“Price is what you pay, value is what you get.” -Warren Buffett
The common wisdom is that a company’s stock price, in the short term, doesn’t always align with its intrinsic value. But eventually, stock prices gravitate towards intrinsic values. That’s the rule of thumb – that a stock’s price will move towards a company’s true value.
But could it also be the other way around? Instead of the stock price following value, can the stock price influence the value of a business?
In certain scenarios, this interesting dynamic has actually played out.
Self-fulfilling stock price
An example of how a stock’s price can influence a business’ value is when a company decides to make use of its rising stock price to raise money cheaply.
A rising stock price is an indicator of healthy investor appetite for a company’s shares, even though the appetite may not always be validated by the company’s fundamentals at that time.
As one of the main characters in the meme stock mania, Gamestop (NYSE: GME) is a recent example. Gamestop’s stock price, due to retail investors banding together to try and trigger a short squeeze, soared to an extent that most experts will agree, far exceeded the company’s actual business value.
However, this steep mispricing in the stock price gave Gamestop’s management the opportunity to issue a secondary share offering at a much higher price than the company would have been able to if not for the meme stock craze.
As a result, the games retailer was able to raise more than a billion dollars with relatively minor dilution to current shareholders, thus improving its business fundamentals. This, in turn, has led to an improvement in the intrinsic value of the business.
Even Tesla has taken advantage of this
Self-fulfilling stock prices are not reserved solely for meme stocks. In fact, a host of other companies have taken advantage of their rising stock prices in 2020 to issue new shares to boost their balance sheets at relatively cheap rates.
Take Tesla (NASDAQ: TSLA) for example. The electric vehicle front runner raised fresh capital three times in 2020 through secondary offerings as its stock price climbed. Each secondary offering happened when Tesla’s stock price hovered around a then-all-time high. These gave the company the dry powder to build new factories in Berlin and Texas and even invest in Bitcoin.
Elon Musk, Tesla’s self-proclaimed “Technoking” and CEO, and Zach Kirkhorn, Tesla’s “Master of Coin” and CFO, have done a great job in identifying instances when the appetite for Tesla shares in the public market allowed them to raise fresh capital cheaply, resulting in relatively minor dilution.
With its newfound financial firepower, Tesla is in a much stronger position to ramp up the production of its electric vehicles to meet the incessant consumer demand that it’s enjoying.
It happens in Singapore too
Although Singapore-listed stocks are known to trade at seemingly low prices, there are pockets of the market that may trade at a premium.
The best examples are real estate investment trusts (REITs) that trade at a premium to their tangible book values, such as those that are sponsored by big-name property giants such as CapitaLand and Mapletree. In such cases, it is actually beneficial for a REIT to raise capital by issuing new units.
For instance, in December 2020, Ascendas REIT (SGX: A17U) raised close to S$1.2 billion from a preferential offering and private placement by issuing new units at a price that’s more than 38% above its last reported adjusted book value per unit.
With the new fundraise, Ascendas REIT immediately improved its book value per share.
Business fundamentals following stock prices down
In a similar light, business fundamentals can also decline because of a falling stock price.
At tech companies, stock-based compensation has become a big component of employees’ overall remuneration. When a tech company’s stock price is down, any stock-based compensation becomes less valuable. This could lead to an exodus of existing talent and make it more difficult for the company to attract new talent.
An example is Lending Club (NYSE: LC), a company that uses algorithms to originate personal loans. After a scandal involving its ex-CEO, Lending Club’s stock price collapsed and the value of employees’ stock-based compensation declined. According to a transcript I read, Lending Club has suffered high employee turnover due to its collapsing stock price.
Value often precedes price. But in special situations, the opposite seems to be true too. This creates a self-fulfilling virtuous or vicious cycle that can make matters much worse or much better.
Note: An earlier version of this article was published at The Good Investors, a personal blog run by our friends.
2022 is nearly upon us. We have found 2 megatrends set to explode in the world of investing. And in our upcoming FREE webinar, we’ll be revealing exactly what these trends are. If you’re looking for more growth stocks, you’ll not want to miss this exclusive event. Click here to register now.
Disclosure: Jeremy Chia owns shares of Tesla.