Some companies pull in enormous profits quarter after quarter and deserve the loyalty of the buyers of their stock. For example, Apple Computer (AAPL) regularly reports profits that beat analysts’ expectations by significant margins. Apple’s stock price has dropped significantly from its high of over $700 a share despite continuing to beat expectations, and more importantly, despite continuing to rake in huge profits.
What about companies like Google or Priceline? Do their stocks deserve the high dollar price? Indeed, do their stocks represent the value of the underlying company?
A company goes public and raises money by selling a number of shares at a given price. The perceived value of the company on the date of the IPO, its products and services prior to the IPO, and more importantly, the perceived value it will have after the IPO all play a part in determining the company’s stock price. The IPO might be heralded with a lot of fanfare (recall Facebook), with the pundits emphasizing what the company has done heretofore, how valuable it is for the many users of the company, and what market penetration it enjoys as a precursor to its future potential. With that kind of hype, the underwriter expects the IPO to bring in a lot of money.
How is Value Assessed?
After the IPO a company must perform. It must show the public that it deserves its price. Retirement plans, mutual funds, and large institutions must have confidence in the prospects of the company to produce as expected. If the company does not perform as expected, as measured by earnings in subsequent quarters, the stock of that company will be sold, sometimes aggressively, by both retail as well as institutional investors. This creates a vicious cycle in many cases, in which the mere drop of the stock price instigates continued selling.
But beyond quarterly earnings and whisper numbers (say, 30 percent of perceived worth), beyond how many widgets a company produces (another 30 percent), or how deep its market penetration, how established it may be in emerging markets (40 percent) – beyond all these tangible matrices is something known as goodwill.
Goodwill is an intangible factor that might be compared to reputation. For example, service cannot be quantified, but it can be qualified and a company’s reputation rests on the overall impression the public has.
When BP Oil suffered that tragic spill three years ago, there was little spoken in the media about the 13 people who lost their lives in the tragedy. What was discussed at length was the amount of oil that continued to flow from the ocean depths. Most astoundingly, BP’s chairman at the time Tony Hayward, appeared completely indifferent and insensitive to the tragedy when he said “I just want my life back” in an interview. That seemed to have struck the death knell for the company in terms of goodwill. The company’s stock fell hard, and perhaps deservedly so.
High Stock Prices/Low Profits
But what about the companies that continue to sport high stock prices yet whose profits seem too low? Amazon is one such company. Institutions and retail investors alike seem to love it, and continue to hold up its high stock price by buying Amazon stock aggressively, in spite of the underlying company itself is not that profitable.
People seem to trust Amazon, not only the model of selling online with a minimum of headaches and a maximum of services in the form of easy returns, easy payments, easy credit, but also the promise of future gains, increased services, increased ease of doing business. Jeff Bezos has shown himself to be a master businessman, a visionary, and a rather conservative man on the personal front. He has created a company that seems to be direct, concerned with people’s needs and wants, caters to those needs, and constantly positions itself to listen to the customer.
That is goodwill, and although it cannot be quantifiable, it would certainly rank in the top 70 percent of a company’s value in the eye of its investors.
This article was written by Richard Craft, an MBA student who is sharing more of his financial knowledge with you so you can make better investments. He writes this on behalf of KEL Credit Repair, your number one choice when looking for credit repair services. Visit their website at www.kelcreditrepair.com for more information on what they can do for you!