All Public Companies Are Alike

The thing investors want is uncorrelated returns. What you worry about, as a big institutional investor, is all of your stocks going down at the same time. If you could buy some stuff — private equity or catastrophe bonds or gold — that doesn’t go down when all the stocks go down, that would be good for you, and you would pay a premium for it. This is true within stocks, too: Some stocks don’t go down when all the other stocks do, and those stocks are in theory more valuable. Investors should pay more for those uncorrelated stocks than they’d pay for more typical stocks that are correlated to the broad market. Those uncorrelated companies should have a lower cost of capital: They should be able to sell more stock and raise more money to do more projects, because their projects are in an important theoretical way more desirable. The market wants to fund projects that won’t lose value when everything else loses value.

This is all a bit fragile, though. Stock prices go up and down in part for fundamental business reasons (the company sells more widgets, etc.) and in part for supply-and-demand reasons (investors like the stock so it goes up). A company’s fundamental business might be uncorrelated (or negatively correlated) to the rest of the stock market, but its stock is owned by investors, and those investors can create correlations. If the stock market goes down, the company’s stock might not go down because of its uncorrelated business, but those investors also own other stocks that went down, so they might decide to dump the stock to raise cash, which will make the stock go down. And so the company’s stock will become more correlated with the stock market, not because of its business but because of who owns it.