The "Little Black Book" will be a series of articles where I will explain several things about the market which you usually just learn with experience, as they're mostly not listed in academic literature.
A Stock Is Not Just a Stock
Before asking the question "what's a share?", you could easily fall into the trap of thinking "A share represents a fraction of ownership in a business". You would be right in a way, but for publicly traded shares, not as right as you might believe.
The great surprise is that when a share trades in a public market, it starts to become more than just a slice of ownership. It also becomes a product, and starts behaving like one. When a share becomes a product its trading dynamics change greatly. The relative importance of the main objective a business has-- which is profit-- drops greatly, and the relative importance of the main objective a product has-- being sold-- soars.
As in any product, its price gets set by the equilibrium between demand and supply, while it gets easier to generate demand if the product is well promoted and distributed. Obviously, with enough promotion, a product can even be seen as a "brand".
But the greatest surprise comes when we find out that the stock market is actually structured according to this product distribution perspective. That is, the stock market is structured to handle shares as being products, not as being investments or slices of ownership. The priority in the market certainly isn't to recommend and promote stocks so that the investor will buy and keep them while he patiently expects the company's activities to reward him. On the contrary, the priority is to promote that which moves, which sells, which circulates. For this, the largest international brokers, such as Goldman Sachs (GS), Morgan Stanley (MS) or Merrill Lynch (Bank of America, BAC), have armies of salesmen that contact their best institutional and private customers on a daily basis-- usually to promote the very same ideas day after day, those for which there is "a priori" some acceptance. It's not a coincidence that some of the fundamentals of publicity and propaganda are repetition and the exploration of pre-conceived ideas
Once you understand that the market is structured this way, it becomes easier to understand how, in spite of a company like Amazon.com (AMZN) having had horrendous quarter after horrendous quarter. In spite of the company's declining earnings and clear threats, such as the imposition of sales taxes, it still manages to trade at 156 times 2012 earnings. Most importantly, it still manages to have the support of the brokerage community, with buys and fantastic price targets all over. This happens because Amazon, as a product, sells. It can be sold with a simple argument that the public is inclined to accept, that online retailing is the future, and Amazon dominates online retailing. This argument - which is true at any price level - gets used to move the product, no matter how ugly the fundamentals are, making a slice of ownership at the present prices simply something that's not rational.
It's also the reason a stock like Netsuite (N) can me moved off the shelves. After all, Netsuite is cloud computing and cloud computing is the future. Never mind that the company doesn't really make money, and dilutes the stock at 5% per year, which means that in just 14 years a present shareholder would be down to half the economic interest in this company.
It is the same reason why steel producers got promoted at the top of a cycle. Or Netflix (NFLX) got promoted at $300 and dropped at $71, why homebuilders were all buys back in 2005/2006, or why virtually all tech was a buy at the top of the Nasdaq bubble back in 2000. Because those products sold, and God knows a merchant will give more shelf space, and promote more heavily, a product that sells.
Indeed, this is also the reason why there's always a race in the market to bring sectorial products such as ETFs into sectors that are hot and overvalued, like the First Trust ISE Cloud Computing (SKYY) ETF. Or IPOs on companies with weak fundamentals, but extraordinary valuations, much like Pandora (P), Linkedin (LKND) or Zillow (Z). Here, we should also add that commissions to place companies in the market are usually more attractive than the commissions from trading said stocks. It's perhaps no coincidence that brokerages have every tech dog on buy. After all, the higher the valuations on the stocks that are already trading, the easier it is to convince and place new stocks on the same space.
In short, what this market structure sells is the product for which the market clamors. Shares are products. A product that doesn't move, for a substantial section of the market (stock exchanges included), has no interest. It's important to understand that the market structure works like this so that you're not as easily influenced by it. We need to keep an open, critical spirit when we judge every investment proposal that is made to us, especially those that are repeated daily.
Disclosure: I am short AMZN.
