, suggest that “going to the market equals going to the casino”.

During the past half-century, numerous well-known economists developed many theories and models, attempting to pin down the stock market. As a result, stocks are bought and sold today with the aid of computers using sophisticated formulas. Gut instinct plays a minimal role. But in spite of all the years of research by high-powered minds a panacea, or “silver bullet” has not been discovered. Even with all the advancements, it has not been possible to eliminate chance, that is, “risk” from participating in the stock market. Some of the subjects and their developers follow: Dividend Discount Model (John Burr Williams); Capital Asset Pricing Model(William Sharpe, Jack Treynor); Separation Theorem (James Tobin); portfolio diversification (Harry Markowitz); index funds(William Fouse); portfolio insurance (Hayne Leland); arbitrage (Merton Miller, Franco Modigliani); pricing options (Fischer Black, Robert Merton, Myron Scholes).

In all of this sophisticated research, I did not find anyone who asked what the individual investor thought about when he purchased a share of stock. On every business day nearly 4 billion shares of stock trade hands ( 2 billion, NYSE and 2 billion NASDAQ). About 70 percent of shares are held by pension funds, other institutions, and mutual funds. Individual direct share owners now hold only 30 percent of outstanding shares. On a given day a seller of shares may have many reasons for wanting to sell: he may need the funds to pay his child’s college tuition or some other need; he may believe that the dividends being paid are too low; he may believe that the company’s future prospects for success have dimmed; or there may be tax considerations. At the same time there will be someone who will want to buy those shares. The question is, “Why”?

Generally speaking, when a person parts with his money he expects to receive a product, a service, or some other return or benefit. When companies began issuing shares in the 1500's, shareholders expected a percentage of any profits in the form of dividends. Originally, that percentage ran as much as 50%. Today, the buyer may want to buy a company’s shares because it has a consistent record over time of paying dividends at a favorable rate of return. From a practical standpoint this is not likely at present because the dividend yield for the S&P 500 companies is only 1.88%, not as good as CD’s or money market funds. Of the S&P 500 companies 115 or 23% pay no dividends at all. Why would an investor want to buy shares in a company that pays such meager dividends or none at all? He may believe that he actually “owns” a share of that company’s assets, and technically that is correct. In reality, the only way that he would receive a share of company assets is if the company, being completely solvent with no debt, decided to go out of business. More likely, if the company files for bankruptcy creditors have first claim on assets and shareholders get nothing. Often in such cases, class action suits by shareholders are filed against the company. They are usually settled for pennies per share.

If one goes to a casino and uses the machines, tables, or wheels, his success will not be as great as his skill level. The thoughtful gambler knows that the house is rigged against him because casinos are profit making enterprises. Similarly, when participating in the stock market the shareholder is at a disadvantage. During the bull market of the 1920's preceding the ‘29 crash, Ferdinand Pecora, assistant district attorney in New York was the Eliot Spitzer of his day. He exposed fraud and unethical practices among companies and their relationships with banks. Following the crash Pecora was called on to lead Congressional hearings into the inappropriate conduct of companies and banks that preceded the crash. In 1933 Congress passed the Securities Act which required issuance of new securities to be registered with the Federal Trade Commission. As more and more improprieties came to light even more regulation seemed necessary. In 1934 the Securities Exchange Act was passed and a commission was formed to oversea the conduct of companies particularly in respect to the stock market. Pecora was one of the original five commissioners. The charge for the SEC was to see that from that time on the stock market would be clean and trustworthy.

The significant number of companies that used fraudulent accounting and other devious practices during the recent stock market bubble indicated that the SEC failed miserably in upholding its charter. Following the recent crash, once again Congress held hearings and quickly passed Sarbanes-Oxley so that in the future the stock market would be clean and trustworthy. Quick action was required because the investors trust had to be regained! There is already evidence that SOX is not likely to be any more successful than SEC. The recent Refco scandal exposed a loophole in Sarbanes-Oxley. In my view, there is little hope that any amount of regulation can be successful. The reason a free market system is efficient and most beneficial is because the participants are involved for their own self interest and success. Human ingenuity will find ways to circumvent rules and regulations. The Efficient Market Theory states that the share price for a company at any given time represents the “true” value of that company. Don’t believe it!

So what does an investor get for turning over his money for a share of common stock? First of all, he receives a certificate, or more likely, a computer entry that he owns it. It has no intrinsic value. It has value only if someone in the future thinks it has value. That buyer will only think it has value if there has been favorable information made available about that company. In the preceding paragraph I question whether it is possible to know what the information really means. Are price-earnings ratios, and all the other financial measures, relevant?

