What is a cynic? "A man who knows the price of everything and the value of nothing."
- Oscar Wilde, Lady Windermere`s Fan.
The cynics say the price of a share can only be determined by the market. If that`s the case, then does the market know something the average investor does not? And how and by whom is the market educated?
While we can`t control the way the market behaves, we can influence what it reacts to - the indicators the market uses to discount value.
Influence
A study by Miller and Modigliani in the late 1950s and early 1960s found that the price of a share reflects the intrinsic value of a company`s stock and that good profit performance won`t have much effect on share price unless there`s a complimentary change in the value represented by the share.
Which begs the question: "Is profit a true indicator of value creation?" The answer is a resounding "no" and immediately poses another question: "Where is the true indicator to be found?"
The premium any company earns in its share valuation is a function of how much it can be expected to outperform its risk-adjusted rate of return. That ability is a function of the company`s competitive advantage in its primary markets as well as its capability of sustaining it.
Warren Buffet, chairman of the highly successful US investment company Berkshire Hathaway, says: "What counts is intrinsic value, a number that is impossible to pinpoint, but essential to estimate."
While we can`t control the way the market behaves, we can influence what it reacts to - the indicators the market uses to discount value. Communicating the hard facts to the market is not good enough. What top management must communicate to investors is the results of customer value creation, customer value preservation and customer value realisation.
An exploration
Over the next couple of months, I`ll explore in depth the various approaches to share valuation and how companies should adjust their strategies and tactics, and how they communicate them to the investment community. I`ll delve into a range of concepts and find out how they influence share valuation - aspects such as competitive advantage, competitive advantage period, whole products, bowling alleys, bowling pin potential, product tornadoes, gorillas (market leaders) and life after Main Street. Along the way we`ll also meet chimps, kings, princes and serfs.
As SA has now become a legitimate player in international equity trading, we are as sensitive to market stability as any other country. We compete head to head for foreign investment with other emerging economies. Our recent achievements are, however, at best dubious. We finished in third-last position in a world competitiveness survey, the rand continues to be weak and the gold price is going nowhere. On top of all that, we are faced with an entirely new challenge called "the new economy".
The "new" economy heralds the age of virtuality and the exponential value of connectivity. Installed base, click-throughs and the loyalty of virtual communities determine value.
Creating value
But the good news is that the "new" economy levels the playing fields between leading nations, the challengers and the also-rans. Value can now be created anywhere, anytime and by anyone.
Who do we have to thank for this? The lawmakers, of course. Not those who have been voted into office at the polls, but the self-appointed visionaries who are plotting the new digital trade routes.
You may already be familiar with some of the laws in the new economy, and you`ll disregard them at your peril.
Moore`s Law: Chip processing power will double every 18 months.
Metcalfe`s Law: The power of the Internet is equal to the square of its nodes.
Gilder`s Law: Bandwidth (the communicative capacity of networks) will triple every year for 25 years.
Law of Disruption: Technology changes faster than social behaviour.
Law of Diminishing Firms: Connectivity negates the reason to employ or to attend work.
Law of Transformation: Bit-based companies are more susceptible to rapid transformation than atom-based companies - banks vs railroads, for example.
In the columns that follow we`ll debunk the myths of share price valuation and discover how to increase share price value and - more importantly - how we can keep it growing in perpetuity without breaking the laws of the new economy and the new rules of performance.
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