Building value.

For over 15 years I had on my desk at work a copy of the seminal Theory of Investment Value by John Burr Williams, written as a thesis to explain the Wall Street crash of 1929. Covered in jam, from a spillage in the early 2000s, and at nearly 600 pages, I fully admit to having failed to get much past page 40 in all those years. Yet those first 40 pages were good enough to build my understanding of financial value that sustained my career, first as a stockbroker, making buy and sell recommendations, and now as a corporate strategist, helping to build value.

The point that JBW makes is obvious but still often ignored: that intrinsic value is different from market value. Intrinsic value is most easily understood as the cash return that a business or asset will generate over its lifetime. Market value is the price paid, speculatively, for that asset or financial instrument. As an equity analyst, investor or business builder, you need to understand the mechanics and dynamics of both. Yet, often, the concepts become muddled and the aims of each not explicitly addressed in business planning and communication.

So if intrinsic value = cash, then we can say that the core elements of intrinsic value creation are the following: Dimension 1: can I make a return on a single sale? Dimension 2: can I increase the units of sale? and Dimension 3: how long can I do this for? All fundamental strategy is based on delivering a plan across all those dimensions. Of course, there is a whirlwind of factors around each of these elements but, if cash is the bedrock of value, then those are your three questions as a strategist.

Then onto market value, which is an entirely different animal. In a bear market, intrinsic value comes back to the fore (and you can always tell a broker whose formative years were in a bear market). It is a reversion to reality. However, in a bull market, market value is just what the next guy or girl will pay you to buy your asset. That’s all well and good, but you need to understand the rules of the game.

Capital is not evenly distributed across the capital cycle — which is the capital available throughout a company’s lifecycle. Capital bulges in big gluts or disappears to nothing, depending on a range of factors, most notably money supply, tax incentives and regulatory barriers. It can be there one year and not the next. If you have built a business with a focus on market value, you might be lucky and win but you also just massively increased your chances of losing. You are reliant on finding, at a time that may not be of your choosing, someone else to agree that the speculative value is correct.

I will talk about valuation in different capital pools another time but it’s imperative that strategists understand that market valuation is not immutable, nor is it the same across VCs, PE, public markets or trade buyers.

Strategic value creation is at best a focus on intrinsic value, combined with a carefully charted path through the capital cycle that is not just about the next 18 months or 3 years. Know the rules of the game in each capital pool that you might be targeting, and communicate clearly to the management team and employees about how the strategy is designed to deliver both intrinsic and market value creation.