Question on the nature of the value of shares

[robusta]

It is not impossible, you simply have an identical copy of comsec, but without the term 'actual own a share of the company' involved, and none of the listed companies have dividends. Then it is exactly the same, and people can trade their shares in the imaginary companies.

Or we could all invest is fairy dust, sounds great to me.

After all, what is the difference in terms of the price action against the equity? You can have all the news about the companies, what they are doing etc, and people can use this information to decide the value of the shares - but like real share it is their trading decisions alone which actually set the price of the share.

I like to call this a "market" where the price I get is what someone else is prepared to buy or sell the share. This is based on trading decisions.

Another example - we sell shares in "Sweden" - yes the actual country. We then say 'you own a part of all the assets and liabilities of Sweden'. And people then trade these shares, based on their opinions of what would value Sweden, since it is all fictitious any way and there is no way to retrieve the equity of Sweden promised by the share directly.

I don't know a lot about it but are currency and bond markets a reflection of a country's value?
Maybe you are trying to make a point about speculation, you could probably sell mining rights on Mars, or Tulip futures but are they a good investment?

However, the one thing I can think of which might give a share real value (tying it to its equity) is the fact that the men with lots of the shares CAN exercise control over the company via voting, thus the minor holdings of shares by many are linked to the major holdings, and thus to those who can do as they wish with the equity.

Or maybe a share (or part ownership) in a good company that makes a profit and has a better than fair chance of making more profit's in the future could be worth something.

Well the share I bought does in fact have a dividend, albeit tiny. But yes you see my point - it has value mostly because it is traded rather than the equity behind it, kind of like fiat money.
Cheers

Hey we all live with fiat money. Do not discount the human desire to gamble and speculate.
The first rule I look at for a company for my investments is it must make a profit. That does not stop a heap of stocks that are engaged in drilling holes in the ground, developing new drugs... from trading on the ASX. A lot of people make money on these stocks, for me I call them speculative and value them at $0.00 This does not mean they are worthless it just means I cannot find a logical way to value them.

On the subject of fiat money how do you value one good old Australian dollar?
We could argue it is worth next to nothing or it could save your life.

 

[So_Cynical]

XYZ goes up XYZ goes down...the price of XYZ changes at any measurement of time, often ending up at the same price at different moments in time and all the time not reflecting the real "value" of XYZ just the price XYZ is trading at, at that particular moment in time.

How well we exploit the price differences in XYZ over time determines how successful we are as traders and investors....this is how it works and any need of deeper understanding is simply over complicating the simplicity of perception, sentiment and reality.

 

[robusta]

XYZ goes up XYZ goes down...the price of XYZ changes at any measurement of time, often ending up at the same price at different moments in time and all the time not reflecting the real "value" of XYZ just the price XYZ is trading at, at that particular moment in time.

In the short term this is correct, but over the long term the price will reflect the value of the company.

How well we exploit the price differences in XYZ over time determines how successful we are as traders and investors....this is how it works and any need of deeper understanding is simply over complicating the simplicity of perception, sentiment and reality.

I find it really difficult to work out perception and sentiment but easy to work out the reality of a profitable business.

 

[tothemax6]

tothemax, it would be a good idea for you to sell any shares you have and forget about the stockmarket. You are clearly very confused. If your comments were intended as a wind-up they would make much more sense.

And you have done nothing to address my post, only criticize its existence. Thanks for nothing. My assumption is that logically, there must be a link between the equity and the shares, but I question the extent to which this link exists, and the extent to which the price action is determined randomly by bidding actions rather than the past/future valuation of the equity.

Or we could all invest is fairy dust, sounds great to me.

But this is exactly my point, you could list 'fairy dust' as a share, and people who buy and sell it in the same way as a no-dividend, no-equity-return, share, since in neither case can the shareholder exercise the use of the equity. Fairy dust can no more be exercised (it doesn't exist) than the equity underlying a share can.

Or maybe a share (or part ownership) in a good company that makes a profit and has a better than fair chance of making more profit's in the future could be worth something.

Why? You don't have access the the profits. In the case of a 1 owner company, the owner can do as he wishes with the profits, so they are worth something to him. To the 1/10000th part owner, he can't use the profits, so again, we return the issue of the link between share and equity.

