Financial Management Association Roundtable on Stock Market Pricing and Value-Based Management

Abstract:     
group of academics and practitioners addresses a number of questions about the workings of the stock market and its implications for corporate decision-making. The discussion begins by asking what the market wants from companies: Is it mainly just steady increases in earnings per share, which are then capitalized by the market at the current industry P/E multiple to produce a higher stock price? Or does the market pay attention to the quality, or sustainability, of earnings? And are there more revealing measures of annual corporate performance than GAAP earnings - measures that would provide investors with a better sense of companies' future cash-generating capacity and returns on capital?

The consensus was that although many investors respond uncritically to earnings numbers, the most sophisticated and influential investors consider far more than current earnings when pricing stocks. And although the stock market is far from omniscient, the heightened scrutiny of companies resulting from the growth of hedge funds, private equity, and investor activism of all kinds appears to be making the market more efficient in building information into stock prices.

The second part of the discussion explored the implications of this view of the market pricing process for corporate strategy and the evaluation of major investment opportunities. For example, do acquisitions have to be EPS-accretive to be value-adding, or is there a more reliable means of assessing an investment's value added than pro forma EPS effects? Does the DCF valuation method always offer a better guide to value than the method of comparables used by many Wall Street dealmakers? And under what circumstances are the relatively new real options valuation approaches likely to provide a significant advantage over conventional methods?

The main message offered to corporate practitioners is to avoid letting cosmetic accounting effects get in the way of value-adding investment and operating decisions. As the corporate record on acquisitions makes painfully clear, there is no guarantee that an accretive deal will turn out to be value-increasing (in fact, the odds are that it will not). As for choosing a valuation method, there appears to be a time and place for each of the major methods - comparables, DCF, and real options - and the key to success is understanding which method is best suited to the circumstances.

Accepted Paper Series