Small Goals in 2021

On my way home from work today, I heard an audio on Himalaya from the program “Xueqiu · In - depth Finance and Economics” that I thought was great, so I’m making a share.
Market Capitalization Change is a Pseudo - proposition
It mainly explains why financial news often reports changes in market capitalization of hundreds of billions, trillions or even quadrillions, and to some extent, it also indicates what attitude investors should have towards market capitalization.

The full text is as follows.

In the securities market, we often hear people say that today the market capitalization of a certain stock has increased by 100 billion yuan, or a certain stock has plummeted and lost 80 billion yuan in market capitalization, or that today the stock market has soared and added 2 trillion yuan in market capitalization in a day, and so on.
Hundreds of billions, trillions or even quadrillions of market capitalization seem to come and go, as if countless amounts of money are flowing in and out every day. Many people are confused and wonder where all this market capitalization comes from. When we do business in our daily lives, we struggle hard but can’t earn much in a year. How come in the securities market, there are often trillions of yuan changing hands?
In fact, the “change in market capitalization of billions of yuan” that we often see is not the same concept as the money we usually talk about. There is no real increase or decrease of trillions of yuan. It can be said that from the perspective of the common understanding of money increase or decrease, the topic of “market capitalization change” that is often seen in the capital market is actually a pseudo - proposition.
Generally speaking, when people say that we have increased or decreased a certain amount of money, they refer to the actual increase or decrease of funds. For example, if a company’s sales revenue this year is 20 billion yuan, an increase of 3 billion yuan compared to last year, then generally speaking, barring some cases of financial manipulation, it means that the company has sold 3 billion yuan more of products than last year. And if the company’s net assets this year have increased by 10 billion yuan compared to last year, then most of the time, barring some changes in book net assets brought about by methods such as property re - evaluation, it means that the company’s net assets this year are indeed 10 billion yuan more than last year.
However, the increase and decrease in market capitalization are not this concept. Fundamentally, market capitalization is not real money, but a product. Moreover, this product is not a reliable one.
Conceptually, the market capitalization of a stock is equal to the current trading price of the stock multiplied by the total number of shares. If the trading price is determined by all shareholders, then the total market capitalization can also reflect the overall value of the company. But the current trading price of a stock is only determined by a small number of shareholders.
Let’s take an example to make this clear. Suppose a company has 10 billion shares, of which 7 billion shares are held by the State - owned Assets Supervision and Administration Commission and are rarely traded on the market. Among the remaining 3 billion shares, 2.5 billion shares are held by strategic investors and are also rarely traded. At this time, only 500 million shares are frequently traded on the market. When the trading price of these 500 million shares has recently increased from 10 yuan to 15 yuan, people will say that the company’s total market capitalization has increased from 100 billion yuan to 150 billion yuan. But has 50 billion yuan really been added? The answer is absolutely not.
On one hand, it is relatively easy to understand that the company’s sales revenue, net assets, net profit, and cash flow, the things that shareholders actually own, will not change because of the change in market capitalization: the listed company has not actually received 50 billion yuan.
On the other hand, the trading value of the listed company that investors own has not actually increased by 50 billion yuan either. Why? Some investors may understand the change in market capitalization as the change in the value of the equity they hold in the listed company. In the above example, the 50 - billion - yuan increase in market capitalization means that the value of the equity of the listed company held by investors has increased by a real 50 billion yuan. But this understanding is one - sided and wrong.
In the above example, the major shareholders and strategic investors who usually do not trade much hold 95% of the equity, which is not bought and sold on the open market at any time. Only 500 million shares participate in daily trading. When the price of these 500 million shares traded daily increases from 10 yuan to 15 yuan, if the major shareholders and strategic investors suddenly say that they also plan to sell their 9.5 billion shares, then they often cannot transact at the price of 15 yuan: the market liquidity simply cannot bear such a large trading volume.