On the subject of fiat money how do you value one good old Australian dollar?
We could argue it is worth next to nothing or it could save your life.

Well I value it by the fact that it is the means of exchange, and is thus the most marketable product, and hence it is high value (even though its just bits of plastic). Again, the only issues it has are the same as always - there is nothing to stop its volume increasing except the morality of men. But thats another topic
Cheers

 

[robusta]

My assumption is that logically, there must be a link between the equity and the shares, but I question the extent to which this link exists, and the extent to which the price action is determined randomly by bidding actions rather than the past/future valuation of the equity.

Are you asking about the difference between investing and speculating? To me when valuing shares if a company makes no money then I classify it a speculative and value it at $0.
With companies making a profit there is a definite link between eqiuty and the share price over the long term. Compare JB Hi Fi and Clive Peters for example. (before Clive Peters went bust)

But this is exactly my point, you could list 'fairy dust' as a share, and people who buy and sell it in the same way as a no-dividend, no-equity-return, share, since in neither case can the shareholder exercise the use of the equity. Fairy dust can no more be exercised (it doesn't exist) than the equity underlying a share can.

I actually have to agree with you here. There are a whole heap of companies on the ASX that are speculative and as a value investor I can't find a value for. This however helps me as I get to draw a red line through these shares and move on to something that will give me a RETURN on my equity.

Maybe a example would help:
Company XYZ, a explorer recently listed with 10 million shares @ $1.00 a share. We have a few pegs in the ground out the back of Oodnadatta and we are going to drill some holes and find something.

Now what is XYZ worth?

Some would say $1.00 a share as this is the equity per share. But I would value at $0 because they are going to spend that $1.00 drilling holes in the ground.

Some would say they have a 20% chance of finding something but to me this is speculation and remember I require a Return on my equity so to me still worth $0.

One year later the rumour mill cranks up XYZ have found something bigger than BHP's Olympic Dam, trading volume quadruples and the sp goes from $0.50 to $1.85

Now what is XYZ worth?

Nothing has changed it is all still speculation I still get $0.00

We could go on but you get my point. Until a resource is found and we know how much is there and the cost of extracting it the value of XYZ is pure speculation.
This goes for the new whiz bang technology or the latest biotech stock, until the product makes it to market we are speculating.

You don't have access the the profits. In the case of a 1 owner company, the owner can do as he wishes with the profits, so they are worth something to him. To the 1/10000th part owner, he can't use the profits, so again, we return the issue of the link between share and equity.

Now I must disagree with you. Take a look back at Woolworths, JB Hi Fi and The Reject Shop and you will find a direct link between the equity, the ROE and the share price over any decent period. (say ten years). Now compare these to the also rans, Coles Myer group, Clive Peters, Qantas.
The share price follows the profits on the equity left in the businesses by the owners (shareholders).

Try this example of a company retaining all profits. (this is fairly rare in Australia but plenty have a low payout ratio when in growth phase.)

Company UVW, a retailer based in Tasmania with 15 stores, we are a giftware store looking to expand on the mainland we have a competitive advantage (cheapest, best service/product range) we earn a constant 40% ROE and we are listing 10 million shares @$3.00 / share, after listing the equity per share will be $0.50

Now what is UVW worth?

At first glance paying $3.00 to get $0.50 equity does not sound like a good deal. But the chance to earn 40% compounded is too good to pass up.

Using one Roger Montgomery's formula I would be happy to pay up to $6.00 for UVW so let's see how we go.

Year 1
Equity $0.50 profit $0.20 fair value with 10% required return $6.05
Year 2
Equity $0.70 profit $0.28 fair value with 10% required return $8.48
Year 3
Equity $0.98 profit $0.392 fair value with 10% required return $11.88
Year 4
Equity $1.372 profit $0.55 fair value with 10% required return $16.63
Year 5
Equity $1.92 profit $0.38 fair value with 10% required return $23.28

Now the owner has been doing exactly what I would want to do with the profits, reinvesting them and earning 40% compounded. Sound extreme? Take a look at JB Hi Fi and the Reject shop in the first ten years after listing.

What about the price? Well it has probably fluctuated all over the place depending on sentiment and whatever. But the market cannot ignore that profit growth forever and over any meaningful period of time I would bet sp would end up fairly close to that fair value.

