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Author: dbau One star, 50 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 677  
Subject: Re: The stock market is a big head game Date: 1/29/2000 3:43 PM
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A bit of philosophy on Sidasbug's revelation: the stock market is a big head game. The only way our stock is going to be worth anything is if there is somebody else who is willing to buy it in the future. On this Sidasbug is absolutely right, and we should never forget it.

Of course, this doesn't mean stock is therefore worthless. The entire economy is based on various kinds of "head games". Every loan that a bank writes, every employment contract that a company extends, every house somebody buys. They are all built on somebody's belief that there's going to be somebody else who's going to be willing to do something or buy something in the nebulous future. Without a whole web of beliefs, there would be no trust, no trade, and no economy!

Most of Gilder's companies are built on towering stacks of beliefs. For example, Global Crossing is built on a belief that a small management team is adept and trustworthy enough to pay back billions in high-interest debt, mainly by laying many thousands of miles of optical cable faster than anybody else; that the technology they've chosen won't be superceded too quickly; that the demand for undersea communication will rise faster than most expect; that over the next few years they will be able to economically operate the network, reach their customers, nurture partnerships, fend off competitors, retain their staff, and maintain the confidence of their creditors and investors.

Underneath all these guesses and leaps of faith is the cold, hard, measurable reality of information crossing the ocean and dollars changing hands. But when you buy GBLX stock, you're placing yourself at the very tip of a shifting mountain of beliefs: you're buying into it all.

The reason Armageddon isn't always just around the corner is that many people do deeply and firmly believe in certain sets of values. Values like "the value of a dollar at Duncan Donuts"; "the value of rigorous science"; "the value of good management"; "the value of persistence"; or simply "the value of a promise." While it's wise to approach all values with healthy skepticism, it's also important to recognize that many of these values are not easily shaken. There is a hard reality, after all, that underlies most beliefs.

In the financial world there are important belief systems that people rely upon to quantify the value of assets and securities. For example, the dominant belief is that the proper value of stock equals the expected, interest-discounted sum of all future earnings minus some risk premium. ("Howww booring!") But from time to time, other beliefs circulate: "the value of a liquidity"; "the value of a gorilla" and so on. The hard truth is, most beliefs in the stock market are only as good as the degree to which people understand them and buy into in them.

If you delve into beliefs a bit deeper, you'll recognize that certain beliefs are "self-correcting"; and others are "self-reinforcing". Self-correcting beliefs don't stray too far from the finite. For example, "value is the product of earnings times earnings growth" is a belief, correct or not, that can be compared every quarter against actual prices, earnings, and earnings growth. When earnings growth slows, valuations and prices stay in check.

On the other hand, "self-reinforcing" values, even when correct, are vulnerable to catastrophic contradition. For example the momentum philosophy "value is price growth" leads to an inevitable breakdown. Rising prices lead to higher prices and stronger beliefs, which lead to more rising prices. When there is no money left to chase the dream, momentum stalls, people lose the faith, and prices crash. Not all self-reinforcing beliefs are hollow: many are based in reality. For example, technological standards are based in self-reinforcing beliefs like "Beta is better than VHS". It's just important to recognize that self-reinforcing beliefs collapse quickly when they are unseated. Of course, in the end it turns out that Beta is not better than VHS, because more people have bought into VHS.

It's not easy to get a grip on all the beliefs driving the value of a particular stock, and it's pretty much impossible to understand the set of beliefs that is driving the whole economy.

There are many, many aspects that can go into the calculation. But you also don't need to take a blind leap of faith when you invest in a stock. Read, study, think. I'm only recently rediscovering the Motley Fool boards - it's a good place to learn.

Good luck, and have fun.
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