That is to say, if an investor understands the change in market capitalization as “a real change in the overall value of the equity of the listed company”, he will be misled by the price fluctuations of a small number of tradable shares. And the problem with the concept of total market capitalization lies here. It is not calculated by multiplying the trading price of the entire equity of the listed company by the total number of shares, but by multiplying the price of a small number of actively - traded tradable shares by the total number of shares. That is to say, for the major shareholders of the listed company who hold the vast majority of shares and do not participate in daily trading, they are “represented by a small number of tradable - share shareholders”.
Let’s look at a classic example. According to the share capital structure of China Construction Bank (A - share code 601939, H - share code 00939) in January 2021, the total share capital of China Construction Bank is 250 billion shares (including preferred shares), of which the A - share tradable shares are only 9.6 billion shares, accounting for less than 4% of the total share capital. If we calculate the total market capitalization of China Construction Bank using the A - share price, it means that the market capitalization of the entire China Construction Bank is determined by the quotation of 4% of the shareholders on that day (in fact, not all of these 4% of the shareholders trade every day). In the case of China Construction Bank, we can also see a confusion in calculating the total market capitalization: when a company is listed on both the A - share and H - share markets, and the trading prices in the two places are different, how exactly should we calculate its total market capitalization? Should we multiply the A - share price by the total share capital, or multiply the H - share price by the total share capital, or multiply the A - share price by the total number of A - shares and the H - share price by the total number of H - shares? It seems that the third method is “the most reasonable”. But in the case of China Construction Bank, the A - shares it issued account for less than 4% of the total share capital, and the H - shares account for 96%. The third method obviously almost ignores the trading price of A - share shareholders, which seems unreasonable.
Given the huge differences brought about by different calculation criteria for total market capitalization, and the fact that no single method can be considered a perfect reflection of objective facts, many data providers, such as Wind Information, directly provide investors with data in three different criteria. As for which criterion investors like to use, they can choose for themselves. It’s like an old joke: young people who want to get married can get married, and those who want to be single can stay single. Anyway, they will all regret it in the end.
Of course, when we say here that market capitalization change is a pseudo - proposition, it doesn’t mean that market capitalization change is completely useless. Here, investors need to consider two situations. In the first situation, the small number of tradable - share shareholders in the market are very calm and give a very rational quotation that accurately reflects the value of the company. At this time, the increase or decrease in market capitalization does indicate the change in the value of the equity. In the second situation, the tradable - share shareholders are not calm. They get carried away and quote prices that are either much higher or much lower than the intrinsic value of the stock. At this time, the change in the total market capitalization of the listed company becomes meaningless: it is not a reflection of the real value, but just a number obtained by multiplying the random quotations of a small number of shareholders by the total number of shares.
So, are the shareholders who trade every day in the capital market generally calm? You know the answer without me telling you.
Since the total market capitalization is actually not very useful, for decades, Warren Buffett has used the company’s net assets, rather than market capitalization, to indicate the true value of Berkshire Hathaway. This situation has only changed recently. According to Buffett himself, due to some restrictions in accounting standards, after the company has been operating for decades, the net assets can no longer fully reflect the company’s value.
So, since market capitalization and its changes are just the product of the emotional quotations of a small number of tradable - share shareholders in the capital market multiplied by the total number of shares, and not real money transactions, why do people often like to say “the market capitalization of a certain company has broken 500 billion yuan” or “the market capitalization of a certain company has dropped by 80 billion yuan overnight”? The answer to this question lies not in finance, but in communication. When we write an article saying “for a certain company with a total share capital of 10 billion shares, the share price traded by 2% of the company’s shareholders has dropped by 8 yuan today, but the other 98% of the shareholders did not trade today”, although this expression is completely accurate, it doesn’t sound cool at all. But if we say “the market capitalization of a certain company has evaporated 80 billion yuan today”, although it’s the same thing, believe me, the reading volume of this article will be much, much higher.
Now, do you know why market capitalization change is a pseudo - proposition?

Author: Chen Jiahe
Link: https://xueqiu.com/1340904670/171195302
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