Today we’re going to talk about trust and how important a role trust plays in our markets. On the surface, trust may seem strange to discuss viz-a-viz investing, but when you think about it – Trust is the foundation of modern-day investing.
Here’s what I mean: when we’re thinking about investing in a company, via its publicly-traded stock, we trust that the information that’s presented by our employees, the company’s directors and managers, to us, the company’s owners, is correct and accurate. Without that trust, we probably wouldn’t invest and if we did, we probably wouldn’t pay the prices that the stock is trading at in the market. It would simply be too risky.
That trust can remove some of the investment risk but not the uncertainty of whether our employees, the directors and managers, of that company will wisely use the capital we’ve entrusted them with.
And that trust is rooted in the Rule of Law here in America, where property rights are protected, in fact, enshrined in our laws and they’ve been around for as long as America has. They’ve become so widely accepted, that our markets are the broadest and deepest in the world. Even foreign investors prefer to invest their money here in the US because they trust that the rule of law will protect their property and their rights.
I’ll give you an example: our markets, historically, have traded at about 15 to 16 times their earnings, meaning a stock will sell for 15 to 16 times what that stock gets as a share of the company’s earnings. Lately it’s been closer to around 20 to 22 times its earnings.
If you compare that to other foreign markets, say in emerging markets – the price is not even half of what we pay here. The reason is, even in foreign markets where their economy is growing faster than ours, there simply isn’t the same level of trust in their rule of law, as ours. So, investors aren’t willing to pay very much for an investment that may make them more money in the long-run, as they’re willing to pay for an investment in the US.
So, if investors, foreign and domestic, stopped trusting that our rule of law will protect their property rights – we’ll no longer be willing to bid up prices 20 to 22 times earnings, maybe only half that – and then our markets would be no different than anyone else’s.
If you have any questions, please add them in the comments below.