Friday, January 16, 2009

Measuring Wealth, Let's Get Real

"XYZ company loses 350 crores in market capitalisation", "450 crores wealth eroded" - these are typical headlines when the stock market goes down or a company's share price goes down. But I wonder what is the meaning of market capitalisation and the releavance of this virtual wealth. To me there this nothing real about either the wealth or the wealth inferred from the so called market capitalisation.

Are these real? Let us assume that share price of a company goes up and thus the "wealth". What can I do with this wealth? The moment people try to realise the wealth by selling the shares, the prices are going to come down. Market ecomonomics - share prices will come down when there are sellers and go up when more people want to buy. Which means that the wealth is a mirage. When I go near it it will not be there anymore. Can I use this "wealth" for creating real wealth? Let us say I pledge the shares at the current high prices and take a loan. Let us say I buy some real assets. This is fraught with risk because the moment the prices come down. I will have to repay the loan which I took and if there is no other option then I will have to sell the asset to pay back the loan. So I cannot use the "wealth" to create real wealth because it is very risky.

So of what good is this wealth and market cap. At best it is a feel good factor making one feel like a king. But one needs to beware that one cannot and should not act like a king because then one will become a pauper.