Share prices: whats the big deal?

[trendie]

(I may have done a similar thread ages ago)

I have a private company.
Its doing well.
I decide to float and sell 1million shares for £1 each.
Putting aside all the comms and costs, I pocket 500,000 and the remainder goes into the company.

Why should the price of the share have any relevance to the company from now on?

If the share price doubles, the company will NOT be making twice as many widgets.
If the share price falls to zero, the company still exists, makes widgets.

The rising and falling of the share price bears little relationship to the manufacturing of widgets. It doesnt affect the supplier relationship or the consumer.

Shares going up or down doesnt affect the pricing of the widgets.

Sales are dependent on consumers needs for widgets, not the share price of the company making the widgets.

The only thing I can think of is the share allows owners to take a dividend from the physical business of making widgets.

Why do we fuss over share prices over and above the capacity of the company to generate revenue and deliver dividends?

EDIT: the share prices going up and down doesnt alter the capital value of the company, or its assets.

 

[aparoid89]

Maybe the directors of the company own shares and would prefer that the price goes up so that they have a higher net worth.

 

[NVP]

yep ...youve mentioned that already Arati...and no doubt will again

 

[Jack o'Clubs]

(I may have done a similar thread ages ago)

I have a private company.
Its doing well.
I decide to float and sell 1million shares for £1 each.
Putting aside all the comms and costs, I pocket 500,000 and the remainder goes into the company.

Why should the price of the share have any relevance to the company from now on?

If the share price doubles, the company will NOT be making twice as many widgets.
If the share price falls to zero, the company still exists, makes widgets.

The rising and falling of the share price bears little relationship to the manufacturing of widgets. It doesnt affect the supplier relationship or the consumer.

Shares going up or down doesnt affect the pricing of the widgets.

Sales are dependent on consumers needs for widgets, not the share price of the company making the widgets.

The only thing I can think of is the share allows owners to take a dividend from the physical business of making widgets.

Why do we fuss over share prices over and above the capacity of the company to generate revenue and deliver dividends?

EDIT: the share prices going up and down doesnt alter the capital value of the company, or its assets.

Hi Trendie,

You're confusing cause and effect. You're quite right, if the company carries on making the same number of widgets, the share price is unlikely to change. But, if the business wins a new order, doubles the number of widgets and that feeds through to the bottom line, then the share price should rise. The value of the company has increased and that's reflected in the share price. The inverse is true. Over time the value of the company reflected in the share price should move to the true economic value of the company. Obviously there's a bit more to it than that, but that's the basic principle.

Why it matters is implicit in the question. As an owner, you have sold half of your company to other investors. Say you sold those 500,000 shares to one other investor and the company remians private. There's no 'mark to market' valuation of the company, all you know is that your new partner thought the business worth at least £1m and was prepared to buy half of it. What it's worth on a day to day basis is probably irrelevant to both of you as long as its well capitalised (ie you're not having to put more cash in) and you're happy that it's growing. The only difference in an IPO is that listing the shares allows 'the market' to place a value on your company every day as different investors sell in and out and establish a 'market' price. If that price moves too far away from the underlying value of the company then that gives a fundamental investor like me, an entry opportunity. To a Warren Buffet / Ben Graham style investor then a bear market or share price fallng is great news as it allows you to buy more of a good quality company for a lower price. The only time it matters is when/if you come to sell your shares when of course you want to get more for them than you paid for them. Someone like Carlos Slim genuinely doesnt care what the share price is of his listed assets and while that does annoy his minority shareholders, at least they know the only thing he cares about is increasing the true economic value of his businesses. The value of the company simply being the present value of its future cash flows.

This sh it is so much more interesting than trading

 

[DionysusToast]

Trendie, you are right that the share price has little relevance to suppliers & customers.

Share price is important to the owners of the company. It's the owners that direct the company towards making more profit and both an increase in profit AND an increase in share price is beneficial to the owners.

