When I was in my early twenties I got really into poker. I actually got pretty good at it too, problem was even being above the average was a problem. I couldn’t consistently make money. The reason was because money was being drawn out and no real new money was coming in. Poker was in effect a zero sum game.
The stock market is not a zero sum game. Companies are constantly creating value from capital. This value is then dispersed to shareholders in the form of dividends or share buybacks. This efficient capital allocation compounds on itself with innovation and more capital allocation.
There are many cases when investing in the stock market where you may encounter zero sum principles, and that’s why you should stay away from them. But, if you remember you are investing in a company then you can take part in the value creation process.
Investing in the Stock Market is Not a Zero Sum Game
The definition of a zero sum game is you can only win at the expense of someone else. In a closed system like a coin toss only one person can win, while the other loses.
However, the stock market has one main difference and that is time. Over time companies will create more value, or on the flip side less value creating instances where investors will either all lose together, or win together.
When you are investing over the long term you are investing in the continued profits and value creation of companies.
This value can be seen in the innovation of new technologies, creation of machines that can assist in the creation of other machines. The turning of raw materials into goods.
This is why I love market investing so much. I love the thought of owning parts of this production process. This value creation then compounds on itself, which creates a better life for everyone involved.
Just think about a company like Amazon, you can literally get anything you want in two days. If that isn’t providing value than I don’t know what is.
Companies are Pushed Towards Efficiency
Now I know what your thinking, the only reason Amazon is able to do all these amazing things is because they are taking advantage of low cost labor and hurting small businesses.
While this may seem like the case, many of these companies would not exist if it weren’t for the ease of distribution that Amazon offers. Amazon is taking care of the marketing, customer service and distribution. These are all things that would cost small companies a fortune.
Market Situations That are Zero-Sum
By contrast short term investing is more geared towards a zero sum game since nothing has changed in the underlying value of the company except the price.
Other examples of times where the stock market is zero sum.
- Futures.
- Currency trading.
- Day Trading.
- Options trading.
- When a stock is government subsidized.
These are all situations that I would stay away from with the exception of government subsidized stocks. While I don’t agree with them as a form of value creation, they do serve a purpose.
If the government did not help support certain industries, it would leave an economy vulnerable and at the whim of other nations. certain industries need to be subsidized for this reason, however the extent at which it is done all over the world I do not agree with.
Companies That Lose Value But Have No Debt
Companies that begin to lose money because of either excessive debt or poor efficiency pose a problem to long term returns. It also begs the question is if they are losing does that mean other companies are winning at the cost of the loser?
The answer to this question is a resounding no. In fact many companies that are losing value are then forced to find a new route where it can create value or go bankrupt. This leads to more innovation and new technologies, further increasing productivity.
These are the situations that I look for, companies that are often selling below book value and somethings for less than the cash that they have on the balance sheet.
Often times, these companies can actually add value through share buybacks when its below book value. You may be wondering how exactly this ads value to the overall economy, the answer is the cash is more efficient in the hands of the consumer that can then re-allocate the cash towards either buying goods and services or investing in more efficient companies.
The Stock Market is A Vehicle of Efficient Movement of Capital
When people think of trading stocks they think of it being a constant struggle of always trying to sell a stock for a higher price than they bought it for.
Which is the goal don’t get me wrong, but they often forget why the stock market exists in the first place. Its in order for companies or people with great ideas to increase happiness and efficiency go in order to gain access to capital.
This capital then creates a runway for the company to realize those gains. Take Tesla as an example, while the stock valuation may have gotten out of hand the amount of social good the company is trying to achieve is far better than a world without Tesla.
It may also be true that Tesla will crash into the future because of its massive overvaluations and there will be losers as a result, but overall if you look far enough into the future the value will be there.
Some may get disillusioned as they see massive amounts of money evaporate, but they were essentially buying the future, now whether they want to wait around to see it return to them is another question.
Valuations are Never Perfect Because of Human Emotion
Market efficiency is rarely perfect. Not only are there endless reasons why a stock may be undervalued, but human emotion also plays a role. Human emotion may be the main reason why people believe the market is a zero sum game.
When a stock is falling and a company is evaporating money its logical to panic and sell. While it can be hard to stomach that is probably the worst thing an investor can do. Selling at times like that will force a company to make up for that loss in efficiency.
In the case of companies with cash on hand, they can buy back stock in order to take advantage of this newly created inefficiency. This will in turn put cash back into the economy where it can be efficiently distributed to those providing the most value.
Back in My Poker Days
Its very interesting to see the similarities in value creation in poker compared to the stock market. While Poker is in no way a win-win for all players involved there can be value created for those who seek it.
What I mean by this is if you are making a player feel great and have a good time, then he will keep adding money to the table, this in turn will create a situation at the table where more people can benefit.
I’ve seen this at many tables, the tables with the crankiest and meanest people tend to continue to be that way. Then at tables where everyone is having fun there tends to be more cash flowing around on the table.
As a rule of thumb, when investing make sure you are sticking with companies that are creating value and you will reap the rewards in the long term.