Tan Liu: Why Many Of Today's Most-Owned Stocks Are Ponzi Schemes

Stocks provide a return to today’s investors via two mechanisms: dividends and capital gains.

Dividends provide and income stream which can be quantiatively values. Capital gains result from speculation – an expectation that future dividends will be higher than the market currently expects.

But what’s the value of a company that continuously pays no dividends and does not appear as if it ever will in the foreseeable future?

Former financier and current statistician Tan Liu, author of the recent book The Ponzi Factor: The Simple Truth About Investment Profits explains how many of today’s perpetually dividend-less companies traded on the public market are operating as ponzi schemes by definition.

As a result, a substantial amount of the market capitalization of our stock market is actually “phantom wealth” that doesn’t truly exist. It will vaporize during the next financial crisis as investors proiritize cash flows in-hand over the promises of starry-eyed CEOs:

When it comes to stocks, there are two ways of making money. There are capital gains and there are dividends.

In the case of dividends, there’s nothing wrong with those, because they comes from the profits of the underlying company itself.

But the issue is with capital gains, the whole buy low/sell high gamble that’s promoted 99% of the time on CNBC, financial news networks, and is also the focus of a lot of financial research.

The issue with capital gains is that they come from other investors. When one investor buys a stock for $100 and then sells it for $110, that extra $10 (or actually the full $110) they’re getting is not coming from the company. It comes from another investor, who will then need to sell it to yet another investor.

So when one person buys low and sells high, another is also buying high and needs to sell for even higher. And a system where current investors’ profits are dependent on cash from new investors is by definition how a Ponzi scheme works.

What’s wrong with that is a lot of stocks don’t pay dividends and why are you an owner of a company if the company never pays the so-called owners?

that’s exactly how it works because when a stock doesn’t pay dividends, there is no monetary connection between the revenues and profits of the company and the actual shares.

And the only thing that’s really increasing is just this Ponzi process of one investor trading money with another investor. And it’s fundamentally different from the money itself that investors ultimately want. No one actually wants to buy stocks and say hey. I don’t ever want my money back. I just want stocks and I want to watch that value grow. And I never want my money back.

Wrong. Everyone wants their money back. Because a stock is essentially completely worthless unless you can get your money back. And every investor that buys stocks wants more money than they contribute.

But if investors are the only ones contributing money into the system, how on earth can they all make money from it? That’s really the bottom line. A stock without dividends is really just a Ponzi asset and there is no monetary connection to the company.

So therefore, it’s not a real equity instrument at all and furthermore, we can see this because some people say oh, well stocks are real property. How can it be real property if literally companies can print this stuff like toilet paper at any time they want? Real property takes time to replicate.

People forget that the reason why stocks were equity instruments to begin with is that they all pay dividends, according to history. Before the 1900s, all stocks paid dividends and there was a monetary connection between the shareholders and the companies that they owned.

That’s how stocks were supposed to work. It was supposed to be that simple. You buy a piece of a company; it makes money; you make money. But that’s not how stocks work now. This idea that stocks can literally have no dividends and these companies can make billions and never pay dividends indefinitely.

Or that these companies can continue losing money and keep printing stocks? In the case of Tesla and many others, this is a new concept that came out over the past 100 years or so. So the way that stocks work now is fundamentally different from how they actually were designed to work and how they worked before the 1900s.

And a stock without dividends when there is no monetary connection to that company should never be seen as an equity ownership instrument.

Click the play button below to listen to Chris’ interview with Tan Liu (48m:55s).