Sooner or later UVW will have opened all the stores they can and start to pay a dividend but believe it or not this makes UVW less value to me.

Year 6
Equity $2.30 profit $0.92 dividend $0.92 fair value with 10% required return $9.20
Look at it the other way, pay $9.20/ share to earn $0.92 dividend equals 10%return.

 

[robusta]

If the above post sound like rubbish to you let's try a experiment.
Pick any listed company you like.
Don't tell me the company name, the only thing I ask is it must make a profit every year.
Get the annual report or look on your online broker financials screen and give me:
Earnings per share, Dividends per share, ROE, book value or equity per share, payout ratio and shares on issue for a period of at least five years preferably ten and we will see how close my value for the company comes to the actual share price.

 

[dhukka]

And you have done nothing to address my post, only criticize its existence. Thanks for nothing.

Actually I've tried to address your questions numerous times, you are clearly very confused. But lets try again.

My assumption is that logically, there must be a link between the equity and the shares but I question the extent to which this link exists, and the extent to which the price action is determined randomly by bidding actions rather than the past/future valuation of the equity.

As Robusta suggests, companies that are purely speculative, i.e that don't earn profits or even have any revenues such as a mining company with a few holes in the ground or a biotechnology company with just an idea. These type of companies will almost always show no correlation between the equity in the company and the share price.

However companies such as JB Hi-Fi or the Reject Shop that have a clear track record of increasing profits and equity per share show a clear correlation with their share price and it has nothing to do with the fact that they pay some earnings out as dividends. The same phenomenon can be seen with the likes of AAPL, a company that doesn't pay any dividends.

But this is exactly my point, you could list 'fairy dust' as a share, and people who buy and sell it in the same way as a no-dividend, no-equity-return, share, since in neither case can the shareholder exercise the use of the equity. Fairy dust can no more be exercised (it doesn't exist) than the equity underlying a share can.

This is just completely false. When you own a share you own a share of the equity of the company. If, as in the case of APPL, the company continues to reap high returns on that equity and doesn't pay any dividends the stock market will assign a higher price to the shares over the long term. Sure the price may fluctuate up and down day to day, week to week but over the long term the price will reflect the increasing equity per share.

If somebody decided to list a company called fairy dust that did nothing (that is it had no business), if there were actually people stupid enough to buy the stock they may be able to bid the price up in the short term, but eventually (and I imagine in the case of a company that has no business it would be relatively quickly) it would soon be realized that the company was worthless because it does nothing. You are saying that APPL, a company that pays no dividends but makes and sells leading technology products (iphones, ipads, macs etc.) is the same. Surely you can see this is ridiculous. A share in APPL is a share in a company with high revenue generating products, valuable assets and IP. The fairy dust company has nothing, it's equity is worth nothing, whereas APPL's equity is getting more and more valuable every quarter.

When shareholders in APPL want to realize the value of their equity they will get a price commensurate with what investors are willing to pay at that time, and given the stellar returns the business has been generating in recent years that price will continue to increase (short-term price fluctuations notwithstanding). Shareholders in fairy dust limited will get nothing because the company is worthless except in the very unlikely case that someone would be stupid enough to offer a price for it.

Why? You don't have access the the profits. In the case of a 1 owner company, the owner can do as he wishes with the profits, so they are worth something to him. To the 1/10000th part owner, he can't use the profits, so again, we return the issue of the link between share and equity.

The 1/10000th part owner may not be able to use the profits but he owns a share of them, those profits are worth something, people are willing to pay for them as evidenced by APPL, they won't be willing to pay for something that doesn't exit.

 

[tothemax6]

This is just completely false. When you own a share you own a share of the equity of the company. If, as in the case of APPL, the company continues to reap high returns on that equity and doesn't pay any dividends the stock market will assign a higher price to the shares over the long term. Sure the price may fluctuate up and down day to day, week to week but over the long term the price will reflect the increasing equity per share.

