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Not a Zero-Sum Game?
Ever since we were born, we’ve been exposed to multiple zero-sum games. It is very common to be involved in competitions. In them, by its own definition, when somebody wins, somebody else has to lose. That’s why most sports and games are called zero-sum games, because when you add up the results of all players, you get to zero. Investing is different.
This was not going to be the topic of today’s article, since I wanted to expand on how chess and poker relate to investing, but I had a curious conversation with a friend during the week. I mentioned that there’s the common misconception about investing and that’s that people think it is a zero-sum game. That all money made has to be lost by somebody else.
The simple argument, limiting ourselves to the US, is that the money supply is at around 7tn dollars. On the other hand, the S&P 500 alone has a market capitalization of 30/35tn. Without even including the bond or real estate market, market capitalization strongly outpaces the money supply. If all people were to liquidate their equity, there would not be enough money for everyone (at today’s valuations).
This means that theoretical valuations are, even though dependent on macroeconomic factors, ethereal. The market allows for true wealth creation, which, coming from a competition standpoint, sounds like an outrageous concept. The mechanism behind asset prices is human interactions and their buying/selling signals. If signals are skewed towards a particular side, prices fall or increase. If we were all to sell our equity, prices would fall until we find buyers, so how is this not a zero sum game given we could eventually come back to where we began?
Prices are set by people making decisions, but they are in respect to an asset, underlying the operation. If people’s decisions are irrational, we would expect the asset price to be far from its intrinsic value. If the market were to price a company much higher than its current market cap in a short time span, it’s very rare for fundamentals to improve in a way that could fill the gap. For this reason, a return to the mean could be expected. Conclusively, since value was not actually created, even if wealth was, it’s not only ethereal, but almost nonsense.
Over the long run, forces equilibrate and the market is able, perhaps because of the times it got to analyze asset prices, to really make fundamentals and prices converge. If there is no value creation nor destruction, transactions should lead towards a zero-sum game because there was no fundamental change in the asset. However, if there is value creation in the process, the most likely thing is that the underlying company appreciates in value. If people are invested at such company valued at 30bn and, 10 years later, it’s at 60bn, that’s 30bn of value creation that nobody had to lose for investors to win.
Companies create value
Businesses solve people’s problems. They create solutions the market is willing to pay for. In this way, they get retributed in money for services or products they offer. When these services are priced above all associated costs, the company earns benefits. These benefits constitute the concrete effect of creating value to the market. It’s the reward a company receives for its contribution to society.
Furthermore, over the long run, companies (if good, of course) tend to earn more and more benefits. They can reinvest them to produce more cash flow in the future, they can get more efficient, more productive, all of them leading to an improved bottom line. This very fundamental appreciation should translate into a market cap appreciation, as the underlying asset is technically more cash-flow productive.
I hit a wall today. I thought I could come up (by reading a fair bit as well) with a relatively decent answer to this matter. The answer seems to be very clear, but the arguments that back up the answer are more hidden than I thought. Nevertheless, I learned that answers not necessarily come immediately, I just have to give it time and it will come. I’d really appreciate your insights on the matter!
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