In terms of value - it's true that there is a very loose relationship between the price and the value of a stock.

In terms of dividends, profits tend to be re-invested for a couple of reasons. Obviously new investment can grow the company but also the fact is that you are better off tax-wise with capital appreciation than a dividend. Companies with excess cash will often buy back their own shares (reducing the float) to drive up the price of the remaining float of shares. Taxes on capital gains < taxes on dividends.

 

[scose-no-doubt]

IMHO pricing is all about cross market risk-adjusted opportunity cost total return. That's why there's focus on P/Es etc for sharses as prices are forward thinking and reflect investor expectations of future income streams. Tax adjusted yield innit.

Then again I tend to over complicate things...

 

[Lord Flasheart]

Trendie

Surely the price within a certain range is the value of the assests + stock+ the eps etc.all traders are doing is deciding if it is good value.

 

[DionysusToast]

IMHO pricing is all about cross market risk-adjusted opportunity cost total return. That's why there's focus on P/Es etc for sharses as prices are forward thinking and reflect investor expectations of future income streams. Tax adjusted yield innit.

Then again I tend to over complicate things...

Youse are confusing price & value.

Price is just the amount the last 2 parties exchanged some shares for.

Value - well - that's all nonsense at the end of the day because the calculations people use to assess value are based on so many assumptions, they might as well pick numbers out of a hat.

 

[barjon]

Ultimately, in the long term, the value of a share is governed by the income that can be derived from it in terms of dividend. Price varies as expectations about that income vary and in relation to varying expectations of the income to be derived from other asset classes.

 

[scose-no-doubt]

Ultimately, in the long term, the value of a share is governed by the income that can be derived from it in terms of dividend. Price varies as expectations about that income vary and in relation to varying expectations of the income to be derived from other asset classes.

Swat I just said

 

[barjon]

Swat I just said

sure, just supporting the mighty scose

 

[DionysusToast]

Stocks do not really have a value. There's a million ways to calculate value and all are based upon a series of presumptions.

Best way to think about it is that stocks have multiple possible values depending on the perspective of the person assigning value and their methods.

Price - well, here's the thing. People's perception of value will of course effect the price BUT this is an environment where supply is finite. Futures contracts effectively get created (and destroyed) when 2 people agree to trade. This is not the case with stocks. Stocks have a float. As such, the float and trading impacts price. Scarcity can be created in a stock, a stock can become too short, a stock can be cornered. All of these things have a huge impact on price.

Value perception is but one of the things that will impact price.

 

[Jack o'Clubs]

Value perception is but one of the things that will impact price.

Thankfully that's true otherwise value investing wouldn't be possible. 'Value' is a tricky concept for some businesses particularly with short track records or very fast growth trajectories, but for more stable businesses it's really neither that difficult or that subjective. Eg if you can buy a company for less than the value of its net assets, and the business is a going concern, then you're buying a bargain.

Let's face it, you come up with the principal of price vs. value every time you go out shopping. It's not that difficult if you apply some discipline and intelligence.

 

[DionysusToast]

Buying a company for less than the value of it's net assets?

Again - what do you mean by value of the assets? Book value? Or the value you'd get if the company had to sell off it's assets? It's the latter that is really important & to calculate that usually means taking a fairly large discount to whatever value is in the books.

You can probably expect to get 80-90% of the property value. Other fixed assets? Say a hard disk factory that's no longer making hard disks? Book value of 500 million but disposal value? How about stock on hand? Worthless to most.

Then I am sure you add in all the fees that would be associated with dismantling the company, lawyers fees, auction fees etc. etc.

If a company is selling below the book value of it's assets, there is usually a good reason. Devil is always in the details.

 

[holmes16]

The intrinsic goal of all corporations is to maximize profits returned to shareholders. So if the stock does not do well, then the shareholders have a better case for replacing the directors.

