November 4th, 2005
Land value taxation and the stock market
According to economic theory, the shares of a public company should be worth the discounted net present value of its future earnings divided by the number of shares issued. That’s theory, but Google today has a market cap of $100 billion on revenues of perhaps $6 billion while Sun has a market cap of about $13 billion on revenues of $14 billion.
Clearly, theory and reality don’t match here - and this wouldn’t matter to people working in IT except that a lot of non-technical decision makers cite Sun’s market valuation as a reason for buying Wintel (or, at least, not Sun) while drawing remarkably enthusiastic (and uninformed) conclusions about future IT trends from Google’s market success.
So how can we get a handle on what’s really going on? I like to explain this kind of thing to myself using an analogy based on a 19th century idea called land value taxation.
Land value tax proponents, and there are a lot of them, say that the value of land is more affected by social decisions than by its intrinsic value - meaning the discounted net present value of the earnings a farmer could make it from it. Thus an acre in downtown Tokyo is worth more than one in rural Saskatchewan because people decided to build a city where Tokyo is, not because more food can be grown on it.
Since the value of location is created by society, taxing that surplus or locational value is said to be fairer than taxing the value created by a land owner through agriculture or mining.
Look at value as the result of what you can hope to earn by farming the land and you can see the analogy to what economic theory says a company’s shares should be worth. Think in terms of what that social decision to build a city around it means, and what you have is a nice analogy to what really happens in stock pricing.
Land speculators make money, so do market speculators - but the money they make doesn’t have anything to do with the real value of the land, or the stock: it’s based on betting for or against change in the difference between earned valuation - market cap as a function of real or expected earnings - and the actual market cap.
Call this difference the "trader’s surplus" and you can see it may be either positive or negative: thus Google sells at $360 because this surplus is absurdly positive - they’re in a virtual Tokyo of their own- while Sun sells at less than $4.00 because their surplus is absurdly negative -they’re exiled to a virtual Saskatchewan.
As analogies go, this one fits nicely but there’s a nasty sting hiding in the tail of the thing: people can’t easily move real cities, but virtual ones last only until someone loses interest and the conversation moves on. In other words, the further a share value gets from its real economic value, the more dependent its valuation gets on the opinions of people who understand market trading and each other, but not the underlying value of the companies whose shares they talk up or down.
The week after next, for example, Sun’s likely to announce volume availability for their first CMT machines and it’s a 50:50 bet that there’ll be a guy from Google standing next to McNealy at the press conference. That should be good for both companies, Sun from a revenue growth perspective and Google from a cost cutting perspective, but what I think we’ll see instead is that only one company’s shares will benefit for more than a few days, or minutes.
Paul Murphy (a pseudonym) is an IT consultant specializing in Unix and related technologies. See his full profile and disclosure of his industry affiliations.
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| 11/04/05
