A conversation that I’ve had with many different people has to do with the seeming randomness of investments. It’s why many people do not trust stocks, as it seems to them to be too much like gambling. The will often cite the internet bubble as an example. The confusion comes from the fact that all investments have two attributes, perceived value and productive value.
A rare stamp is at one extreme. It’s entire value is based only on perception. You can’t even mail a letter with it. If everyone’s opinion about the stamp changes, it can be worthless overnight. On the other extreme is a bank 4% bank CD. Regardless of anyone’s opinion, it’s worth exactly 4% a year. But those are the extremes. Most investments have components of both. With real estate it’s supposedly all about “location, location location”, i.e. perception. But regardless of the perception, I can build a house on the property and live on it. It has a productive value as well.
This is especially true for stocks. Stock in a company with big dreams and no profits, runs up solely on perception. But the stock in a profitable business enterprise has productive value regardless of public opinion. If the stock gets too low, competitors will step in and buy the company, because of it’s productive value. A recent example is Hollywood Entertainment (i.e. Hollywood Video) bidding war between Movie Gallery and Blockbuster. They didn’t bid hundreds of millions of dollars because of some hope of selling it to a bigger fool. They were bidding on productive assets, hundreds of stores that make money.
Obviously if you stick with stocks that are more productive than perceived you’re taking on less risk. Think about that in the future, “Is the stock I’m thinking about buying priced now based on perception or productivity?”. Stocks seem a lot less like gambling looked at that way.