Many people say that we are now passing through a serious stock market bubble. They are probably right if one only looks at the top ten shares traded in the Dhaka Stock Exchange. In particular two mutual funds have really topped the list of bubbles to the extent that the fund manager was forced to reveal the underlying asset value, a fraction of the traded price. Then again a new banking listing has hit the roof. People say that new investors' who are financially illiterate are doing this. One expects the ignorant to do all kind of stupid things. But then again if one reviews the history of bubbles and market crashes, one will find that financial illiteracy being a prominent cause of the 'band wagon effect' in both developed and underdeveloped countries.
Right now all efforts are being made to tell investors about the facts of fundamental value of shares. Does he understand this jargon is anybodies guess? But the fact is what is the price of equity? What is its value is a question, which has often bugged investors. There are many approaches to the matter but what remains unresolved is the mindset of the regulators who often get confused by the issue of price protection often provided by marketers of consumers' products. In most cases price is a mindset based on psychological considerations. What is the price of a child? What is his value of a human life? Parents and the government will have very different views on the matter.
While theoretical approaches are helpful and given for determining the "hypothetical" value of an equity interest, there is a distinct difference between value and price. Value, in general, is what an appraiser estimates the value to be under a given set of assumptions, facts and circumstances at a given valuation date. This is most common when determining a hypothetical value for purposes of wealth planning, litigation, stock issue plans, property and other situations.
Price is what someone actually writes a cheque for and closes the deal based on a negotiated value. This is the market driven price at which a transaction actually closes. One thing is clear-the market drives the price of listed companies when it comes to an investment and/or a transaction for a merger or acquisition.
Professional investors-such as venture capitalists, corporate venture funds and buyers of private equity interests and companies-will use sophisticated valuation models, some "text book" and some proprietary to determine their estimated value. But when it comes right down to it, the price they ultimately pay is a function of the marketplace at the moment and their target rate of return on investment (ROI). There are times when the theoretical or model approaches can come up with a number that if the investors put their money in at that value or price, the target ROI could not be achieved. This is where negotiations, knowledge and experience come into play in the form of valuations.
There is an art form to the valuation process for equity financing that require "gray hairs," to coin a phrase for experience and knowledge of the dynamics of the market at the time of the valuation. To do this, the gray hairs must be in the deal flow and understand the perspective of both the buyer and seller. It is more than just subscribing to a database with transaction records. I recall that one international fund had a database on capacity utilization and cost of production of all cement plants in the word. This was its basis of valuation. Another looked into the locked in assets of the company and was particularly fascinated by the land bank a company claimed to have. Thus valuator or appraiser must be able to drill down using their intellectual capital to interview industry contacts, the technologist that understands the basics, the banks who financed the last similar company, competitors, analysts, specialist researchers and academics, among others.
Valuations can be expressed in one word-judgment. The ability to look at a formula result and say, "This is not right." The ability to sit in a room of experts and come to a mutual agreement that the number is X and not Y and justify ones position based on market evidence. And finally to have to the confidence in the result to write a cheque or put ones name on the bottom line and stand up with conviction on ones number and judgement.
Then what is the market like today? It depends. It depends on the industry, the segment of the industry and the appetite of the buyer for what is being offered. In this respect the stock market changes like a weathercock with the direction of the wind. This is an amazing place and never ceases to astonish everyone with its ability to remain inconsistent and often recover and move on with blistering speed. With the masses continuing to discuss the old news of the bubble bursting, exciting new developments are taking place behind closed doors and this place is still a hotbed of innovation and exciting news about new companies. People forget the past and look at what is in front often at a cost to them. But this inconsistent market is what appeals not only to the professionals but also to the mom-pop investors who often burn the fingers by chasing the illusive yesterday's price of the shares.
