Saturday, April 28, 2007

Taking Stock




I was sitting in a seminar the other day and various things regarding business operations of insurance companies was being discussed - don't worry, I'm not going to get into the bowels of an insurance company's engine. We were discussing how we can generate money - and from a more macro view - how any company can generate money.

There are three ways, generally, for any company: 1. Selling whatever your product is (and keeping costs low enough that you turn a profit), 2. Investing that profit wisely to generate more capital and 3. Selling stock.

In the course of the conversation, someone in the seminar mentioned that my company's (whose name shall remain nameless) stock had hit an all time high that day. This was widely agreed to be a very good thing by all in the room. It seems like a fact of life that if you're a company and your stock goes up, that's dope. Right? No one really would question that.

Given the above, I got a few strange looks when I posed the question: 'Why do we care about our stock price?' But, given the lengthy answers that followed - maybe it isn't such a stupid question.

Here's the thought that prompted my question: If you're a company, when you do your IPO (Initial Public Offering), you're selling stock in what you as an entity previously completely owned. So, all that's income right? After your stock is public, though, you don't own that anymore. So if you sell your stock during the IPO at, say, $50 a share, you've made however many millions, it's yours, in the bank and that it. Once it's sold, it's not yours. You don't own it, you don't make income on it. If it triples in price, then it's dope for the person that turned a profit - but it's not an income generator for you (the company) anymore - so why do executives and employees care about their stock price?

The analogy I drew was this: If you're a baseball player and you sign with Fleet, Topps, or whoever for for the rights to print your baseball card, you get paid whatever the agreement was. After the agreement is completed and you're paid - the value of your card may go up or down depending on if you have a career year or pull a Chuck Knoblauch. Regardless of how you do, you're alraid paid though so it doesn't really affect your bottom line.

After much discussion, I'm not sure I entirely understand - but this is what seems to be the case as far as I can tell:
  • Self Preservation: The executives managers of a company all answer to the Board of Directors, chosen by the stockholders. The officers, answer to executive managers and so on. Ultimately you have to keep your boss happy and the ultimate boss of a public company is its shareholders. You, your boss, their boss, their bosses' boss, and their boss' boss' boss want to keep their jobs so they have to keep the next guy up in the food chain happy - this chain continues up until you get to the shareholders. Poor stock performance probably means management shake-ups at best or a hostile take-over at worst.
  • Self Reflection: People buy shares because they think they can sell it for a profit (buy low, sell high). They also buy based on what the dividends will be - which is linked to how they company itself is doing. If people want to buy pieces of your company it's most likely a reflection on how you, as a firm, are doing.
  • Self Interest: Many people in a company own pieces of that company, whether it be in the form of a mutual fund, a 401(k) plan, outright stock or stock options, so it is beneficial for them directly for the share prices to increase.
  • Self Respect: Simply put, it's ego. People want to feel like the best, so it's a somewhat pride thing to know that you're working for a company that's trading at high prices.
  • Self Owned: I'm not sure if this is true but I assume that most companies own a significant percentage of their own stock. Good performance of their stock probably means they get to count whatever dividends they pay as income. Also, they can always sell their own stock for capital if they so choose.
It appeared to me like it is a somewhat involved answer to what would seem to be a simple question.

2 comments:

ChuckJerry said...

It seems to me like the 3rd and 5th reasons are the real ones why they actually care. A lot of the shares of stock are tied up either nominally by the company or directly by some percentage of the emplyees. Either the executives and partners or in more progressive companies by a good percentage of the employees. Having stock options is motivation for your company to do well and drive the price even higher.

Joe said...

I agree with you that it isn't a silly question.

Truth be told, if you sell $1000 of company equity for $1000 of cash, you haven't profited at all. You've just gained liquidity.

In my opinion, post-IPO sales on the public market are generally *not* as beneficial to the company as they're made out to be.

There are circumstances where a high stock price is great:

* If you are temporarily overpriced (i.e. if the stock price is $75 and you feel that is overvalued, you could sell stock, buy back at $50, and have $25 profit)
* If you want to acquire another firm, you can give up a much smaller percentage of your company to do so.

Of course, it goes without saying that high stock prices are great for the shareholders. And, once you go public, you answer to people who *only* care about getting the stock price and/or dividends as high as possible.

Truth be told, stock price doesn't say anything except that, at that instant, one person thought it was overpriced and another thought it was underpriced and this is where they compromised.