OK my question is still why is this the case. It is all very well saying "X is Y", but it is never an answer to "Why is X Y?". I have no problem with the factors that modify the value of the equity (present and future), and I understand all the factors you are mentioning. But you have avoided the question by using a gap, specifically in this case "the stock market will assign". Why will it do it? You are speaking of a constant state of "should" arbitrage, in which all values are determined by what traders think "should" be the case. There must be a link between the "should" and "is", or it is all false.
In the case of a bag of wheat, the "should" is all very well, but the "is" comes from the real act of people producing and consuming wheat. The "should" cannot but help be connected to the "is". To try again to explain why I think the link can be missing in the case of equities:
Imagine a bus. The original bus owner issues 1000 shares in the bus, keeping another 1001 for himself. The shares 'title the owner to a share in the bus'. However, these share holders cannot ride the bus at a discount, they cannot hire out the bus, they cannot collect any profits created by the bus, they cannot sell any part of the bus, they cannot make any modifications to the bus, etc, etc, etc. In what way is the equity in the bus then connected to the share price? Purely by "should" arbitrage. In reality, even if it trades at $10, the share is worth $0. Yes or No?
PS, I am not having a go at you or anything, I am just determined to get to the bottom of this

If the above post sound like rubbish to you let's try a experiment.
Pick any listed company you like.
Don't tell me the company name, the only thing I ask is it must make a profit every year.
Get the annual report or look on your online broker financials screen and give me:
Earnings per share, Dividends per share, ROE, book value or equity per share, payout ratio and shares on issue for a period of at least five years preferably ten and we will see how close my value for the company comes to the actual share price.

No, 'twas a good post . I am having difficulty deducing these values from the information in the financial screen. Is there a particular book you would recommend for learning about this 'value investing', since I am more inclined towards a 'buy and hold' investment strategy than a day-trading (shudder) strategy (for time/stress/being able to concentrate on other things reasons).
Cheers

 

[ducati916]

et al

I would actually second robusta's suggestion in that you pick a company, and several people who use fundamental analysis to value stocks, can undertake an analysis of said company and provide a valuation.

For myself, I would need the name of the company so that I could undertake an analysis of the financial statements.

Should make for a robust discussion, and clarify many of the abstract issues that have already been raised.

jog on
duc

 

[dhukka]

OK my question is still why is this the case. It is all very well saying "X is Y", but it is never an answer to "Why is X Y?". I have no problem with the factors that modify the value of the equity (present and future), and I understand all the factors you are mentioning. But you have avoided the question by using a gap, specifically in this case "the stock market will assign". Why will it do it? You are speaking of a constant state of "should" arbitrage, in which all values are determined by what traders think "should" be the case. There must be a link between the "should" and "is", or it is all false.

If you understand all the factors that effect the value of the equity then how can you not understand how these same factors affect prices? In the case of AAPL the value of the business is increasing, so investors are willing to pay more for it, what is confusing here?

Remember that a lot of all traders are not concerned with value, they couldn't care less what the underlying or intrinsic value of a stock is, they may be purely momentum players following a trend and therefore equity 'values' have no meaning to them.

To try again to explain why I think the link can be missing in the case of equities:

Imagine a bus. The original bus owner issues 1000 shares in the bus, keeping another 1001 for himself. The shares 'title the owner to a share in the bus'. However, these share holders cannot ride the bus at a discount, they cannot hire out the bus, they cannot collect any profits created by the bus, they cannot sell any part of the bus, they cannot make any modifications to the bus, etc, etc, etc. In what way is the equity in the bus then connected to the share price? Purely by "should" arbitrage. In reality, even if it trades at $10, the share is worth $0. Yes or No?

It's hard to know what the value of the 'bus' is, does it make any money? Or does the bus just sit idle in someone's driveway? How old is it? Does it work? Even if the bus does nothing the shares are probably worth something because there will be a liquidation value for the bus and all the shareholders will get a piece.

You seem to have trouble understanding what a shareholding actually is. Regardless of whether the stock pays a dividend or not, a share entitles the owner to a claim on the profits (or losses) of the company. Paying dividends doesn't affect this relationship. Whether you have the ability to tell management what to do with the profits is irrelevant.

 

[Knobby22]

et al

I would actually second robusta's suggestion in that you pick a company, and several people who use fundamental analysis to value stocks, can undertake an analysis of said company and provide a valuation.

For myself, I would need the name of the company so that I could undertake an analysis of the financial statements.

Should make for a robust discussion, and clarify many of the abstract issues that have already been raised.

jog on
duc

I'll be in that. Pick a company and we shall all value it in our own way.

