29 Nov 2011

Karl Smith Shouldn’t Start a Mutual Fund

Economics, Financial Economics 12 Comments

I really like Karl Smith as a person. During our debate–where Karl knew he was entering the lion’s den of Mises fans–one of his slides said he was going to “teach Bob how to dance.” At the time I was so busy analyzing his arguments, I didn’t realize that was a white guy joke. Awesome.

Having said that, Karl’s recent post on Apple’s low stock price boggles my mind:

I have a theory.

On the one hand you can buy Apple stock for $375 a share and pay $7 to ScottTrade. On the other hand I also have a trash can in which you can deposit your $375, pay me $5 and I will set it on fire for you.

Clearly, I am offering the better deal as in both cases you have approximately zero probability of getting your money back and I am willing to burn it for $5 whereas you have to pay ScottTrade $7.

Now that’s not quite true. Apple’s stock price is sustained by the fact that if it goes low enough someone will buy the whole company and liquidate it. However, current investors shouldn’t be under any delusions that Apple has any plans whatsoever to provide them with a return on their investment.

As Arnold Kling might say: Thank You for your donation to the Steve Jobs Consumer Product Enrichment Fund, have a nice day.

It took me a few minutes to even understand what the heck Karl was talking about. One of his commenters spelled it out:

The gist of the joke I think is that companies are supposed to give dividends. Even tech companies. Even ones with huge market shares are supposed to provide a return and spin their assets back to their investors.

Because someday we’ll all be dead, and the company won’t exist anymore. At some point you have to return the assets or your stock is just a meaningless piece of paper. The East India Company had a huge market share also once upon a time.

I agree with this guy, that this must be what Karl is driving at. (Or, as Winston Churchill would say, this is that at which Karl must be driving.)

I have some questions then for Karl:

(1) Does his theory apply to all companies that don’t pay dividends, or just Apple?

(2) If Apple’s stock price is effectively a bubble (at least above a certain level), it’s been going on for a while, hasn’t it? I mean, people buying Apple stock right now aren’t giving their money to Apple, they’re giving it to other investors. So the question is, “Will I be able to sell this to someone else down the line, for more money than I paid?”

(3) If this is how Karl views non-dividend paying stocks, how can he support fiat money?

(4) Karl’s offhand remark about the liquidation possibility provides insight into why his explanation is silly. Suppose Apple’s management stopped reinvesting its net income into product development, and instead started buying nothing but Treasury bonds. Over time, all of Apple’s existing equipment, licenses, etc. were converted into an exponentially growing stockpile of Treasury bonds. Does Karl still think buying a claim to that pile of assets would be equivalent to burning your money in a trash can?

12 Responses to “Karl Smith Shouldn’t Start a Mutual Fund”

  1. Sealander says:

    Ha! I love this.

  2. Brent says:

    I agree they should pay dividends, but it is kind of chicken and egg. A tech company’s assets are always in danger of becoming obsolete… which means investors should want a cut of current profits, but it alsi means they need to constantly reinvest and continue to frantically innovate.

  3. Tel says:

    Karl has talked about his unlove of tech stocks many times, it’s not personal grudge against Apple. For example RHAT on the NYSE has been cranking along nicely growing in price, but pays no dividends. People buy it expecting to sell it over to the next guy, and so on and so on, but somewhere down the line someone is going to want money back out of the pool.

    In theory, while the company is expanding into new markets it is better value for the shareholders to plow the money back into expansion, but at some stage when the company becomes mature it is better value for the shareholders to pay dividends and concentrate on streamlining and efficiency. Sadly, many tech companies misjudge the future and come unstuck. Once their position starts slipping it’s too late to really extract much money out of the investment.

    That said, Karl seems to ignore that the shareholders actually own the company so if Apple shareholders want dividends then all they need to do is get together and make that clear to the management and they get dividends.

  4. Major_Freedom says:

    (2) and (3) are awesome.

  5. Gene Callahan says:

    “(3) If this is how Karl views non-dividend paying stocks, how can he support fiat money?”

    If you will note, the element gold does not ever pay dividends, either.

    • Bob Murphy says:

      Right Gene, and to the extent that people are using gold purely as a medium of exchange, the same point applies. But, I didn’t want to confuse people because gold has a fallback use as jewelry, etc. In contrast, paper dollars have no other use except as assets that are in a perpetual “bubble”.

      • Major_Freedom says:

        In contrast, paper dollars have no other use except as assets that are in a perpetual “bubble”.

        Not true. Paper dollars can eventually be used as wallpaper.

        • Rick Hull says:

          Insulation, packing material, combustion heating — it’s miracle stuff!

  6. MamMoTh says:

    Apple is just a great example of how people love participating in Ponzi schemes.
    Analysts never mention that however high their profits from selling iFads might be, it’s even higher from selling stock.

    • Major_Freedom says:

      “Apple is just a great example of how people love participating in Ponzi schemes.”

      Today I learned that Mammy doesn’t understand Ponzi schemes.

  7. kavram says:

    Does Karl know something the rest of us don’t? Unless Apple’s share price is about to drop to $2 or less it’s still better than his offer. Taking a loss on one’s investments is usually still better than just burning the money in a trashcan.

    On another note, doesn’t Karl understand that his plan would be deflationary and negate all of Bernanke’s extraordinary efforts to rescue the economy? His attempt to undercut ScottTrade could send us back into a 30′s-style Depression!!

  8. konst says:

    Over time, all of Apple’s existing equipment, licenses, etc. were converted into an exponentially growing stockpile of Treasury bonds. Does Karl still think buying a claim to that pile of assets would be equivalent to burning your money in a trash can?

    Is that “pile of assets” a metaphor for something else?

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