Casino Capitalism

Stock Buybacks: Another Sign of Casino Capitalism

I was intrigued today by press release from PWER (a stock I wrote about during the financial crisis) about their initiation of a stock buy back program.

Of course, stock buyback programs never work to actually increase shareholder value, since they merely shift money from the company to selling shareholders, whoever they may be. No value is created whatsoever. Quite simply, the company has less money, but now owns more shares, and reduces the total shares outstanding. For all intents and purposes, ignoring the specious "lower share count" argument, with a stock buyback the company is simply betting its capital on the share price. And when the company is not betting on the stock price, it's simply buying back stock from employees that are exercising cheap options (this is what stock buybacks are used for at most large tech companies).

Assuming the buyback is not for option dilution issues (and a buyback because of options is really simply a form of corporate theft - employees should buy and sell stock at regular market prices like everyone else), can one imagine a more silly corporate decision than a stock buyback? You successfully build up a business and the company is flush with cash. What do you do? Go out and gamble it on the stock price!

A better use of cash is to hire more employees and develop additional products and services. And if you can't find any growth areas, then simply put the cash in a safe security. A dividend would also, in theory, be a good idea, but our tax code is inimical to such a basic investment positive such as a dividend.

Federal Reserve: Kings of Casino Capitalism

Every time the Federal Reserve meets, I cringe, because the whole basis of the Fed now is to support casino capitalism, which is destroying the US economy.

Today it was reported after the Fed meeting that: "The Federal Reserve moved closer to a second wave of unconventional monetary easing and said for the first time that too-low inflation, in addition to sluggish growth, would warrant taking action."

Only in an environment of casino capitalism can someone seriously believe that purchasing paper assets can somehow help an economy. An economy is based on people working to produce useful products and services, not shuffling paper between themselves. The paper economy is merely a means to an end, not an end in itself. Of course, in casino capitalism, the paper assets become the end and the solution.

The theory of course behind the Fed's actions is that by purchasing assets they drive more money into the banks, who supposedly can then provide more credit to the economy. This is a nice theory, if you don't live in the real world. In reality, when the Fed begins printing money to buy assets, banks trade around this, take the free money and pay themselves gigantic bonuses. Then we're back to where we started from. Money is drained from the system, no jobs are created, and economic misery continues.

The obvious solution is to give money to the masses directly by lowering taxes, getting rid of all the financial middlemen, like health insurance companies, and creating jobs.

Unfortunately, I don't see any reprieve anytime soon. The US has been hijacked by a bunch of rabid casino capitalists who think the basis of the entire economy are some quotes on a computer screen. The human element of the economy, the real basis of capitalism has been lost.

Situational Bias: Key to Stock Market Profits

I'm always asking myself, how it's possible that I've made money investing in the stock market. What is the intellectual basis for some of the investment strategies I follow?

One idea, I've become convinced of, is that situational bias is a major cause of investment opportunities.

Situational bias, sometimes called recency bias, refers to the fact that we as humans tend to think that events will continue in the future as they have in the most recent past. Basically, we are intellectual prisoners of our current circumstances. We cannot see how things can and do change, for better or worse.

The reason why this bias plays an important role in investing is because in many instances it is nearly impossible for people to see how a company's financial condition can change dramatically in the future. Basically, we see companies and evaluate them based on their recent performance, failing to spot significant changes that may vastly improve (or degrade ) the company's finances. A company is losing piles of money and we can't see how it can ever make money. Or a company is minting money and we can't see how it will suddenly lose money. So inevitably we "overvalue" those companies with strong recent financial results, and "undervalue" those with weak recent performance.

In order to make money investing, however, one needs to spot situations where this situational bias is potentially wrong. One has to spot certain changes that can turn a weak performer into strong performer, or vice versa . Successful investing is about spotting changes and turning points, and being able to intellectually conceive of a situation that is dramatically different than the one the Market perceives of today.

You can make money in these situations because situational bias is so strong that it will take several quarters or even a bit longer for the Market to finally believe that things are getting better (or worse). This time lag due to situational bias is what opens up the opportunity for investment profits.

Inevitably the key question becomes: Where can one find situations where situational bias is strongest and what clues are there that the bias is false, i.e. the future is about to be vastly different than the recent past?

Future Expectations: The Key to Stock Market Prices

The key fact to understand when gambling in the stock market is that financial prices are set by expectations of the future. It is this focus on the future which sometimes make investing so counterintuitive. So for instance, stock prices can go up on bad news, and go down on good news. More importantly, stock prices rarely reflect reality, since they are a function of the future, which is formed by our imagination. And since our imagination knows no bounds, there is really isn't any stock price that is not justifiable based upon some future scenario that can be conjured up. This is why it is best to not focus much on whether a stock is undervalued or overvalued, as the valuation is purely imaginary. It's more productive to always think about the future. Ask yourself: What's Next for this particular company and is anybody thinking of what's next? Too often the investing world is caught up in the recent past or the present, and is unable to focus what could happen in the future. This is when you can make money. Develop a future expectation, based on solid evidence, that is not currently shared by most investors and then hope that others soon buy into your fairy tale. 

Proper Sizing of Investment Positions

I've had quite a few big winners this year in my stock portfolio, i.e. OSTE, NAVI, TZOO, VOCL, and of course I keep asking myself the basic question: "Why didn't I buy more of XYZ stock? I knew it would triple."

This is the common doubt asked whenever greed takes precedence over fear in the stock market Casino. It almost seems that when stocks go up, you should have had more, but when stocks go down you wish you had less.

The truth is that I, and probably noone else, has any idea where a stock price is going both in the near-term or long-term. One analyzes the investment situation, and takes a risk, hoping that it will work out. At any time, it's possible that some flawed analysis and/or overall market conditions will conspire to cause a large paper loss, of between 30% to 50%. And in 5% of cases, it's very conceivable to suffer an 80% loss, even if your investment thesis is ultimately proven correct (e.g. PWER).

So because you cannot know in advance which investments will appreciate and which will decline, it makes no sense to ruminate about what one should have or could have done. The better approach is just to make decisions based on the prospects of a potential loss. So before one makes an investment it is best to envision a loss of 50% and see how you feel about it. Could you suffer a 50% loss without major financial consequences and without your investment judgment becoming compromised? Assuming the situation did not change, would you buy more stock at a 50% lower price?

The 50% loss vision should provide some direction on what to invest in any one particular situation. It provides a constant reminder that like any Casino, we are not ultimately in control of the outcomes of our investments, and we do not know the future. So it makes no sense to ever risk an amount of capital we do not feel comfortable losing, even if that means that we may in retrospect have left alot of money on the table.

What is Casino Capitalism?

Casino Capitalism is an economic system that is built on the belief that society's resources are best allocated by profit-seeking individuals betting on short-term price movements in intangible or paper assets. 

The mantra of Casino Capitalism is simply to create an infinite amount of paper assets that can be traded between individuals. The theory is that the prices of these paper assets, because they are set by many profit-seeking individuals, i.e. the Market, somehow represent a true image of society's needs, and therefore can be used to determine economic policy.

Casino Capitalism is best contrasted with another form of Capitalism called Productive Capitalism, which is built on the belief that society's resources are best allocated by profit-seeking individuals attempting to provide long-term and "valuable" products and services to members of society.  

The US is currently predominantly a Casino Capitalist country, and as time passes more and more of the economy is becoming conditioned by Casino Capitalism.

Perhaps the best way to understand Casino Capitalism is by way of a few examples. I'll provide a few future posts.