 

[Tysonboss1]

. Is there a particular book you would recommend for learning about this 'value investing', since I am more inclined towards a 'buy and hold' investment strategy than a day-trading (shudder) strategy (for time/stress/being able to concentrate on other things reasons).
Cheers

The intelligent investor, By ben graham.

Ben is the father of value investing.

Here is a link to a video series with the audio of the first couple of chapters.
listen to atleast the first few videos and you will gain a wealth of infomation.

http://www.youtube.com/watch?v=02_kWrNOAQk

 

[ducati916]

I'll be in that. Pick a company and we shall all value it in our own way.

There is obviously a wide variety to choose from: a resource company like BHP, a retailer like WOW, a biotech like CST, each have their own distinct analysis style [for want of a better word]

It would be quite fascinating to choose 1 [not necessarily any of these] and have the various styles of individual analysis.

I think we're waiting on tothemax6 to pick a company.
jog on
duc

 

[tothemax6]

Very well, I nominate the company Nufarm (NUF).

It's hard to know what the value of the 'bus' is, does it make any money? Or does the bus just sit idle in someone's driveway? How old is it? Does it work? Even if the bus does nothing the shares are probably worth something because there will be a liquidation value for the bus and all the shareholders will get a piece.

The bus is new and in use. And yes this is what I am getting at, liquidation is a link between the equity and the shares. Is there an example of a company recently being liquidated, resulting in the shareholders realizing a profit from the returns?
Cheers

 

[So_Cynical]

Very well, I nominate the company Nufarm (NUF).

Good choice, NUF has been thru the ringer lately, lots of issues so should throw up some interesting analysis, personalty i added NUF to a watchlist back in July 09 at $9.10 ~ watched with interest and completely made a mess of my bottom call in the NUF thread so have lost all confidence in my ability's (re NUF) to offer any analysis with confidence.....other than to say that i have put NUF in my too hard basket and prefer to look elsewhere for new entry's.

 

[robusta]

Very well, I nominate the company Nufarm (NUF).

The bus is new and in use. And yes this is what I am getting at, liquidation is a link between the equity and the shares. Is there an example of a company recently being liquidated, resulting in the shareholders realizing a profit from the returns?
Cheers

Think I understand the confusion now. IMO it is not so much the equity but the return on that equity that gives the shares value.
This makes NUF a good example.

First glance tells me I will never invest in this company. NUF seems to be in the business of destroying shareholder value.

Shares on issue have gone from 162m to 261m form 2003 until now. This tells me either shareholders have been asked to put in more money or this business has been on the takeover trail.
Profit has gone from 77m up to 149m to a loss of 34m over the same period.
ROE is terrible @ 3.2%. Long term debt of 807m!!!
This is not a business it is a money pit where owners throw more and more money in and occasionally get some out.
Things may improve for NUF but why bother punting on that chance?
Better to look at a business that is allready building shareholder value and has a better than even chance of maintaining that momentum.

OK having said all that what would I value NUF at if it could maintain the status quo and halt the down hill slide?

$2.87

Yes that's right about 1/2 the equity per share.

Yet I am happy to hold JBH @ $18.68 when equity per share is about $2.71 (that is almost 7 times the equity per share) because they can generate a 40% return on that $2.71

 

[tothemax6]

OK thanks guys, this thread has been useful to me. I will get a copy of "The intelligent investor, By ben graham" and read up. I was interested in NUF since it is a big fertilizer producer, I foresee increased food demand from Asia, and its downward trend had ceased. However if the company is a bit of a sick dog, I should probably look at its competition.
Btw does anyone know a good way to get full listings of ASX companies by what they produce (roughly)? I saw one website (http://www.australian-economy.com/) has full listings of companies and codes, but only shows the financial figures for each.
Cheers

 

[ducati916]

tothemax6

NUF it is then.

jog on
duc

 

[ducati916]

et al

If anyone can provide a link to their financial statements, that would be appreciated. Every google search takes me to a virus etc.

jog on
duc

 

[Whiskers]

et al

If anyone can provide a link to their financial statements, that would be appreciated. Every google search takes me to a virus etc.

jog on
duc

Will this do the job, duc?

http://www.asx.net.au/asxpdf/20100928/pdf/31srstn8f4jxwh.pdf