Behind the stock price is the value creation of listed companies


Is the stock market a zero-sum game? Yes, you often hear the media and investors refer to the stock market as a zero-sum game, akin to gambling. While this fits the intuitive impression, the analogy is not true in an economic sense.
Zero-sum games are actually a form of game theory. In a two-player zero-sum game, no matter which side wins, the other side loses. In a zero-sum game, one person's gain corresponds to another person's loss, and the total gain for all participants is zero, with no wealth created or destroyed during the transaction.
A zero-sum game may be played by two people, or even millions of people. Some typical examples of zero-sum games are gambling games, such as poker, or other types of games, such as chess, rock-paper-scissors, etc. The derivatives market is a classic example of a zero-sum game where actual currency transactions are involved.
In the derivatives market, if an investor buys an option or futures contract, there must be a seller on the other side. A seller is either a person who sells a long contract or a person who initiates a short position. Regardless of whether the underlying asset rises or falls on the maturity date, there must be a profit on one side and a loss on the other side, and the total gain of the winner will equal the total loss of the loser. If transaction costs such as commissions are taken into account, this would be a negative sum game.
The stock market is often confused with a multi-player zero-sum game because there are many investors in the market and it is assumed that what some investors lose, others gain. In the long run, the stock market is not a zero-sum game, real and actual wealth creation takes place in the stock market.
For example, there is a car manufacturer that buys or manufactures parts and then assembles them into a moving car. Firms set a price that covers inputs (parts and labor) and profit margins, so profits are value added and reflected in rising share prices. Obviously, the production activities of the automobile companies lead to actual wealth creation. As stock prices continue to rise, investors trade on the basis of future expectations. Because the risk tolerance of the participants varies, the person selling the stock is not meant to lose money, they may have made a substantial profit and are willing to cash in the profit. Similarly, buyers may be able to sell further at higher prices and thus make a profit. Here, both buyers and sellers can win.
In addition, as part owners of the company, investors are obligated to share a portion of the company's profits. A dividend is an additional amount paid to the investor as a profit distribution, since the dividend is not dependent on the loss or profit of the previous transaction, and therefore. Having extra net cash flow also makes the stock market a non-zero-sum game.
In the long run, the stock market is a place to invest in corporate growth and economic expansion, the economic "pie" will always get bigger and bigger, and economic crashes and contractions are a very rare event. As companies grow and produce more, their profitability, dividend levels, and future prospects improve, and the overall market cap of the company and the stock market grows, which translates into real wealth creation in the stock market, so it can be a positive-sum game. The position-sum game concept urges investors to research and understand a company's business and invest in companies that will ride the wave of economic growth, while avoiding those that do not create value or even destroy it.
Value creation in the U.S. stock market
The US stock market is the largest capital market in the world, and its development history fully proves that stock market investment is not a zero-sum game. On the contrary, driven by the value creation of a large number of outstanding listed enterprises, the stock market can completely become a positive sum game and an important place for the appreciation of national wealth.
According to the research results of Professor Bessenbinder of Arizona State University, in the 97 years from 1926 to 2022, 28,114 companies have been listed on the US stock market. Together, these companies generated $55.11 trillion in net wealth (the difference between the total value that investors eventually received and the level of return they would have received if they had invested all their initial assets in risk-free Treasury bills). A closer look at the structure of wealth creation in US stocks over time reveals two interesting things:
The first is the "four six" phenomenon. 11,633 companies (41.38% of the total) generated $64.23 trillion in investor wealth over the course of their business life, compared to 16,481 companies (58.62% of the total) whose shareholders saw their investments shrink, totaling $9.11 trillion. It can be seen that even in the US stock market, which has historically maintained a long bull trend, only about 40% of the stock yield exceeds the return of short-term Treasury bonds, and up to 60% of the stock performance is poor, and even the long-term yield is lost to short-term Treasury bonds. Thus, when investors start picking stocks, they are taking on a huge asymmetric risk, with little chance of great returns, but a high chance of losing wealth by picking the wrong stocks.
The second is the "4%" phenomenon. Since 1926, the top 4 percent of publicly traded companies have created nearly all the wealth in the U.S. stock market. This suggests that stock market wealth creation is concentrated in a small number of companies and becomes more concentrated over time. In the period 1926-2016, 90 companies (0.355% of the total) generated 50% of the wealth, 1,094 companies (4.314% of the total) generated 100% of the wealth, and in the period 1926-2022, only 72 companies (0.256% of the total) generated 50% of the wealth. 966 companies (3.436% of the total) generated all the wealth.
