FINANCIAL HEALTH OF THE CORPORATION – MISSING VALUE IN SHARE VALUATIONS
BY: SHEPHERD SHAMBIRA
The previous articles discussed the essence of share valuations and its impact on share purchases and disposal decisions. The interesting fact however, is that even though an investor should normally buy or sell shares on the basis of the share value, there is evidence of investors acting in a way that does not reflect this perception. Some investors simply follow the crowd. This means that the investors do not necessarily seek to make decisions on their own, they watch the direction in which other investors are moving and follow. The argument is one of democracy, where it is believed that the majority rules because they are right! The market in this instance is driven by sentiments of investors and such sentiments are not always based on logic. The key driver of sentiment is usually the public relations function and companies with excellent public relations records will normally ride on good sentiment in capital markets.
The perception of investors when they assign value to shares is based on various factors. For example, the performance of a company is based on financially measurable targets and non-numeric targets. Non-numeric targets like the quality of service are a critical driver of value in any organisation. However, it is difficult to assign a financial value to such a measure of performance. When you visit a bank for example, you may be offered a comfortable seat and water while you wait to be served. However, when you visit another bank, you may actually be offered an even more comfortable leather seat and choice of soft drift and snacks while you wait to be served! The position here is that the latter bank may be perceived to be offering a better quality service by virtue of the improved nature of service and facilities. The staff in one bank may be very friendly and generous with smiles and greetings and these counts for quality of service. The concept of quality service encompasses several issues which may not be easily measurable let alone comparable between different institutions and over time. However, investors and customers alike, establish a worldview of an organisation’s state of quality of service over time. Consequently, when investors assign a sentimental value to a share, it is a reflection of their valuation of the organisation’s non-numeric performance.
The previous articles discussed the concept of a net asset value and alluded to the valuation of a company based on expected future cash flows. The expected future cash flows and future profits are a subjective measure of performance. For example, the firm’s ability to deliver in future will depend on its ability to satisfy customer demands and maintain market share. As discussed above, the perceptions of customers regarding quality of service has a bearing on the investors’ view of the company’s value. The other dimension of performance which must be assessed is innovation. A company which is innovative normally stays relevant in its business environment. However, it is not always easy to assign a numeric value to the level of innovation in an organization and reflect this in the share value. The interesting fact, though, being that the true value of an innovative breakthrough may result in outstanding financial benefits to the firm.
The concept of valuation of intangible assets such as goodwill and product brands has been a subject of debate for some time now. For example, the goodwill of a company may be due to the current employees’ abilities and personal relationships with customers and suppliers. The elements of a business balance sheet are normally deemed to be assets, capital and liabilities. The fourth factor of business is labour and it is unfortunate that this factor is not reflected in most balance sheets. However, there appears to be no conclusive agreement on the approach to recognize this value in the published financial results of a firm and consequently the firm’s market value. A number of different and discretional treatments are used to account for non-numeric performance of companies and for the value of its intellectual capital. This position makes it difficult for one to say that there is an absolutely correct share value which will be acceptable to all stakeholders at any one point in time. There will always be a range of values and that is why investors always have opposing views about particular counters. Some are selling presumably because they consider the share overvalued while others are buying the same share trusting that it is undervalued! The absence of consensus on share valuations may be sited as one of the good reasons driving the capital markets.
This article is published for general investment advice and it must be noted that the price of
equities and the income derived from them can rise as well as fall. Neither First Mutual Limited nor the author shall be held liable for any losses as a result of the investment advice
contained in this article. It is important that specific investment advice is sought as each
investor’s investment will be dependent on their circumstances.
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