What is the latest fuss on the world sharemarkets about? Will it affect you? PETER CALDER asks some experts about town to explain. In plain language.
What has caused the slump on world sharemarkets?
The price of any commodity from gold to marbles traded in a school playground rises and falls according to how much demand there is for it. The butcher used to almost give lamb shanks away; now they are fashionable and featured on food pages they cost a fortune.
Shares are just the same: they are as valuable as buyers and sellers agree they are.
A company on the sharemarket uses investors' money to produce whatever it produces - whether it is chocolate bars or ball bearings. Investors get a return on their investment in the form of a dividend payout or an increased share value as the company prospers. If the company fails to prosper (or worse) the investor gets nothing and sometimes loses everything.
Traditionally, investors can get a sense of how solid a company is by looking at what is called its price-to-earnings ratio.
This is calculated by dividing the price you pay for the share by the earnings per share.
So if you buy shares in a company at, say, $2 each and its earnings per share (the total profit divided by the number of shares) is 10c, the p/e ratio is 20.
In the case of established companies, the earnings per share has some history. But the drop in share values over the past few days has been most devastating in the so-called "technology stocks."
These include established - and very rich - companies like Microsoft and IBM and also Internet companies which, for the most part, do not produce anything concrete or have any earnings.
Technology stocks: if they don't earn anything, why would people buy shares in them?
They are - or have been - the flavour of the month. Or year. Like the railroads in 19th-century America, they have been attracting investors even though they haven't been showing profits, because investors believe they are the Next Big Thing.
There is no question that the Internet has fundamentally changed the way business is conducted, but most observers have been warning that tech stocks have been grossly overvalued. Demand has fuelled their popularity and their prices have been rising steadily and spectacularly over the past four years, particularly since last October.
Investors have fought to buy them not on the basis of their past or even present performance, but on the anticipation of their glorious future.
A classic example is the online bookshop amazon.com. It has never made a profit (indeed it has lost more than $US700 million in the past three years) and there is no immediate prospect it will. But investors have made it into a sharemarket darling because they know it is changing the face of retailing and they believe the profits will come.
The steady rise in the prices of these so-called "Internet" or "technology" stocks had all the makings of a bubble about to burst. That's no new phenomenon.
The so-called Tulip Bubble in 18th-century Holland prompted a wave of investment in tulip bulbs. The price skyrocketed before slumping.
The slump in the technology stocks had been predicted for weeks, if not months.
So why did people keep buying shares?
Any investment market operates by balancing greed against fear. When prospects are good and people feel confident that they will be able to sell the commodity at a price better than they paid for it, greed prompts them to buy. When they don't, fear prompts them to sell.
If prices rose and then fell again, how can investors have lost money, particularly when the price hasn't fallen as low as it was to start with?
It is a truism of investment, often ignored by the unwary, that a sharemarket profit is not a profit until you have realised it (by selling the shares). By the same token, a loss is not a loss unless you have to sell the shares whose price has fallen.
But many who have climbed on the tech stocks bandwagon borrowed heavily to do it, reckoning that the gains would easily pay for the cost of the loan. Now these investors are hurting because they have lost money that was never theirs to start with.
What is the Nasdaq we keep hearing about?
The business world typically measures the performance of stock markets by looking at the performance of a group of stocks on those markets and expressing it in the form of an index.
The oldest and most famous of these indices is the so-called Dow Jones Industrial Average (named for Charles H Dow and Edward D Jones, the American financial statisticians who developed it in the dawning years of the 20th century). It covers 30 big industrial stocks - mostly old and blue-chip and mostly traded on the New York Stock Exchange, though it includes some modern ones such as Microsoft, which is not.
But technology companies, whose entrepreneurial style is less orthodox, trade on an electronic market run by the National Association of Securities Dealers. The Nasdaq (for National Association of Securities Dealers Average Quotation) has evolved into a market for high-tech stocks and has its own indices. It is the largest, and most dominant high-tech stock market.
If the slump was caused by the overvaluing of the high-tech stocks, why have older, more conventional stocks suffered too?
The slump comes at the end of a sharemarket boom which has lasted almost 20 years (everywhere except New Zealand; the 1987 crash is seen, at least in retrospect, as a minor correction).
The extraordinary boom in Internet stocks has created a wave of euphoria and some of the gloss has rubbed off on older stocks - price-to-earnings ratios, traditionally around 16 or 18, have climbed to around 30.
There is also a practical connection. Internet commerce is dramatically changing the way older-style companies work. Business to business (or "b2b") connections online are making supply chains (of raw material or information) more efficient.
So a slump in Internet stocks rubs off on old stocks too.
How will the events on the sharemarket affect me if I don't have any shares?
They may not appear to, but as any business analyst will tell you, you don't have to hold share certificates to be a shareholder. Your superannuation fund or insurance company has likely got funds tied up in shares. Its fortunes over the past - and the next - few days, will have a profound effect on you.
But you may never realise what happened.
Next big thing not always a good bet
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