Real value

May 30, 2013

The View From Taft

BusinessWorld

Benito L. Teehankee

A GENERAL euphoria is sweeping the middle and upper classes as the economic performance of the country impresses the ratings agencies enough to give us our first ever investment grade status. The stock market continues to ride one of the longest bull runs in memory, breaking record highs again and again and delivering almost a 50% return for those who invested a year ago.

Even young people have gotten interested in buying stocks. I have heard teenagers talk about stock investment like it’s the most ordinary thing; they even do their transactions online! Certainly, this kind of interest in the financial market is unprecedented in our country. Could this be the beginning of a real breakthrough for us? Could this be the final transition into the development that we have been trying to achieve for so long?

I wish it were so, but any celebration would be premature, to say the least. In the first place, history has shown that any euphoria related to the financial markets can turn into delusion after some time. A business boom can turn into a bubble waiting to burst. We need to look carefully at what is driving the financial markets to make sure that we aren’t fooling ourselves.

A few key questions can help us see through this situation. Let’s start with price. Are price and value the same thing? Does a highly priced stock indicate a valuable company? The simple answer is "No." Many things affecting the price of a stock have little to do with the value of the company itself. A general positive sentiment in the market, investment funds flooding into the country with nowhere better to go, company hype, and herd behavior, among others, can push a stock’s price higher than what it is really worth.

Real company value comes from basic things. How good are the company’s products and services? How well are these doing in the market? Are there more coming down the pipeline? I’m amazed at how many people are willing to believe that they are investing in a good company without knowing what the company has under development. If MBA students need hours of research and several cups of coffee to evaluate the soundness of company, how can a teenager know enough to invest in a company just by looking at a website and the graph of the stock price?

But shouldn’t the price be based on the company’s profitability? This is true only in a limited sense. Profit is history. It’s what the company has achieved in the past, not what it will achieve in the future. Profit itself is a product of accounting decisions made by the company and is often subject to window dressing. An investment should be about returns expected in the future. So buying a stock based on past profits alone can’t be a sound decision.

Real value depends on the quality of a company’s governance and management. We have seen time and again that today’s darling of the business press can be tomorrow’s pariah if the directors and managers of a company are untrustworthy. If the company’s leaders focus on enriching themselves at the expense of other stakeholders and the community, the company is actually destroying total value to benefit only one group -- shareholders.

Real value also depends on how a company develops its people. We know that future returns come from innovation, and only good people can generate a sustainable supply of good product and service ideas. Does the company have a positive work culture? Will it attract the young talents coming out of schools who are tech savvy and full of idealism?

I like beer. When I pour my favorite brew into a glass, I never confuse the level of the froth with the actual level of the beer. In a business boom, prices rise to frothy levels, and it is a certainty that they will come down at some point.

In the business literature, there is a term for an economic scheme that relies on positive sentiment to get more people to buy in and thereby drive the returns higher for those who came in earlier: a Ponzi scheme. Let us continue to ask the tough questions to make sure that our financial market is based on real value creation.

Real business value comes from companies that have good products, that create wealth for all, and that provide good work for people. I hope that the favorable business climate we are enjoying now will encourage the creation of more such companies. If not, the lesson of history is crystal clear: what goes up must come down. Everything’s price eventually settles to its real value.

Dr. Teehankee is the chairman of the Management and Organization Department of the Ramon V. Del Rosario College of Business of De La Salle University. He may be emailed at benito.teehankee@dlsu.edu.ph. The views expressed above are the author’s and do not necessarily reflect the official position of De La Salle University, its faculty, and its administration.