Other Ways To Listen: iTunes | Google Play | SoundCloud | Stitcher | YouTube | Download |

This is a companion discussion topic for the original entry at https://peakprosperity.com/tan-liu-why-many-of-todays-most-owned-stocks-are-ponzi-schemes/

Wrong. Everyone wants their money back. Because a stock is essentially completely worthless unless you can get your money back. And every investor that buys stocks wants more money than they contribute.
Stocks aren't essentially completely worthless. Some stocks have a non-zero intrinsic value. The basic accounting identity applies: Assets = Liabilities + Equity. Or another way of saying it is, Equity = Assets - Liabilities. This equation is important because the shareholders own the Equity! That's what a share is - a fractional ownership of the Equity of the Company. And so if Assets > Liabilities, your shares have a value. During bear markets, one trick is to find companies trading below their "book value" - which is to say, if you total up the Equity, divide by shares outstanding, that gives you the fair market value of the company. If you can buy well below that price level - theory is, market forces will eventually drag price back up (or the LBO people will come around and take the company out for something closer to that price). Assuming the balance sheet isn't full of lies, of course - such as the ever-popular "goodwill."
davefairtex wrote:
Wrong. Everyone wants their money back. Because a stock is essentially completely worthless unless you can get your money back. And every investor that buys stocks wants more money than they contribute.
Stocks aren't essentially completely worthless. Some stocks have a non-zero intrinsic value. The basic accounting identity applies: Assets = Liabilities + Equity. Or another way of saying it is, Equity = Assets - Liabilities. This equation is important because the shareholders own the Equity! That's what a share is - a fractional ownership of the Equity of the Company. And so if Assets > Liabilities, your shares have a value.
I believe that's true if you have the capacity to grab 51% of the voting equity and then make the decision to sell or liquidate or whatever. But for the average retail "investor?" What do they actually "own" when they own a share, especially a non-voting share that never pays dividends? Arguably, nothing at all. And what if the shares you own don't entitle you to weigh in on management's propensity to dilute via option compensation? Again, you "own" something over which you have no effective say or influence. The only way to cash in on a gap between equity value and the current market price is to buy it all up and liquidate it to your favor. Now we're back to the fundamental point that your ownership "entitles" you to a portion of the net income of the company via dividends. But, again, companies have really gotten away from that of late and it's not clear what might return them to paying dividends vs corporate buybacks which do not return anything to shareholders that intend to hold their shares. Nothing. Zero. Nada. Except an apparently higher portfolio statement that you can brag about at the next dinner gathering. So there is that.

Marketing cap is Price X Shares outstanding - understood.
If a company issues more stock…it’s per share price may go UP or DOWN depending upon it’s intended use for the funds. the market determines that based on an analysis of intended use for the funds… The price doesn’t remain static (as he seems to be implying??).
Not following his argument here at all regarding market cap and shares outstanding…he’s completely missing the Price piece of the equation…what am i missing?

I didn’t finish the podcast, I think that is the first one for me, I just coulnd’t follow the logic. I will continue to invest in the ponzi scheme along with the other 99.9% of the population. No disrespect.

cowtown2011 wrote:
I didn't finish the podcast, I think that is the first one for me, I just coulnd't follow the logic. I will continue to invest in the ponzi scheme along with the other 99.9% of the population. No disrespect.
The S&P PE Ratio currently stands at 21 times earnings. That's 21 years to break even on a dollar you invest today. Many, many, many years ago, people looked to buy stocks with ratios below 15, preferably around 10. Of course, that was in the days when the markets actually perforned the function they were desigend to perform. US Corporate debt is at an all time high above 46% of US GDP. That is some serious leverage. Insanely high corporate debt combined with ludicriously high PE ratios. Yeah... I want to jump on that band wagon.

Capital gains have, for a long time, struck me as speculation relying on nothing other than “greater fool” theory. Non-dividend paying, non-voting (who cares) shares are like corporate baseball cards - much like a baseball card, their worth can rise and fall with the performance of the player due to hype, but isn’t actually connected in any way. And the intrinic value of the stock is basically zero, just like a piece of cardboard with a baseball player’s likeness on it.
Enjoyed the interview, and glad to hear Mr. Liu think that idea through with more depth.

