Have you ever wondered where the advancement of your wealth comes from in an equity? In a bond it comes from the coupon rate. In a $1000 bond with a 5% coupon, your wealth advances $50/yr. This is actual interest and can be reinvested for compounding or used for spending. A Bond therefore is a kind of legal contract offering you a money motor called cash flow.
A stock OTOH is a piece of property. It’s ownership and it’s value is indeterminate. For example more stock can be created or some can be bought back. It’s only worth what someone will pay you for it. If you own 1000 shares of BRK.B you own a percentage of BRK.B. You can trade your BRK.B for money but until you do that you just own some property, same as a house or a farm or a car. So what makes a stock valuable? We glibly buy stocks and quack about the “magic of compounding”, but on it’s own property does not compound. On any given day it can be worth more or worth less or even become worthless. What’s the motor for a stock?
Henry Bessemer patented a process for making steel in 1856. The process made steel purer stronger and easier. The process existed in other parts of the world (cold blast) since the 11th century. The story is an intriguing look into creativity and mythology and perhaps a dollop of theft, but none the less the blast furnace method of steel production ensued. This new steel compared to cast iron lasted 10 times longer, was malleable and could be produced in vast quantities. Bessemer’s process brought down the price and improved the quality. Because of Bessemer’s process Minnesota’s Mesabi range of Iron Ore went from a 6% of need output to 51% and steel workers went to work making steel (imagine all those jobs and lives changed). Cheaper steel allowed rail roads to prosper. A rail was cheaper to make and lasted 10x longer. At one point Chicago was the cross road for 14% of the nations railways. My Grandfather had a second grade education and worked the steel mills in south Chicago his whole life. He raised 6 kids. They were poor but Henry Bessemer’s innovation fed them. My other Grandfather had an 8th grade education. He became a meat buyer for A&P foods. Eventually he worked his way to the C suite as VP. I used to tag along to the Chicago stock yards where gramps would inspect and cull meat to send to the butchers, the meat my other grandfather would feed to his kids. The meat got to Chicago as cattle on the trains, which road the rails so much improved by Bessemer’s process. My uncle (grampa #1’s son) was a butcher who cut up the meat, and the abundance of meat brought down prices and grew strong people with good solid brains. God bless Henry Bessemer where ever you are! The Chicago stock yards are what peaked my interest in commodities trading. There’s gold in them there pens!
What this is, is a description of creative destruction. Creative destruction is the motor that drives stock price. It’s productivity and innovation and a relentless improvement in efficiency. It destroys the inefficient and creates the efficient. It’s a concept born of economist Joseph Schumpterer of the Austrian school which uses Marx’s dialectic as the motor. In Marx’s theory production was static and money flowed from have not’s to haves causing what he thought would be social unrest to the extent the proletariat would rise up and smote their bourgeoisie overlords and usher in utopia. Marx lived in the fossilized society of London and his mistake was misunderstanding human ingenuity and creativity. The sucker was stuck in the mud without the creativity to understand he was in the belly of a fossil not something alive and growing. Unfortunately tens of millions died and lived in abject poverty over his stupidity. Not creative destruction but pure destruction and quenching of the human spirit.
Production is not static so the pie can grow! Not only can the pie grow but you can bake a bigger better pie or a dozen bigger pies! What Schumpterer saw was the real dialectic is between creation and stagnation. The creative dynamo would rise up and pulverize the fossil. The creative dynamo would rise up, eat the fossils lunch and multiply the loaves and fishes (increasing value). The real dialectic was Bessemer’s efficiency of the new steel v the inefficiency of cast iron. The pie expanded and trillions were created out of thin air, and the opportunity flowed to my Grandfathers who each in their own way were able to feed their children, and their children had children. Creative destruction of course predated Schumptlerer he just normalized an understanding. It’s creative destruction, improving efficiency and productivity that is the motor in stocks. That’s were the excess value comes from. Unlike a bond which is pretty much a fixed legal contract creative is a living thing where something is made from nothing.
There are tons of examples of this dynamo. Cyrus McCormick developed a thrashing machine (also developed in Europe). In pre-machine days 1 man could harvest 1 acre of wheat a day with a scythe. Post machine 2 men could harvest 20 acres a day. Henry Ford and his innovation, the recent fracking technology etc etc. Examples enough to prove the path forward. Anything that places a boot on creative destruction is deadly, and as investors you best know which side of your bread has the butter. Creative destruction is the motor impelling us into the future, not the “magic of compounding”