Among the stocks that created the most wealth in the past 100 years, Apple created the most wealth with a whopping $2,680 billion, followed by Microsoft with $2,090 billion, and ExxonMobil ranked third with $1,210 billion. Other companies at the top of the list include: Google, Amazon, Berkshire Hathaway and others. On the other hand, Worldcom, notorious for accounting fraud, topped the wealth destruction list, leaving investors with a loss of $102 billion. RIVIAN, an electric car star, was second on the wealth destruction list, destroying $91.6 billion.
The fact that the vast majority of money made in the stock market has long come from a small number of companies that have soared in value has important implications for investing.
First, some star stocks (such as Apple, Google, Microsoft) can rise by thousands or even tens of thousands of percentage points, while losers like WorldCom or Enron can only lose 100% at best, which is the intrinsic reason why the long-term overall return of the US stock market is so high.
Second, driven by the modern information technology revolution, the US stock market has increasingly entered the era of "superstar companies", with a small number of companies such as Google, Amazon and Apple accounting for an increasing proportion of market capitalization and contributing more and more market gains, which provides solid support for the prevalence of index investing.
Value creation and distribution in China's stock market
Compared with the US stock market, the study of the value creation of the Chinese stock market must consider two special factors:
First, the first-day rise of new shares on the Chinese stock market is much higher than that on the US stock market. Between 1990 and 2021, the average first-day rise of new shares on the US stock market is 21%, but the figure is as high as 172%.
Second, compared with the IPO scale, the annual refinancing scale of China's stock market is much higher, and has remained above 1 trillion yuan in recent years, about twice the IPO scale.
Based on these characteristics, the A-share market value creation can be divided into two different stages:
The first is the stage of stock issuance and listing, which mainly includes IPO and secondary issue. Its value creation is mainly manifested by the jump growth of the company's market value in a short period of time.
The second is the stage after the stock listing and circulation, which is the objective reflection of the value creation from the production and operation of the listed company in the growth of the company's market value.
In terms of IPO, the transition from the unlisted state to the listed state greatly increases the company's exposure and significantly enhances the liquidity of shares, which ultimately leads to A significant increase in stock prices in the A-share market environment where "speculation" is always prevalent. If the value creation of new shares in the month is summed up and drawn as A curve, it can be found that the curve is always positive and continues to rise, indicating that the "new" strategy of the A-share market is profitable in almost all periods.
In the aspect of secondary issue, the discount of secondary issue price is an important factor in the value creation of secondary issue. At the same time, additional issuance may also be accompanied by mergers and acquisitions, restructuring, asset injection and other high growth expectations in the future, will also promote the overall value of the company to improve. The value creation curve for the month of secondary offerings is broadly similar to that of new offerings, but slightly lower in volume.
The value creation of shares after they are listed and circulated can be measured by the difference between the total value that investors eventually receive and the level of return they would have received if they had invested all their initial assets in a risk-free deposit account. Since the value creation after listing is mainly determined by the price fluctuations in the secondary market, its trend is relatively similar to that of the broader market. According to statistics, the percentage of months with a positive cumulative value after listing is 46.8%, which explains why investors in the secondary market lose money most of the time.
The author and his collaborators have analyzed the value creation of the Chinese stock market from 1991 to 2019. Over the past 29 years, 3,760 companies have been listed on the A-share market, creating A total value of 25.29 trillion yuan for investors. Among them, the value created by the share listing process was 24.03 trillion yuan, including 18.45 trillion yuan of value created by the IPO process, accounting for 73%, and 5.58 trillion yuan of value created in the process of additional issuance, accounting for 22%. The value created after the listing of shares (in the circulation process from the month after the listing of shares) is 1.26 trillion yuan, accounting for 5%. In the case of transaction costs such as stamp duty and transaction handling fees, secondary market investors get almost zero income from the value creation of listed companies.
At the same time, the profit and loss structure within the investors is also very unbalanced, a small number of institutions and large households use information and capital advantages through the manipulation of stock prices, insider trading and other forms of "cutting leek", aggravated the losses of the majority of small and medium-sized retail investors, the majority of secondary market investors overall "sense of gain" is seriously insufficient.
It can be seen that more than 90% of the value appreciation in the A-share market is completed in the first month of stock listing, overdrawing the growth in the future for A considerable period of time in the short term. The circulation stage of the stock listing from the next month is mainly the continuous digestion and re-realization of the previous valuation. Therefore, if the income obtained by participating in the new and fixed increase is removed, the A-share market is similar to A "zero-sum" game in A sense, and the slow decline after the rapid rise is also one of the important reasons for the "bull short bear long" in the A-share market.
(Shi Donghui is a professor at the Oceanwide School of International Finance, Fudan University)