So if we assume the balance sheet isn’t full of lies (which some certainly are), and there is a gap between market price and book value, then that gap is exploitable because of the fractional ownership of that underlying intrinsic value, if we assume that eventually that gap will be narrowed either by market action, by a hostile takeover, by an LBO, or by an eventual dividend payment stream. That’s only in the case of a real business, with real net equity, of course.
Of course there are a thousand exceptions where this won’t work out, so you need to be careful. But the cases where it doesn’t work out don’t result from an intrinsic lack of value from fractional ownership of net equity, it has to do with a scam layered on top of the real value of fractional ownership.
A scam such as non-voting stock, overcompensated CEOs, halting dividend payments for pretend reasons (like overcompensating the CEO by a bunch of the CEO’s cronies on the board, and then lamenting the lack of cash to distribute), and other situations which sum effectively to fraud or theft can definitely cause your fractional ownership to become valueless.
But when that happens, we should point the finger at the fraud or the theft, not at the fractional ownership, as the root cause of the trouble.
And if you are getting into a venture - even a local venture with just a few people involved, with no elites anywhere in sight - absolutely by all means keep your ass covered for the potential frauds and thefts, because they are plentiful, especially when the money starts to get good. During tough times, its “shared sacrifice” and “all for one and one for all”, but when things start to go well and the pressure lets up, that’s when the frauds start to proliferate.
It turns out, frauds and theft are not just perpetrated by the elites.
In my experience anyway.

A couple months ago when the markets were tanking I heard ads on the radio reassuring investors to stay in the stock market for the long haul. They reasoned that the stock market has had a long decades-long run up, implying that its fundamentals go up, up, and away… (forever??) Just weather the hard times and you’ll come out a winner. The corollary view to this, that the stock market’s decades-long run up has grossly overvalued it and it’s due for a correction, and that maybe that rout was the beginning of that correction, wasn’t even entertained, LOL.
That being said, what is to stop the market from going up even higher? It may be an overvalued ponzi scheme but so is the entire financial system. At least those high profile stock prices are making real gains compared to bonds which are essentially zero; assuming you’re willing to take profits and get out before the herd stampedes, whenever that will be. One could argue that bonds offer more safety but I don’t know if I agree. They are all equally vacuous. I could see the stock market going up and up and up until the whole monetary system resets, at which point bonds will be dramatically revalued lower as well as stocks.
Can we be certain that the “investors” inflating the stock market aren’t actually just in large part the Fed and ESF?

… is the frauds that are so prolific; so that people with wisdom are hesitant to invest their money, seeing as investment isn’t supposed to result in theft losses.
And that same gap of course is then exploitable by those who are part of the frauds, working together, because they are part of the system, and therefore their odds of loss are less.
So I DO place it right back at the fractional ownership…but with a specific…
But that’s only true because our government specifically avoids justice; otherwise the fraudsters would suffer the highest losses.
So I put it at the foot of HOW WE DO fractional ownership.
Yes, the system is designed for theft. And it starts at the loss of courts of justice, and the loss of laws of law. We have courts of privelege and procedure, and ordinances and regulations in the place of law.

As with everything in life, it is important to know who you are dealing with. CAF says, “don’t do business with dishonest people.” Amen to that. In my experience, management is everything. If they are slimy, well, then no undervaluation makes it worth your while to put in time and money - you will just end up in court eventually, and that’s an utter waste of time and energy.
On the other hand, fractional ownership is a fine vehicle if management is generally trustworthy. And that’s not about elites or non-elites. Companies big and small have this same issue.
Often the “gap” between intrinsic value and price appears because the herd has thundered away from a particular sector for quite some time, and it is deeply unpopular. I’m sensing that the mining shares could be like that right now. Now I don’t know which management is good in the sector, but the people closer in (Sprott, Fleckenstein, etc) have a much better idea.
Tradeable gaps occur ultimately because investors are not rational - they are herdlike in nature. (Of course, sometimes gaps occur because the company is about to die, and the valuation is looking at information that is a year old, and way out of date. Its important to sort out which one you are dealing with.)
Now then, am I going to throw out the baby (fractional ownership) with the bathwater (our current state of market disorder and deformation)? No, I am not. Although companies do require regulation since, if not kept in check, they can be very predatory. Kind of like having a big dog around - you need them on a leash at all times.
Same thing with capitalism. If companies market shares are kept small, and money is kept out of politics, and the “commons” are regulated appropriately, then capitalism works great. Best system ever. That’s because it lines up perfectly with the inner nature of humanity. But let companies grow to take over their marketplace, then they seize government and wang things around to keep their cartel control in place, and its literally the worst system ever. The old US Steel. The Seven Sisters. Big Tobacco. And now: Facebook, Google, Amazon. Bezos even acquired his own propaganda vehicle as yet another lever of control over government.
Do I throw out capitalism because today’s crony-capitalism is horrible? No. I prune capitalism back to where it works best. That’s because the other options: socialism, communism, fascism, are just ridiculous - are not even real options, because they do not align well at all with Man’s inner nature - the love of a windfall, the desire to minimize work, etc.

