The Market Doesn’t Always Get it Right

While advocating the principles of shareholder value, I am not suggesting that good financial management will always be reflected in the share price.

Analysts and investors are working with poor quality data. The fundamentals, the financial statements, are full of judgement calls and interpretation and are silent on many of the intangible performance drivers. Moreover they record the past; it is like using yesterday’s weather to forecast tomorrow’s.

There are investors’ briefings but if you work in an organisation you see and hear things from colleagues customers and suppliers that no analyst could ever be privy to. Things which could radically alter a business or market but to which no number can be attached. And yet in these days of algorithm-based, automated, computerised trading there is an even greater reliance on quantitative data. In a sense trading is becoming even more divorced from business.

A place for the skilled trader still exists but the words of Nassim Nicholas Taleb in his book ‘Fooled by Randomness’ suggest that such an individual may be hard to identify:

“There is one world in which I believe the habit of mistaking luck for skill is most prevalent – and most conspicuous – and that is the world of trading.”

You have probably heard the terms bull and bear markets. Huge swathes of investors move as one; there is safety in the herd and it is a brave or foolish trader who bucks the trend.

In such an imperfect world there will be times when a share is under or overvalued. The very fact that so many trades take place in a day implies different opinions on the value of specific shares. When a share is undervalued a board of directors may consider buying back the company’s shares. This increases the percentage of the company owned by each shareholder meaning that they will take a larger slice of future profits – profits not yet incorporated in the share price. The support of existing investors for this move sends a message to the market that they believe the executives are doing a good job.