In 1999, Warren Buffett made a speech about how he thought the stock market was overvalued and due for a correction.  Of course, he was correct.  You’ve probably heard me say this a million times before: I don’t invest in the stock market or follow it anymore.  I prefer tangible investments that I can control.

The Ponzi Factor: The Simple Truth About Investment Profits by Tan Liu offers a controversial take on the stock market.

Buffett’s comments from 1999 still ring true today.  I recently read The Ponzi Factor: The Simple Truth About Investment Profits by Tan Liu.  It’s all about how the stock market is a Ponzi Scheme.

The book states that the only way to make money in the stock market is by selling your shares to someone else for a higher price.  Okay, that is straightforward enough, but if you’re buying and selling shares in a company you don’t control, you probably don’t have a say in how profits are distributedWe’re often led to believe company profits and investor profits are tied together.

Liu gives an example in the book: From 2007 to 2011, Google earned $28 billion of net profit.  With Google earning such a huge profit, you would expect investors to be rewarded with some combination of dividends and stock price appreciation.  However, during that time, none of the net profits were shared with the owners of the company and the stock price remained static.  Investor performance was entirely separate from the performance of the underlying company.  I had never thought about it this way until I read the book.

Let’s look at Tesla, whose situation is the opposite of Google.  In 2010, its stock price was $20 and by 2017 had risen to $380 a share, yet Tesla reported a loss of $4.3 billion.  How is this possible?  The only way to explain this bizarre scenario is to recognize that the market is not efficient.  Stock prices reflect investor sentiment, which oftentimes has nothing to do with the actual performance of the company in question.

Investors buy a stock, which makes the price go up and in turn, makes it seem like a good investment to other investors.  More and more people buy, pushing the price up far beyond the actual value of the company.  At some point, the only way to make money on the stock is to hope that another investor comes along to push the price even higher. 

This is how a Ponzi Scheme works. 

And it is no secret.  The Securities and Exchange Commission actually has a page on their website where they clearly define a Ponzi Scheme as, “an investment fraud that involves the payment of purported returns to existing investors from funds contributed by new investors.”  It’s hard to argue that growth stocks with negative earnings, like Tesla, don’t fall squarely within this definition as someone in the end can be left holding the empty bag.

Liu explains, “Real profits come from end-users.  Ponzi profits come from other investors.  The truth is really that simple.”

“Don’t watch the market closely,” Warren Buffett once said.  These are wise words to heed from someone known for timing the market.  

Real estate is a great venue for investors in search of “real profits.”  A well-executed real estate investment is an investment in a tangible asset that produces a steady monthly cashflow.  There is no mystery as to where the profit comes from and it definitely is not a Ponzi Scheme.  Done correctly, real estate can be beneficial to all parties involved.  The tenant receives a nice place to stay, and the investor receives a healthy return.  It is a true win-win.

As of March 2020, the Oracle of Omaha’s Berkshire Hathaway is sitting on $137 billion in cash.  While we don’t have a clue which direction the stock market is heading, the fact that he is keeping that much money so close could indicate reason for caution.  If anyone knows how to time the market, it’s Buffett.  We are thankful to be in a position where timing the market is not going to make or break our performance.  In fact, it really doesn’t have much of an impact at all.  The types of homes that we buy and the types of markets that we operate in are largely insulated from the economic cycle.  People always need an affordable place to live.

While many hard-working families and financial advisors around the country are up late at night trying to figure out whether they are invested in a Ponzi Scheme, our investors don’t have to worry about that.