1.) P/Es are higher today than they were historically because interest rates are lower. Equity P/Es are dictated by the bond market. Look at the “bond P/E” (1/yield… you can use the 10YT for example). Stock P/Es are in the 20s, bond P/Es are in the 30s. It boils down to overall cost of capital (WACC) and the most efficient structure for companies.
2.) If you can’t sell a house, at least you still have a house. If you can’t sell a stock, you have nothing. If you can’t sell your dollars (trade them for something of value), you also have nothing. There is nothing inherently wrong with the value of stocks being somewhat abstract and based on confidence alone,…That’s what we’ve been saying about USD for a long time. How is Tan so down on stocks while at the same time being so high on USD (and both for the same reasons).

DAVEFAIRTEX: Do I throw out capitalism because today's crony-capitalism is horrible? No. I prune capitalism back to where it works best. That's because the other options: socialism, communism, fascism, are just ridiculous - are not even real options, because they do not align well at all with Man's inner nature - the love of a windfall, the desire to minimize work, etc.
I think the issues for capitalism are well beyond just cronyism. There is a core problem with letting "capital" rule. If you ask someone on the street, "Should money be the basis of all decisions?" very few people would say "Yes." In a way, the systemic mess is not capitalism's fault any more than corporate malfeasance due to "regulatory capture" is the fault of the regulatory system. If we had a capitalist system where the capital was "of, for, and by the people," things would at least have a chance of working. This is what the current public banking trend is about. (We'll see how far the psychopaths let that get!) But we don't have that; we have a capitalist system "of, for, and by the elites." People who deeply crave wealth and power will always work ceaselessly to acquire them, and once they acquire them, will work to pervert the system so they further entrench their power and wealth. That is their nature. But the rest of us just want the basic good things in life and have no such uber-lust. And though we like the idea of defending liberty, justice, and fairness, it's really hard to stay vigilant forever. Like evil, psychopaths apparently never sleep. I agree that socialism is a non-starter. Perhaps a "cooperative capitalism" model could work -- we disempower the parasitic investment class that does nothing but make money from having money (when they're not actively printing themselves more!) and we instead empower the entrepreneurial class with loans from the publicly owned central bank, with the interest being used to pay for the things taxes now support. It sounds utopian, but that's an idealized version of what appears to be going on in the public-baking state of North Dakota. Maybe a PP'er from North Dakota can add some on-the-ground context, but the reports I've seen make it seem a lot better than the model being used elsewhere. It really comes down to who controls the money system. Fun experiment: Four people play the board game Monoploy. One person doubles as the banker, only in this case, the banker-player can take additional free money out of the bank and put it in their pile, again and again. Go ahead and try to beat that! mark

