Business valuation – listed company volatility

February 5, 2018

I read with interest the headline this morning in the AFR: “ASX set to plummet after broad Wall Street sell-offASX set to plummet.

The article explains the Dow Jones in the US declined 2.5% on Friday, the largest decline since 2016 with increasing volatility, weaker than expected profit announcements and speculation the Fed Reserve will increase interest rates. Bitcoin mentions – nil.

A collapse in U.S. stock prices certainly would cause a lot of white knuckles on Wall Street. If Wall Street crashes, does Main Street follow? Not necessarily.” Ben Bernanke

Around noon today, the ASX 200 had declined a more moderate 1.2%.

Imagine reading a headline in your news feed that “speculated” the value of your private business was about to “plummet”. Has your business really declined in value by 2.5%?

No.

Conjecture: For one, private business owners should not be fixated on investor news and conjecture about a correction in prices. The business will continue to operate regardless of whether BHP share price “plummets” 2.5% today.

Index weighting: Secondly, the Dow Jones and other indices are represented by a combination of shares in companies. The ASX 200 index is heavily influenced by the 10 largest companies – BHP, Rio Tinto, the big banks and a few others make up approximately 47% of the index.

Volatility: Thirdly, prices of listed companies are volatile. Their share prices change daily in most cases. Thankfully, the value of private business are less volatile than listed companies.

Information: Listed companies have share prices that are easy to observe. There are lots of rules about providing continuous disclosure of information – profit changes, ownership changes, and so on. This provides a constant flow of information for which investors can assess value. Also, the management of listed companies are under constant pressure to perform. Their success or failure is regularly captured in the share price – an indicator of company value.

For private businesses, there are no prescriptive rules about providing information to owners or potential owners. There are no equity analysts asking questions and providing buy or sell recommendations.

The only way to address the impact on value of information is to undertake a valuation. Most businesses only do this as a reaction to a problem – a dispute, an offer to buy, a change in ownership.

While the value of your private business has not plummeted 2.5%, value does change over time. It is just not measured regularly.

Lachie McColl