Friday, July 18, 2014

The Importance of Share Price by Koon Yew Yin

Another valuable and great advise by KYY on investing in share market.
 
Author: Koon Yew Yin | Publish date: Sun, 13 Jul 00:26

Koon Yew Yin

After having being a company director for a long time and having read hundreds of analyst and company annual reports in search for good public listed shares for investment, I think I have some knowledge and experience to share with you. I hope this article will benefit all investors and I also hope company directors can get some ideas to create more value for their shareholders.

The price of a share is indeed an interesting item. It had brought joy to many and brought tears to just as many, if not more, investors.

There is a classical saying ‘good management produces good share price and bad management produces bad share price’. When you select a share to buy, you expect to gain from the dividend and the appreciation of the share price; both of which are important catalyst to move share price.

Share price is an indicator about the health of the company. Increased profits, for example, will drive the stock price up; excessive debt, for example, will drive it down.

The share price has a profound effect on the company overall: for example, a declining share price will make it hard to secure credit, attract further investors, build partnerships, etc. Also, when employees are often holding stock options, a declining share price can severely dampen morale. In an extreme case, if the share price plummets too far, the company can be delisted from the stock market.

It is every clever businessman’s dream to list his company in the stock market to get more capital to expand his business. An initial public offering (IPO) is the way most companies get their shares traded in the stock market.

However, companies often go to market again and again to issue/sell more shares, after their IPO to raise more money to expand their operation. A clever way is to issue rights to buy the share together with bonus and free warrants which would encourage more investors to buy their shares, thus pushing the original share price higher.

Besides these secondary offerings, some smart companies issue shares to acquire land, factories or competitors to expand their operations to benefit shareholders. Unfortunately I seldom see companies making use of the advantage of their listed status which is like having a license from Bank Negara to print dud notes.

Why don’t they take advantage of this privilege of printing dud notes to acquire assets more often?

When a company goes back to the market to raise additional funds for expansion, the share price of the company's existing shares that are being traded is a good indicator of what they may expect to get for a secondary offering of shares.

To get the same amount of money, a company with a higher share price will require to issue less number of shares than another company with a lower share price bearing in mind that all the new issues will dilute existing shares of the company.

Also, consider corporate acquisitions: When one company wants to buy another, instead of the transaction being entirely in cash, there is often an equity component, which involves swapping shares of the company being acquired for new shares in the acquiring company or merged company. In that case, the values of the shares in the public marketplace also matter, to provide relative valuations for the companies, etc .

We often see examples of many companies where corporate exercises can sometimes undermined the value of share price, especially in cases where a company's profit growth is challenged. In situation like this, it shows that management is unable to make use of the funds raised to increase future earnings vis-a-vis the value of the business, leading to a destruction in shareholders's value where the dilution outweighs any advantages.

The importance of share price will therefore be valid provided the following conditions apply:

1. The business in question must in the first place be a well run business with consistent profit growth where the increase in share price is in alignment with the increase in the value of the business.

2. Any corporate exercises undertaken by leveraging on the "share price" (underlying value of the business) will be advantageous in increasing shareholders' value provided that the potential increase in the value of the business outweighs the dilution impact of the corporate exercise. (This is where management's expertise and judgement comes in. Very often, the entrepreneurial type of management has the ability to conjure up deals that tend to increase the business value more than the dilution impact, leading to an increase in shareholders's value. This is because entrepreneurs are instinctively able to see the "wood from the tree " and are able to make decisions that effectively increase shareholders' value. Education and qualification are helpful but not a pre-requisite to be enterprising.

If these two conditions are met, all good management should, in my opinion make full use and take advantage of its share price to grow and expand the business. The ability to use the share price or value of the business to finance the growth of the business is always an option that should be explored as long as the exercise can improve shareholders' value. Failing to do so is akin to not optimizing the resources at management's disposal to act in the best interest of the company.

Bear in mind that when you select shares you should not be unduly impressed with higher educational qualification of the members of the Boards. There are some CEOs with very impressive university degrees cannot perform and yet shareholders cannot remove them because of their controlling share holdings.

Good companies invariably have good businessmen or entrepreneurs as directors. Clever businessmen do not necessarily have tertiary qualifications e.g. Tan Sri Yeoh Tiong Lay of YTL, Tan Sri Lim Goh Tong of Genting and Tan Sri Teh Hong Piow of Public Bank.
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