Capitalism worked fairly well when businesses were small, and didn’t have enough throw weight to control government. And you may have noticed my bit about keeping it on a leash - regulation of the commons is important, since capitalism doesn’t care about the commons. That’s a tension and a balance, and most definitely capital will always agitate to tip the balance in their favor. Didn’t someone say that the price of liberty is eternal vigilence?
As for your consigning equity to the dustbin and replacing it with debt - equity is better than debt; as a guy who used to do startups, getting equity investment means you never have to pay it back, nor do you have an interest payment (so you aren’t required to have income right out of the gate - which allows for longer-term projects), and you end up with people who invest for the longer haul. They are partners with you, wanting you to succeed, rather than leeches sucking your blood and eyeing your assets “just in case” you can’t make your payments.
None of my startups would have qualified for loans. How on earth could we have paid them back? No assets, no income, just a dream and a business plan. No bank takes risks that extreme - because they don’t share in the upside. Startups can only be funded with equity capital. And please don’t tell me the government should be in the business of picking startups to fund…
So yeah. I’m a fan of capital, capitalism, equity as a funding source, and as an investment. As long as companies are kept relatively small, its the best system ever. And that’s the challenge. We pruned capital back down to size during the 30s, but people forgot the lessons and let companies get big in the 90s. The Clintons got rich, and we got Glass-Stegall repealed, and now we’re stuck with cartel-monopoly capitalism.
And that’s the cycle. We’ll eventually prune capital back down again, fix things for another 80 years, and our great-grand-children will dutifully forget the lessons we paid blood to learn and the cycle will begin all over again.

I would like to know who this person is with the pruning shears, not sure that really exists. I’m not sure we ever had “nice” small scale capitalism. During the energy bonaza there was so much surplus, nobody noticed how unfair the system was. Capitalism in a small well fortified cage, maybe. Works if you have a strong cultural construct the reigns in human behavior, but have no such check in the USA now. The money hungry, something for nothing sociopath, has become the accepted social norm, if not even a behavior that is now revered. Monetary values have supplanted culture values. We live in a cultural and spiritual waste land. My last hope and you do see it happening everywhere, small business doing things because of the love and passion of what it is that they actively do every day, not a passion to be rich. The current predatory system actively makes life miserable for those people that “capitalism” pretends to venerate. Capitalism with a capital “C” will always do that, it always has. The point is not to find the easy way, lucrative way, but the meaningful way!

The problem with capitalism is that capital seeks returns (profit). Or in other words, growth. Collectively, this means that the economy must grow.
This is why capitalism previously “worked” (term used loosely), because the real world could grow due to resource surpluses and accommodate those capital returns without impoverishing others who werent receiving them.
Now that the real world is reaching limits so that it cannot grow, and will sctually start contracting, then by definition any gains made by capital investment will come out of a shrinking pie which will impoverish the rest of society.
This is why capitalism won’t really work. Not that I’m advocating communism, mind you. We need the efficiency that markets provide in allocating resources. However, we need a way to keep capital returns from making people exceedingly wealthy. A wealth tax is the way to do this. The only way.
It’s the age old bane of the human condition – the rich get richer and richer. Growth, for a while, has hidden the other half of this – the poor get poorer and poorer – for quite a while. We will now have to squarely face that bane of human existence instead of deluding ourselves into believing that it no longer applies because of capitalism providing opportunities for everyone as long as they put in hard work. Not true anymore.

What a fun and refreshing interview. Tan Liu’s infectous laugh reminds me of the kid who recognizes that the emperor has no clothes. A very smart kid. Who explains the facts in very simple language. While I really appreciate Chris and Mitch and Wolf and everyone who points out how many decades (milennia) it might take to recoup an investment in stocks at the current P/E ratios, Tan Liu laughingly points out that unless your stocks are paying a dividend (E), or you can sell them to another (sucker) (P), they are worth nothing! Zero return equals zero! If liquidity dries up and no one buys your stock portfolio, it is worth nothing!
25 years ago, when I was a young engineer, the boss came in and lamented the state of stock market. He’d just experienced another downturn, and had much more invested than I did at the time. He said that perhaps it doesn’t make sense to invest in stocks. “Heresy!,” I thought. “You HAVE to invest in stocks, that’s just how things work.”
It works until it doesn’t work, and perhaps Tan Liu’s book will be another straw that deflects (if not breaks) the camel’s back. Perhaps another person will wake up to the realities of the financial ponzi schemes. I used to believe the charts and financial advice. Now I believe in chickens, energy efficient housing, and other tangible investments. And I can laugh about it, because my capital is not at risk in the ‘markets’.

forgive my ignorance, but what were the factors that led to the pruning of capital in the 30’s? Was it blame for the Great Depression? Do you see similar conditions brewing now? Perhaps if corporate debt is the epicentre for the next crash it will create a backlash against big business again?

