Friday, March 16, 2012

The Myth of Market Cap, Part II

Headline on MSNBC today:

Goldman Sachs, roiled by 'Muppetgate,' loses $2 billion

The bank’s shares fell 3.3 percent in trading Wednesday as London-based Smith’s article set Wall Street and the media ablaze with discussion about the behavior of big banks bailed out by taxpayers after the financial crisis. The share price decline meant Goldman lost some $2 billion in market value. Its market capitalization is currently just short of $65 billion.

OK, what have we learned about market cap?  It is meaningless.

But, first of all, Goldman Sachs did not "lose" anything.  If anything, the shareholders lost unrealized gains in the value of their stocks.

But unless they SOLD their stocks yesterday, they did not realize those losses.

And even if they SOLD their stocks yesterday, but paid less for them than they sold them for, they did not even realize a loss.  Ask the IRS - you would face stiff penalties for claiming unrealized losses on your taxes.    You can't claim phantom paper losses on hypotheticals - there has to be an actual sale.

Until that happens, it is just a market fluctuation of 3.3% which doesn't sound very sexy.  Two Billion Dollars does - and sells newspapers, so to speak.

Gain = Amount Realized - Amount Paid.   End of story.

You don't have a gain or a loss when the price of a commodity or a stock goes up or down, and then you later sell at a different price.  Actual gains and losses are calculated only at the time of sale.

And this illustrates, too, that one should not panic when stocks go up and down in value.    They will.  And  if you respond in a knee-jerk fashion to stories like this and sell your Goldman Sachs stock, well, you will be broke in no time.   As one GS officer put it, all this talk of "Muppets" aside, the company won't have any clients if they did not provide at least average returns on investments.   And apparently, they are providing higher than average rates of return.  So much for Grover.   (Note:  I do not have any accounts with GS, but use Fidelity instead.  I do own some of their corporate bonds, though, which ironically went UP in value in response to "muppetgate").

It is pretty simple math.  If your house was worth $600,000 last year, and only worth $500,000 this year, you have not "Lost" anything.  It is only a hypothectical loss in phantom equity.

If you sell your house this year for $500,000 and bought it for $400,000, then you have a gain of $100,000.  End of story.   It don't matter what it was worth in the interim.   And if the profit from that sale was taxable income (which it is not, for most people) you could not argue with the IRS that you "broke even" because you "lost" that phantom $100,000 when the house dropped from $600,000 to $500,000.

Seems pretty simple, right?  Unless you have a realization event you have no gains or losses.

And you would think a financial reporter would realize that, right?

But they don't.  Which is why you should not take financial advice from financial reporters.

They can't even get the most basic stuff right.

Market Cap is a meaningless term.  It signifies nothing whatsoever.  No one "lost" two Billion dollars yesterday.   That is just crap.

And no, Apple is not "worth" 550 Billion.  Market cap is not an indication of a company's overall worth - just the stock price paid by the last sucker in, times the number of shares outstanding.   It is a made-up meaningless number.