July 30, 2017
Since several people have asked me why I bothered to write about Amazon’s stock price possibly being overvalued, let me get out the sledge hammer and hit people over the head with the issue.
Let’s imagine that this week the god of Wall Street comes down and announces that Amazon’s proper valuation is half of its current level. (This is a hypothetical, not my target price for the stock.) Since the god of Wall Street is never wrong, we would expect that Amazon’s stock price would quickly plunge, eliminating $240 billion in market value.
Has this information destroyed any wealth? Well, the folks who owned Amazon stock have $240 billion less than they did previously, so they clearly have less wealth. But the god of Wall Street knows the true value of Amazon stock, so there really was not any basis for this $240 billion in wealth. In effect, they would have this wealth and be able to spend based on it, as long as other investors did not realize that Amazon’s stock was hugely over-valued.
In this sense, it can be seen as very similar to counterfeit money. Suppose Amazon stock was priced in line with the god of Wall Street’s assessment, but Amazon shareholders collectively held $240 billion in counterfeit money that everyone accepted as though it was real. If the government suddenly discovered a way to detect these counterfeits so no one would ever be able to spend this money again, it would be the same story as the Amazon stock losing half its price.
The moral of the story is that there is no reason for those of us who don’t hold large amounts of Amazon stock to be happy about it being overpriced if this is the case. It is the same story as people having large amounts of counterfeit money. It’s good for them, but when they price the rest of us out of the housing market and their spending causes the Fed to raise interest rates and slow growth, it’s not good for everyone else.
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