Stock market prices are often taken as the gospel truth, until they are not. Today’s price of any stock – bought through a stock exchange, over-the-counter or in a private sale – bears no necessary correlation to the stock’s price tomorrow or two weeks from now.
So why have we built a mighty fortress of global finance on possible falsehoods? The first asset bubble and crash of stock valuations was the tulip mania of 1637, right at the start of capitalism in its birthplace in Holland. Our market valuations are no more “true” today, nearly 400 years later.
Just ask those who bought the stock of Uber or Lyft when those companies listed their shares for public trading. The initial offering price immediately dropped as the market followed the preferences of buyers.
The May 28th edition of the Wall Street Journal carried a story that the price volatility of stocks has become such that judiciously picking individual stocks will bring more profit than “throwing money into index-tracking funds.” Stock pickers make their own valuations of shares company by company, competing to be more perspicacious about future prices than other market buyers and sellers.
After the collapse of credit markets in 2008, I was educated in price theory by Suppiah Dhanabalan, then Chairman of DBS Bank in Singapore. Reflecting on the bubble and collapse of prices on securities tied to American sub-prime mortgages, Dhana said “prices are only nominal.”
Nominal – in name only; in appearance but not in essence.
So, to some extent, the essence of financial markets is speculation on appearances, on what others think is the “right” price. And as we have seen since 1637, people have different ideas about what the “right” price of a stock should be. The fact that a market reflects one price today has no bearing on what people will think the “right” price of that security will be in the future.
Consider: what is the right price for a share of Tesla stock?
On May 24th, Tesla stock closed at $190.63, down 42% for 2019, a loss of $30 billion in market value. Tesla’s shares now have a negative return over the past 5 years. Two analysts predicted the stock would fall lower, to $36 per share.
The reality of Tesla is that it has spent $10 billion since 2011 on running its operations and has only made a profit in 4 quarters. It has funded its going concern costs with infusions of capital from trusting investors. What will happen to its share price when investors no longer believe that the company will be profitable someday?
Consider Uber. The company raised $8.6 billion between December 2015 and October 2018 at an average cost to investors of $48.77 a share. Uber shares now trade about $40 a share.
Other companies which went public but now see their stock trading at prices lower than what investors paid in private placements before the public listings are Snap, Dropbox and business software maker Cloudera.
Lyft’s stock price is higher than what early investors paid in private offerings but it is down 19% from its March 2019 public offering.
Why the gap between hope and reality?
With Uber and Lyft, “There is no profitability within sight even with binoculars and that’s been a tough pill for investors to swallow,” said Daniel Ives with Wedbush Securities. “It’s a totally different ballgame trying to get public investors around the valuations,” he added.
Uber lost $3.7 billion in the 12 months through March.
Since 2014, startups Tencent Music, Meituan Dianping, iQIYI, Sea, Pinduoduo, Uber, Snap, WeWork, Lyft, Spotify, Pinterest and Dropbox have cumulatively lost nearly $47 billion.
In the San Francisco Bay Area, there are 88 startups each valued at more than $1 billion.
The Economist magazine looked at the financials of 10 such highly priced startups, finding that while their sales have doubled since 2017, operating margins average a minus 30%. So, the more they sell, the more they lose.
How do you put a “true” value on such companies?
If we can’t accurately price a company, how then can it be managed for optimal advantage to its owners, customers, employees and society?