A wise man once said “Price is what you pay and value is what you get.” Whilst Mr Buffet first said this back in the 1980’s, this still rings true today, particularly in what seems to be a new normal of turbulent capital markets that is often driven by factors other than fundamentals.
Take for example the short-term sell-off in global equity markets in late September 2015 due to a research report on Glencore that calculated a nil value for Glencore in an unlikely scenario of static long-term commodity prices. This report caused a 30% fall in the share price of Glencore and a 3% decline in the ASX All Ords (c $55 billion) despite no changes in underlying commodity markets. However, investors immediately realised that this doomsday scenario may have been overly pessimistic and the share price returned to the pre-rout price within 2 days.
This is not a unique scenario. The recent plunge in the Chinese share market provides another example of extreme price movements not entirely driven by fundamental factors. The ‘Flash Crashes’ from program trading are another. These are obviously extreme examples of investor and market behaviour but clearly demonstrate that ‘price’ and ‘value’ do not always equate.
These ‘value gaps’ can result in undervaluation or overvaluation (although bad news seems to travel more quickly when it comes to capital markets) and can persist for a variety of reasons including:
- Information gaps – either from lack of access, understanding or acceptance of information
- Sentiment and momentum for an asset class, industry sector or particular company
- Lack of liquidity
Understanding the value of your business and any divergence to pricing is important for boards, CFOs and business owners for a number of reasons:
- Making decisions about when and where to deploy capital. For example, share buy backs for undervalued companies may provide the most optimal returns
- Ensuring timely decision making for unsolicited takeover offers or other corporate activity
- Educating investors and other stakeholders by clearly communicating and, if possible, bridging any mis-pricing of your shares and/or underlying assets/business units
Our team has a unique balance of commercial and technical skill sets and often assist clients (listed and unlisted) in understanding the value of their business (or business units) to assist in strategic decision making. Recent examples include:
- Valuation advice to the board of a mid-cap ASX company on the fundamental value of its shares and reasons for the current valuation gap to assist the board in determining the price at which they were willing to buy back shares
- Assisting the board of a mid-cap listed company understand the intrinsic value of its business, and business units in preparation for potential unsolicited takeover offer
- Assisting a $10 billion+ company assess the reasons for the difference between its market cap and underlying value