Corporate Finance in the News

What a week!

This was quite a week for corporate finance news. Facebook (Meta) announced earnings and updated guidance and the stock price fell 25%, wiping out over $200bn of shareholder “value” and costing CEO Mark Zuckerberg over $30bn personally. And something very similar happened at PayPal, which also released earnings and updated guidance following which its stock fell over 20%. Amazon on the other hand released earnings and the stock went up 15%, similar to what happened at UPS, which also announced a 50% increase in its dividend. And those quintessential “old economy” stalwarts, the oil majors Exxon and Chevron, announced record earnings and increased shareholder distributions and saw smaller but still significant one-day gains of 5% or so.

What is going on here?

How can it be that the entire stock market, not to mention all those highly paid equity research analysts and portfolio managers, did not see any of this coming? Can the equity value of Facebook—supposedly discounting all of the Company’s future cash flows in perpetuity—really be worth 25% less today than it was just two days ago? Why should an announcement of increased shareholder returns at UPS and Exxon trigger such a significant increase in the share price? How “efficient” can the stock market really be if its view of value moves this much in a single trading day, based just on the release of a quarterly earnings report and some updated near-term guidance?

Folks, what we witnessed this past week was a good demonstration of how the capital markets actually work, which may look quite different in the real world than it does in the classroom. In the real world, capital markets are messy and sometimes violent. And they don’t always behave in apparently sensible ways consistent with what financial theory might at first glance suggest. The operation of the stock market is a bit like making sausages. Once you’ve seen how sausages are made you may think twice about eating them. But sausages are tasty and stock markets are generally pretty efficient. The process of getting there is messy and disruptive, however. Just ask the shareholders of Facebook, who have seen major corrections in the share price on several occasions since the Company went public in May 2012, after which the Company’s share price promptly fell 50%.

For over a decade now we have all been living in a Fed-induced La La land, where investors seem to believe that what goes up will never come down, except interest rates of course. But those of us who have been around for more than a few years (or decades even) can tell you from personal experience that the past ten years or so have not been “normal” in any historical sense. What goes up in the capital markets can and often does go down, sometimes a lot and with little advance notice. As we saw last week in the stock market.

Today’s meme stocks, start-up unicorns and cryptocurrencies are similar in some respects to the “new economy” dotcom stocks of the late 1990s, which crashed spectacularly in the early months of the new century, in most cases never to be heard from again. If history is any guide, things may not turn out much better this time around for those investors who continue to confuse price with value and speculation with investing. GameStop shares have now lost over 70% of their peak equity value (price), but they are still up 5x from where they traded before the stock was first hyped on Reddit. This story is not over and the damage will not be limited to GME.

Facebook’s share price went down because investors concluded, with the benefit of some newly released (but not entirely new) information, not only that the Company’s future growth rate would slow but also that the Company’s historical earnings were not sustainable. Investing it seems is not an activity which takes place in virtual reality, regardless of what name is put on the company.

UPS shares went up because investors concluded, with the benefit of newly released information and a previously announced change in operating strategy, that the Company would in fact generate more profit and cash flow in the next few years than investors had previously expected. Importantly, UPS also made clear that much of this increased future cash flow would be returned to shareholders rather than invested (spent) by UPS increasing the volume of its business done with low-margin and low-value customers. UPS’s increased dividend announcement did not cause the share price to go up per se, but the change in dividend policy reinforced the company’s renewed strategic commitment to creating economic value for shareholders rather than simply driving growth.

The same thing happened with the oil majors, who now recognize that theirs is a declining business (albeit one with a long tail) and that the right strategy for a company in this position is to aggressively return capital to shareholders, allowing the company’s owners to reinvest corporate profits in other more promising and sustainable investment opportunities outside of the oil patch.

In some sense there is never any one true value for a company’s shares, just a series of ever changing market prices which adjust at the margin to match buyers and sellers. Stock prices do not fall because of “more sellers than buyers”, as my old boss liked to say. Of course not. For every share sold there has to be a buyer, albeit often at a lower market clearing price. And sometimes this market clearing price is a long way off yesterday’s close, as we saw this past week. More sellers than buyers indeed!

And while “market price” does not always equal or even approximate “intrinsic value”, it may be the best objective measure we have. As corporate finance practitioners, we care about changing stock prices not because of their impact on the pocketbooks of shareholders—let alone fund managers, security analysts or CEOs—but rather because of the value signals these prices send to corporate decision makers charged with allocating scarce capital in a competitive real economy. This is what we do in corporate finance; we help companies manage financial risk and allocate capital. And if we don’t have access to sound fundamental value signals generated by the capital markets, we can’t do our jobs properly.

To me, that is the real lesson to be learned from this week’s stock market events. Whether Mr. Zuckerberg and the others will learn anything from it is of course quite another thing entirely.

Links:

Facebook Shares Plunge, Lose More than $200bn in Value

PayPal Stock Tumbles after Disappointing Earnings Guidance

Amazon Share Price Surges Following Bumper Earnings

UPS Increases Dividend 49% after Strong Q4 Earnings

Exxon, Chevron Hit Gushers of Cash, Lure Back Investors

Start-up Investors Cut Valuations amid Tech Stock Route