When Stocks Decline in Market Value
“…So when at times the mob is swayed
To carry praise or blame too far,
We may choose something like a star
To stay our minds on and be staid”
- Robert Frost “Something Like a Star”
Keep in mind, as you read this, a very important distinction: the distinction between a company’s market value, as opposed to it’s true, intrinsic value.
In today’s fast paced world, dominated by “efficient markets” and the near instantaneous delivery of information, it seems to me that there are more emotional and psychological factors that affect market movements than the cumulative effect of either improving or deteriorating factors that cause changes in the intrinsic value of particular companies.
There are any number of reasons that might explain the decline in market value of a particular company; here are a few of the most prominent:
- The company is swept up in a general market decline, as in the recent financial and credit crisis, and what is happening now (late July – early August, 2011), which is a combination of the US fiscal situation and negative economic news that has some economic forecasters giving probability to a double-dip recession). In this instance, otherwise good companies get “swept up” in the emotional elements that often drive the market, in contrast to the staid and unchanged fundamentals of the particular company itself.
- The company is caught up in “out of favor” sentiment for particular industry segments. This has to do with those companies that operate in cyclical industries or those who operate in industry segments that may temporarily be in “out of favor”; (think large money-center banks which were at the center of the financial and credit crisis, and still today are lagging, having not returned to pre-crisis levels nearly 4 years after the events and whose share of the S&P500 has shrunk dramatically).
- A change having to do with “analyst expectations”. We see this most often in the publicized affect of a company “missing earnings expectations” (negative); or “beating earnings estimates”, (positive). Generally, after these announcements there can be significant price swings that largely dissolve in short order.
- A change in market value for a company having to do with either a “negative”/”positive” circumstance which is particular to the company (for example, when a Best Buy misses same store sales growth, a perceived “negative”; or when Apple sells more iPad's than was “expected”, a “positive”).
- A change in the earning power, or financial structure of a company, which affects the intrinsic value of a company; or when an investor has misjudged intrinsic value on the buy, and the market, over time, adjusts the market value to the lower intrinsic value assessment.
As an investor, which of the above is the more troubling?
Granted, the changes in market value having to do with any of the items #1-4, can be cause for the investor to indulge in large doses of alka-seltzer, for sure. However, most companies that have been in existence for a long time period, will have suffered declines in market value for any one of the 4 reasons cited in items #1-4 above, without ever affecting intrinsic value. Good, resilient companies with provable business models, and track records, more often than not recover from any of these, albeit, depending on the DNA of the company, at differing recovery rates.
The long-term history of the market is that even what at the time seems like a “new normal” and there are large, significant changes in market value, (most recently, recessions, the tech bubble, the financial and credit crisis), these all appear as mere blips when viewed in the context of greater time. But no doubt, living it causes us to believe that we are in for a seminal change, when in fact it is very much like getting caught up in a terrible storm that seemingly lasts forever, and all of the angst prior to the storm hitting, then experiencing living through it, only to see that after a while there is indeed a return to calm, blue skies.
The macro events of today, the several trading days of negative market value changes and the effects of the possibility of a double-dip recession and the continuing fiscal status of the U.S., should all be viewed in the context of the immediately preceding paragraph.
However, it is the change in market value deriving from item #5, that one should most concern oneself with, (assuming that you are not forced to sell into the dips in the market). Changes in intrinsic value and/or the miscalculation of intrinsic value at purchase represent the real risk of investing in equities. If, on the other hand, you own good companies, and have correctly assessed their quality and intrinsic value, and have purchased at a price below the intrinsic value which affords a “margin of safety”, then the temporal affects of changes in market value which are macro and even perhaps extraneous, are just something that we have to endure as we move toward the market realization of the true value of the company.
The takeaway from this: The important characteristic of “expanding intrinsic value” that some companies possess, is alive and well, despite Mr. Market’s tantrums and personality defects. If you own good companies and are assured of their quality and financial strength, then hold on and try not to fret too much over the daily price changes of the stock indexes, even though the variability might persist for an uncomfortable time period. And try to do as Frost admonishes, above, “choose something like a star, and be staid.”
Michael Kindred is a former CFO and board member of a public company with a degree in economics and finance. He has held various positions with major financial institutions and investment partnerships. He is developing the soon to be available website http://www.knownothinginvestor.com. The site is being developed as a resource for individual investors to help them identify financially strong (weak) companies. He also consults with small business owners to create long-term sustainable value for their companies, which enables the enhancement of the personal net worth for them and their families. Michael's email is firstname.lastname@example.org