Another reason why a company should care is that the share price will effect how much dilution there will be if you need to raise capital through a stock issuance.

Let's say that you what to open a new factory, and so you need to raise capital. You hire some investment bankers and they say that you should issue more shares rather than taking on more debt. Naturally, if your share price is low, you will need to set the deal price lower than if the share price was high. This would mean that you need to issue more shares to get the money you need. The dividends you payout or will one day pay out get more diluted the more shares you issue. So this also goes against the goal of maximizing profits returned to shareholders.

 

[trendie]

The intrinsic goal of all corporations is to maximize profits returned to shareholders. So if the stock does not do well, then the shareholders have a better case for replacing the directors.
.......

Whether the stock (price) does well or not has little to do with making widgets.
I acknowledge the goals of the company to make profits.

Suppose the company makes a profit of £1million to disburse to shareholders.
If the stock price is £1 or £10, or £100, the profit remains £1million.

Lets imagine the share price has a history of rising, say from £1 a share to £5 a share.
You bought at £5. You know someone who bought at £1 a share.
There are 1million shares.
Therefore the dividend is £1 a share.

The relative returns are a function of the price you bought the share at, nothing else. If you feel you arent getting a good dividend yield, thats your fault at buying too high, not the companys fault for being valued by others too highly.
The company only makes widgets.

The share price going up/down may have absolutely nothing to do with the companys performance.

Whether the stock "does well" or not, is totally removed from the actual business of making widgets.
Removing the directors wont make the factory make more widgets.
Even if it could, you can only sell as many widgets that there is a market demand for.
There is a PHYSICAL limitation on both the manufacturing capacity and market size.
There HAS to be a saturation point, beyond which the dividends cant go, and therefore the share price.
However, in our virtual world, we are fixated on continuous growth and continuously increasing profits.

I remember, not too long ago, where some virtual companies were given valuations that were GREATER than the value of the entire market they were in.
(that didnt end too well)

The share prices, as we know, can falter on rumour.
The fluctuation of the share price is pretty much out of the hands of the directors. They should be busy making and selling widgets.

 

[holmes16]

i agree that many companies have crazy valuations, we all remember the .com bubble.

on a theoretical basis, the price of the stock has everything to do with a company's performance. theoretically, the price of a company's stock should equal the value of holding that share. so what is the value of that share?

the value of a share is equal to the present value of future cash flows received from owning that share with each cash flow discounted at some risk-adjusted rate. so as the company sells more widgets and makes more profits, presumably it's going to pay out larger cash flows and therefore the theoretical value of the share price rises.

i definitely agree that the world is fixed on continuous growth, and in many industries, especially old industries, that's unrealistic. i would also agree that theoretical case that i mention is rife with real-world exceptions and complexities. like take-over targets: if a company is a take-over target, then the share price will be high in anticipation of a good tender offer. but if the company believed to be likely to make the tender offer comes under duress for whatever reason, the take-over target will see it's share price drop. and the drop of course had nothing to do with the take-over target's corporate performance.

 

[twojustin]

@trendie in your example, you mentioned that "you pocket 500k" which i take it you mean that you hold 50% of the company. if that is the case, then you are absoltely right, you can run the share price to the ground and there is not a thing any body can do about it. but rarely does management of the company have total control of the voting rights. nor do they have the ability to "pocket" considerable portion of their equity stakes. and the amount traded daily limits the management's ability to "dump" all at once to "cash out". hence insider selling is a huge negative signal to investors. usually investors will get off the wagon before insiders have a chance to sell it all.

 

[scose-no-doubt]

Oh ffs profits goes to equity in the balance sheet so the company has more $/share. More dollars /share means prolly more dividends. More dividends means higher yield. Higher yield means higher premium. Therefore share price is a reflection of profitability/market share/general well being of the company. Management get paid in options with a future vesting period and

 

[scose-no-doubt]

When they try to manipulate profits up it feeds into the cycle.

Shares in a nut shell.