So what is an investor to do? He has little alternative but to invest in the stock market. It is extremely large and liquid. It is one of few investments where it is possible on almost a moments notice to convert an investment into cash. If the investor is able to find a company that has regularly paid a significant dividend and he buys those shares he knows the return he is receiving. If he invests in any other stock the outcome is so uncertain that he is counting on the Demon of Chance to reward him. He should realize that swings in stock prices are random. (See the study below). (If shares are purchased through mutual funds there is another level of risk because the fund will invest in a way most beneficial to itself.) In whatever way the investor participates, he should acknowledge the risk - - - much like going to the casino.

Bibliography

Bernstein, Peter L. “Capital Ideas”
Bernstein, Peter “Risk at the Roots” www.risk-analysis-center.com
Geisst, Charles R. “Wall Street”
Lowenstein, Roger “Origins of the Crash”
Malkiel, Burton G. “A Random Walk down Wall Street”
Mamis, Justin “The Nature of Risk”
Micklethwaite, J. & Wooldridge, A. “The Company”
Shiller, Robert J. “Risk in the 21st Century”
Smith, B. Mark “A History of the Global Stock Market”
Taleb, Nassim N. “Fooled by Randomness”

Over the years, the role of shareholder has changed greatly. Historically, there is evidence that equities were being used in the Roman Empire in the second century BC. The first organized bourse, or stock market, came into being in Antwerp in the mid 1500's. By the early 1600's Amsterdam replaced Antwerp as the financial capital of Western Europe. In 1609 the Dutch East India Company was formed as a joint-stock company. Joint-stock companies were those where the investors were not partners, or managers, of the company. Dutch East India is regarded as the first example of the modern corporation. In 1819 the UK went on the gold standard. At the time this was widely accepted as such a sound financial decision that world finance shifted toward the UK. London dominated as the financial center during the nineteenth century. Today the financial markets in New York and London are regarded as the most open and sophisticated in the world.

In the early development of stock markets, shareholders were really that. They were almost a partner in the company. It was expected that at least one-half of any profits would be returned to them as dividends. But they also had liability concerns. They were liable for all actions and debts of the company. The liability went so far as to have their personal assets confiscated if needed for settlement. It was only in the latter part of the eighteenth century that the British government began to specify limited liability for shareholders in corporate charters. As mentioned, the primary reason for investors to purchase equities was for dividends. Appreciation in the value of the stock was not much of a concern except for speculators.

To address the question of the meaning of shareholder or shareowner today the words need to be defined. Webster’s dictionary has the following: Share - any one of the equal parts into which the capital stock of a corporation is divided.; Owner - one who has, possesses, or holds as personal property.; Holder - one who owns, possesses, has the duties and privileges of. The key word in both Owner and Holder is the word “possess”. It is defined as: “to gain strong influence or control over”. Clearly, the individual purchasers of shares have no influence or control over anything related to the company whose shares they hold. Except for Bill Gates, Warren Buffett, Kirk Kerkorian, or some others, no one could have enough shares to be listened to by company management. The average company in the S&P 500 has about 400 million shares outstanding. General Electric has 10.6 billion shares. There is no effective shareholder association, or union, covering each company to exert influence on management. Shareholders receive proxy statements that are essentially irrelevant. Making complaints at a shareholder meeting are noise that goes in one ear and out the other. The individual shareholder is no more than a bothersome gnat. Managements give lip service to shareholders but their concern is not sincere. They do care about having their share prices rise, not for the shareholders, but because much of their compensation is tied to their stock price. That shareholders are irrelevant, I need only mention Enron, Worldcom, Tyco, Adelphia, Imclone, Putnam Investments, etc. etc. If shares are owned through mutual funds, and that includes 95 million people, the investor is removed another step further. Two centuries ago Adam Smith warned that managers of other people’s money cannot be expected to watch over it with the same anxious diligence as their own. He also warned of the dangers of separating the management of corporations from ownership.

So what are shareholders or shareowners ? These terms connote average good upstanding citizens who have a long-term horizon and are trying to prepare for their future. They are not speculators. The definition of such are: one who takes part in any risky venture on the chance of making huge profits. Speculators are operating in the stock market: daytraders; purchasers of puts, calls, options, etc. Rather shareholders are investors. Investors: those who put money into businesses, real estate, stocks, bonds, etc. for the purpose of obtaining an income or profit. The terms shareholder and shareowner should be eliminated from the business press because they are misnomers and are misleading. Instead they should be called what they are: investors!

But even with this background, investors have no better alternative but to invest in equities. Historically, they have had the best real returns. Equally important, as in the past, the market is huge and therefore is very liquid. In contrast to real estate, art work, or other fixed wealth, funds can be put in and taken out with ease.