Hey all,
Okay, I have a question that’s really important… the story behind this is really long and complicated, but what I need to know boils down to this.
Let’s say you invest in a company with a $3 billion market cap. Now let’s say that the value of this company eventually grows to $30 billion. Is the worth of your long-term investment always going to be 10 times what it originally was? Are there any exceptions to this? What about stock splits? Can anyone think of historical examples?
And yes, this has a VERY practical application, but for now… it’s probably best to just leave it as a basic question. All opinions are welcome.
Thirty is always going to be ten times three. I’m ignoring dividends or any new investment (capital calls, or new issuance of shares, whether or not for cash). With their usual definitions, the words “value” and “worth” don’t seem to express consistently different concepts. Under those conditions, the answer is yes, by definition.
Of course, when you say the value grows to $30B, you probably mean that the quoted value of the stock, from its most recent trade, implies that market cap. If the price is moving quickly, then by the time you read the print, you may be unable to trade at that same price yourself. If you own many shares, then you may be unable to quickly sell them for anywhere near that price, since you’ll move the market.
The people trading at that price may have been grossly mistaken about the company’s fundamentals, and that price may not reflect the company’s fair economic value (as the NPV of its future dividends) by any reasonable definition. After inflation, the dollars with which you purchased the shares may be worth less than the dollars for which you could sell them. All of this ignores tax. The NPV of any dividends paid must be added back, and of any payments in response to capital calls subtracted.
If the company issued more shares (like for cash, or executive compensation, or to pay for an acquisition), then your gain is less than the gain in market cap because your percentage share of the company decreased. Public companies issue new shares routinely.
Stock splits are irrelevant, just accounting. It’s generally hard to value companies; that’s why finance classes spend so much time on it, and a reason why investment bankers get paid. I think you’re trying to get at something, but I don’t think it’s clear what. Any hints?
I think that does BASICALLY answer the question, but here’s the background. I am going to be vague and not give names or identifying details, because I absolutely do not want to sound like I’m pumping any stocks.
All of the stockholders just found out that a biotech company I own stock in will be bought out (by a company based in Japan.) This wouldn’t have been my ideal outcome as an investor. As a patient, though, it’s a totally different story. The original company had a lot of drugs in the pipeline, but the one furthest along in trials is for a major disease with no current treatments. (Which I had a few years ago… I’m in remission, but there is no guarantee of anything.) The entire science team and CSO will move to the new company. So (assuming it all works out, which has certainly been the case with the trials so far), a Japanese company will be able to get this drug to market several years earlier than would ever have been possible here. (The reasons why are another story, and I’m not even going to get into it!) The cure is so much more important to me.
As an investor, though, it’s a question that I do have to think about. I don’t think the potential for growth is as great because the new company already starts out with a $30 billion market cap. But there’s still so much potential for a return on a new investment. Basically, they bought the IP for cures to several dozen currently incurable and untreatable diseases-- if everything pans out, obviously. (NOT giving any details or names here and NOT recommending that anybody buy any stocks!!) Most of the stockholders are furious that they’re not getting a better pps in the buyout, but I’m trying to be more philosophical about it. The original company was not going to be able to bring these treatments to market on their own.
In general, speculators will be slightly disappointed if a company they own is acquired for something close to market price; if they thought market price was fair, then they’d have already sold. That’s a “loss” only to the extent that they were marking their position to “what I think/hope the shares will be worth” instead of market, though. They did lose whatever time it took to identify and research the investment, but that cost was already sunk.
Academic research has shown pretty consistently that larger public companies underperform smaller ones. That’s not just the central limit theorem, where averaging performance over a bigger organization gives you fewer outliers in either direction; the mean really does shift down. So knowing only the respective market caps, I’d expect the big acquirer to deliver lower returns than the little target did, though also with less volatility. You can speculate on the reasons for that, whether it’s from market saturation etc., or new layers of expensive management, or something else. That’s a different question from the original, though.
This is not the same thing as the original company growing from $3B to $30B. It is now one-tenth of a company that is worth $30B and your original stake in company A will still be worth the same because each share is converted to one-tenth of a share in company B. Nothing changes in the present.
But the share price of a stock is the investors’ estimate of its future value. When a large company buys out a smaller one that estimate changes, often dramatically and unpredictably. I don’t know what the new company will do and from the sounds of it neither do you. Anything may happen now. They may develop the drugs in the pipeline and makes billions. They may exploit the existing IP value and cut all new research to save money because they borrowed $3B to buy your company. They may now be overextended and fail. They may get bought out by an even bigger company.
You need to do research into this new company. Does it have a history of buying up smaller firms? If so, how have those acquisitions been treated? Has the company been consistently successful or is this a desperate ploy to create “growth” to impress short-term stockholders? Ask yourself lots of questions like these and make informed guesses about the answers. That’s the only way to know whether your current investment has any future value.
As for the drug, I certainly hope that it goes wonderfully for you. But that’s a separate question that nobody can answer.
as for splits, suppose a company splits due to high share price, then it might split 10 shares for one.
So should the new share be valued at 10%
Well the reason for the split was to allow trading, and so that may be seen to increase profitability… thus dividends … or at least the ability to pay dividends even if not profitable, and hence value… the 10:1 split might result in a share value of 11%… say…
The original company was not going to be able to bring these treatments to market on their own.