It’s time for a vote of no confidence in the stock market!

This is not as passionate as it might be because I don’t own any stocks. I did play around with them many years ago and came out more or less even. I didn’t enjoy any massive increases, nor did I suffer any major losses. I decided the whole thing was silly when I chose to temporarily hold some cash gained from a sale with my stockbroker in the form of shares in Marks & Spencer. Shares in M&S had been very slowly rising for the last 3,000 years so to my mind this was not far different to keeping the money in a jar in the kitchen. Very shortly after buying the shares, M&S suffered the beginning of what has now been a very long fall from grace and the stock fell for the first time in living memory! Deciding that I must be jinxed, I have not bothered wasting my time and money since. Mind you, at these prices I have to say that I’m very tempted to get back on that horse.

Anyway, that’s not the point and if I had my way there would be, temporarily at least, no stock market to process my purchase. My point is about the currently ludicrous values of stocks and how in the majority of cases these prices cannot possibly reflect the true value of a company.

Let’s look at a company I know quite well, Acme RE (not the real name), it is in the real estate/professional services sector. According to the stock market/share price Acme RE is currently worth 26.5 million GBP and the likelihood is that it will be worth even less at the end of next week. This is a company who’s revenue in the year ended April 08 was 450 million GBP and where a profit margin of at least 10%, 45 million, is expected and usually delivered. The company is obviously being affected by the munch-bunch especially in the high-end investment side of the business where the availability of large sums of money is key. However, the business is well diversified and other parts of the business are still trading well and will continue to do so. The company is well placed to take advantage of the opportunities the munch-bunch will throw up as well as helping clients who are still investing to seek out the best quality deals.

Acme RE is being affected no more than its competitors and (although this is hard to back-up because everyone is keeping schtum) my guess is that it is affected considerably less than its most direct competitors – the top three such companies in the world. I say this because the top three are the top three because of the significant volume of their business generated in the USA and with global corporates, neither of which are good places to be right now. Acme RE are the biggest in China and the Far East generally as well as being very significant players in the Middle East, UK and Europe and with a growing business in the USA.

When one company looks to acquire another, if the target is not quoted on the stock exchange, they usually take a view on various important issues and then apply a multiple of earnings (EBIT). Lets say that Acme RE has a historical EBIT of roughly 20 million GBP and potential for much more in the (medium/long term) future, it would not be unreasonable to value that company at say 100 million GBP. So, why does the share price currently value Acme RE at around 25% of that?

The answer, I have to assume is because everyone (responsible for share prices) is running around like chickens with their heads chopped off, taking microscopically short term views and taking “better safe than sorry” to new levels of incompetence.

This would not be anything to worry about if the share price was just an arbitrary guide number that wasn’t really that important but it’s not. Incorrectly valuing a company in either direction, especially by large amounts, can have a very significant impact for example;

  • restricting a companies ability to either survive or to grow
  • significant value gained or lost by shareholders possibly leading to bad decisions
  • either preventing or encouraging take-over to a much larger degree than it should

I understand that these are difficult times and that some account of the much-bunch needs to be taken in most companies share prices as most companies will be affected by it. Can’t help noticing better than expected results posted by the Royal Mail and Microsoft in the last week though, so it’s not all bad news! What I am quite certain of though is that my example of Acme RE is not an isolated case and that whoever is in charge of setting share prices is doing a damned awful job right now. Such a bad job in fact that people are starting to ignore share prices because they are laughably unreal.

My suggestion is a vote of no confidence in the stock markets. Every company withdraws or suspends trading for an indefinite period and they all, en mass, demand a better system and do not partake further until somebody either gets some sense into their heads or comes up with a whole better way to value companies. One that really does reflect the true picture of a company’s present and future potential over a time span longer than a gnats cock.

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5 thoughts on “It’s time for a vote of no confidence in the stock market!

  1. OK, it’s an attractive idea to avoid huge downward swings in the market. If for no other reason, to help those who have been forced into privatized retirement schemes and do not have the wherewithal to manage those funds. These are the people who suffer the most at times like these and the stories are tragic and dire.

    But by halting trading or setting a floor price for shares according to some valuation formula, aren’t you reducing the liquidity of funds? Again it would be the least affluent who would suffer the most. If you have a personal financial emergency and have to sell stocks to put food on the table today, a closed market obviously does not help. This would also apply if an artificial floor price were set. Let’s say Acme floats at, say, 30 pounds per share today and from tomorrow, the minimum price is set to 50 pounds to better reflect book value of the company. It’s likely that the problem would become finding willing buyers for the shares. Then the hungry guy with shares to sell is screwed again.

    It may seem counterintuitive, but book value or market capitalization of a company does not always correspond to earnings potential. It probably makes sense since you are making a big assumption about Acme: that it will continue to enjoy profits similar to today’s levels. And it may be a good one since you know about property. Share values incorporate perception of risk into their prices (which is often very subjective, as we are seeing now quite clearly).

    Look at the airlines for a good example, even in normal times. They have it far worse than Acme! Their market capitalization is often far less than than the sale value of a fraction of their aircraft. So in theory, you could buy the airline, close it down, and sell off the aircraft at a nice profit. Why? Because it’s a ruthless business with thin profit margins, and today’s BMI could be tomorrow’s Swissair with just one horrible crash.

    Another thing – I’m not sure how your system would work. Companies calculate their financial positions only a few times a year, and share prices in a free market move daily. Would it not be possible for price floors to become out of synch with reality pretty quickly?

    Sooo… I’m kind of curious why you don’t seem to be looking at this as an opportunity. From previous posts, I know you know to keep a cool head about residential real estate. Does this thinking not extend to the stock markets? And you probably know more than the average Joe about commercial property. If Acme is so undervalued, why not hop on? A few days after 9/11 was another great time to buy stocks and you can look back and see the results. Warren Buffet is buying up stuff left and right – usually a good sign!

  2. I’m sure you’re right, DC, it might not work but I’d really love to see every CEO making a stand like this. Even for a week.

    I am looking at this as an opportunity, just chewing it over before taking a plunge. A small plunge. More like a bath really.

    Anyway, what I need to know is “What have been the largest margins of victory in a US election in the last, say, 50 years or so?”. Reason being that I think Obama is going to break the record and would like to say so but not before I check what the record is! ;)

  3. Everyone here is focusing on the Treasury Secretary to sort out the mess. I think the focus should be on the Attorney General (top law enforcement guy). My take is that if even a small number of the right people wind up in jail, things will sort themselves out fairly quickly without a huge need for new regulation (although some for new investment products) or to reinvent the market system. Besides, it’s the right thing to do. Much of this boils down to theft.

    Well, a little sad for a Saturday night (I’m semi housebound, temporarily) but I’ll see what I can find. He’s vastly ahead in, say, New York State, but shaky in Pennsylvania which is probably a must-win. I’m worried. It’s winner-take-all by state, in case you didn’t know. And they keep making unnecessary mistakes, like using the phrase “redistribution of wealth” which makes many Americans wet themselves.

    I sure hope your optimism is well placed!

  4. Thanks, DC. Looking at the way Reagan beat Mondale in ’84 I think I’m going to have to forget any idea of ‘biggest ever’ and just settle for ‘big’. ;)

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