Sunday, December 23, 2007

Manage your business and your stock price will take care of itself.

If a business does well, the stock eventually follows. - Warren Buffett

If you manage your business to control your stock price, then your business is your stock price. If you manage your business to produce (and sell) your product, then your business is producing (and selling) your product.

Companies issue stock to raise money. Generally, the money is used for capital investment to produce a product. If you’re not raising capital, why issue stock? With the advent of executive stock options, the price of stock and not the level of profits determine compensation for the top executives.

Investors used to use a company’s profit as part of the equation to establish “market value” for a stock. Now, investors seem to be using an estimate of what other investors might pay for the stock tomorrow.

As this is written, initial public offerings (IPOs) for companies expecting to sell over the Internet are selling for several times their IPO price without the company having made a profit. The feeling of investors seems to be, “We think they’ll make money sooner or later, but we think someone will pay more for this stock tomorrow anyway”.

In the late 1950’s and early 60’s, there was a rush to “conglomerate” creating large “holding” companies with many divisions having little business relationship to each other. This diversity was supposed to be hedge against the downturn of a single business unit. That is, if washing machine sales were down, cell phones would be up. By the early to mid 1980’s, companies were shifting back to their “core competencies”, that is, re-focusing on washing machines and selling the cell phone division. Stock prices jumped in the 60s as companies merged. Then the same stocks jumped again years later when the company sold those same acquisitions, sometimes after losses.

The investor has a different set of priorities than the manufacturer. Your company has to decide who its customer is; the investor in its stock or the buyer of its product. This decision-making process gets thrown out of whack when the manager’s compensation is keyed to stock prices and not directly to profitability, sales, or production.

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