Koon Yew Yin 官有缘 - Koon’s Investment Lesson #7: The Importance of Share Price

After having been a founder of IJM Corporation Bhd which has a market capital of about Rm 12.5 billion and have read a large number of reports of companies in search for good public listed shares for investment, I think I have some knowledge and experience to share with you. I hope this article will benefit all investors and I also hope company directors can get some ideas to create more value for their shareholders.

All company directors must remember that they are paid to manage shareholders’ money and they are duty bound to create more value to shareholders. Shareholders can only benefit from the dividends and increase in share price.

Why I say that the share price increase is only partially dependent on the company’s net profit is because there are other ways to increase the share price. The ways include:

1.   Giving out bonus shares.
2.   Giving out bonus convertible warrants.
3.   Issuing more shares to make suitable acquisition such as another company, more land or factories.
4.   Place out not more than 10% of the total issued shares as permitted by Security Commission to financial institutions that will logically support the share price.
5.   The money received from share placement can be used to reduce debt or for expansion.
6.   If the company has suitable subsidiary, the assets can be revalued via listing to bring in a large amount of cash. IJM listed IJM Plantation Bhd. and IJM Land Bhd.

IJM has been doing the above and as a result, the market capitalization of the company has grown substantially in the last 20 years.

The movement of share price is an interesting phenomenon. It can bring joy as well as tears to many an investor.

There is a classical saying that ‘good management produces good share price and bad management produces bad share price’. When you select a share to buy, you expect to gain from the dividend and the appreciation of the share price, both of which are important catalyst to move share price.

Share price is an indicator about the health of the company. Increased profits, for example, will drive the stock price up. Excessive debt, for example, may drive it down.

The share price has a profound effect on the company overall. For example, a declining share price will make it hard to secure credit, attract further investors, build partnerships, etc. Also, for employees holding stock options, a declining share price can severely dampen morale.

It is every clever businessman’s dream to list his company in the stock market to get more capital to expand his business. An initial public offering (IPO) is the way most companies get their shares traded in the stock market.

However, companies often go to the market again and again to issue or sell more shares, in order to raise money to expand their operations. A clever way is to issue rights together with bonus and free warrants which would encourage more investors to buy their shares.

Besides these secondary offerings, some smart companies issue shares to acquire land, factories or competitor companies to expand their operations, thus creating more value. However, I seldom see companies take advantage of their listed status which is like having a license to print money.

Why don’t they take advantage of this privilege to acquire assets more often?

When a company goes back to the market to raise additional funds for expansion, the current share price is a good indicator of what they can expect to get from the secondary offering of shares.

To get the same amount of money, a company with a higher share price will require to issue less number of shares than another company with a lower share price as all new issues will dilute existing shares of the company.

Also, consider corporate acquisitions: When a company acquires another, instead of the transaction being entirely in cash, the deal can be transacted in part cash and part share swap. In this case, the current share price also matters, to provide relative valuations for the companies.

We often see examples of many companies where corporate exercises can sometimes undermine the value of share price, especially in cases where a company’s profit growth is challenged. In a situation like this, it shows that management is unable to make use of the funds raised to increase future earnings vis-a-vis the value of the business, leading to a destruction in shareholders’ value where the dilution outweighs any advantages.

The importance of share price will therefore be valid provided the following conditions apply:

1.  The business in question must in the first place be a well-run business with consistent profit growth where the increase in share price is in alignment with the increase in the value of the business.
2.   Any corporate exercises undertaken by leveraging on the “share price” (underlying value of the business) will be advantageous in increasing shareholders’ value provided that the potential increase in the value of the business outweighs the dilution impact of the corporate exercise. This is where management’s expertise and judgement comes in. Very often, the entrepreneurial type of management has the ability to conjure up deals that tend to increase the business value more than the dilution impact, leading to an increase in shareholders’ value. This is because entrepreneurs are instinctively able to see the “wood from the tree ” and are able to make decisions that effectively increase shareholders’ value. Education and qualification are helpful but not a pre-requisite to be enterprising.

If these two conditions are met, all good management should, in my opinion make full use and take advantage of its share price to grow and expand the business. The ability to use the share price or value of the business to finance the growth of the business is always an option that should be explored as long as the exercise can improve shareholders’ value. Failing to do so is akin to not optimizing the resources at management’s disposal to act in the best interest of the company.

Bear in mind that when you select shares you should not be unduly impressed with higher educational qualification of the members of the Boards. There are some CEOs with very impressive university degrees who cannot perform and yet shareholders cannot remove them because of their controlling share holdings.

Good companies invariably have good businessmen or entrepreneurs as directors. Clever businessmen do not necessarily have tertiary qualifications e.g. Tan Sri Yeoh Tiong Lay of YTL, Tan Sri Lim Goh Tong of Genting and Tan Sri Teh Hong Piow of Public Bank.

Koon Yew Yin 官有缘 - Koon’s Investment Lesson #7: The Importance of Share Price