First- profits and growth:
It is possible to have profits without growth. Think about it. If you are adding value, you can charge for that. If nobody can charge for adding value, then all production of everything will stop. “Why on earth would I produce something for free?” Runs clean against human nature, and that state of affairs will not last very long. Likewise, profits don’t require growth, and growth doesn’t necessarily lead to profits. NFLX: lots of growth, no profits.
Profit comes from value add less costs. If something isn’t profitable - over the long term anyway - it stops being produced.
Yes my sense that the Democrats prior obsession with “size is bad” (which, sadly, is now long since gone - and helped provide a counterweight to the Republicans who were always the water-carriers for Big Business) came from two places: the Trust Busting of Teddy Roosevelt (which was supported by a popular movement against said Trusts by disgusted real people), and the follow-on activities post Depression, where Big Business was looked on as something evil - and blamed for the Depression. Now - well, Google is everyone’s best friend, as is Facebook, as are our usual collection of Defense, Sickcare, and the Big Ag & Poison companies. At some point people will figure out they are being hosed, and they will sniff out who is doing the hosing, and - hopefully - the Yellow Vests will come out and we will start pruning once again.
Either that, or we’ll get Socialism as the “solution” which of course, it isn’t, because it doesn’t align with humanity’s inner nature at all.
Sociopaths have always been with us, and they’re not going anywhere. As I see it, we have a choice:
Either we have socialism/a Command economy (which doesn’t work - and will be run by the sociopaths anyway), or we have capitalism which has this design flaw - it always turns wholly rapacious, and so we have to keep it on a very short leash, and to keep the individual players small so that a handful of sociopaths don’t have the capacity to inflict lots of damage.
Right now we have a pretend-capitalism command economy, which is really the worst of both worlds. Little people get bupkis in this situation. Socialism might actually be better, for a short time, until its flaws were exposed. Which always happens, of course. But the little people might get some crumbs for a time, under socialism. Until it all blew up spectacularly.
That’s why I like small capitalism on a short leash. It requires Eternal Vigilence, but it has a lot better outcomes for everyone than either of the other two. Size restrictions restrain the sociopaths, while harnessing the drive and energy of human nature.

Miriam Webster (and others) define capitalism as:
an economic system characterized by private or corporate ownership of capital goods, by investments that are determined by private decision, and by prices, production, and the distribution of goods that are determined mainly by competition in a free market.
Actually this definition is wrong. Irrespective of what text books say, the definition is simply this:
Capitalism is a system where the ownership of enterprises (corporations) is distinctly separate from the individuals who manage and work in the enterprises.
There is nothing inherent in capitalism that it has to operate in a market economy. It arose in the market economies of the, 17th, 18th and 19th century. The capital requirements for the big projects, such as building the railways, were too large for the existing enterprise structures: individuals, family firms and partnerships. Hence capitalism has always been associated with markets, but the system does not need markets, and certainly not free markets.
In fact I can think of three industries in which capitalist corporations do not really work in markets these days:

  1. the banking industry where the price of their principle commodity, money, is centrally set by the Central Banks. They have also, I think, captured and control the legislators and their regulators.
  2. the American Health/Medical industry which is dominated by capitalist companies who have captured both the legislators and their regulators to the extent that the sector runs as a command economy, not controlled by the government, but by the industry itself.
  3. the defence industry who have only one customer, the armed forces, and have also captured the legislators like the other two industries.
    The issue is not between socialism and capitalism. It is between the market economy and the command economy. It is making sure that we do not slide into a command economy, as Capitalism is currently doing; that we maintain a genuine market economy with lots of choices and no dominant companies or group of companies. This includes maintaing a diversity of different forms of enteprises, such as partnerships, indidvualy owned enterprises, employees owned enterprises and mutuallly owned enterprises, rather than just having a mono culture of capitalist corporations (as derived from my definition of Capitalism).