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Thursday, May 24, 2012

Stock Price



Stock Price


There is a very sad situation in business. Stockholders elect the board of directors for a company. The board of directors hires and fires management. Management must make sound financial decisions for a company. Often times what is a very sound financial decision for a company adversely affects the stock price.


Often managers’ decisions are effected even further by the potential of a change in stock price because they own shares or stock options in the company. These shares and options become more valuable as stock prices go up.


The problem is that stock prices don’t reflect reality. Stock prices reflect stock purchasers “Perception” of reality. Enron would be a good example of perception versus reality. Enron traded above $90 back in September of 2000.It dropped to as low as 7¢ a share before it completely disappeared. In reality, because of all the “Funny Money” and shenanigans that went on at Enron it was never really anywhere near as valuable as the stock price would indicate.


A company is only really as valuable as its basics. How valuable is its management team? How much debt is the company carrying on its books? How much cash does it have? What kind of revenues does the company have? What type of return does the company have on its investment?

I like to compare the valuation of companies to oil wells. When you start out you have a piece of land that may or may not have oil under it. Geologists and other experts can come in with sophisticated instruments and make all sorts of reports after performing countless tests but the bottom line after all it  is that there may, or may not, be oil.

The drilling company seeks out people to invest in the oil well. They contact friends, relatives, and people who are known to invest in this type of endeavor. Those who invest, or choose not to, base their valuation on the well, not on the well itself but on their perceived value of the well.  They base these perceptions primarily on the team of people who believe that there is a good shot at finding oil at this particular well. In other words, they place a value on the management team and not on the well.
As the well is being drilled hopeful signs may emerge. The drill bit might strike mud that gives clues about the oil content. This would raise or lower the perceived value of the well. In the end there is no real value on the well until oil is actually struck. Once the oil is struck estimates may be made about how much oil is in the well. Still this value is based upon assumptions and not reality.

What do you think is most important in determining the value of a company, the stock price or the long-term potential?
This is not meant as investment advice. If you are looking to invest you should consult an investment expert.


Disclaimer
The opinions or advice listed in this blog or website should be used as a place to start only. It is not a substitute for the use of a professional.
Please be sure to consult your attorney and/or accountant with any specific questions.
There is no one right answer to any business question that will cover all circumstances.
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