We all know that stocks are sometimes undervalued or for the fortunate sometimes overvalued.
In most cases this can be due to general market conditions, such as a trending industry sector. If you are lucky enough to be in an industry that is in the news the positive side can be enormous.
Nothing motivates investors to buy a stock more than a rising share price. Such situations can become self-fulfilling prophecies when a rising stock price attracts more investors, who are willing to pay more for the stock. Momentum traders buy stocks simply on the assumption that once an uptrend starts, it is likely to continue.
Most CEOs or CFOs ever admit their share price is too high — at least not to the public. This obsession with seeing your company shares as “cheap” can lead to some unfortunate corporate actions.
Given all the time corporate executives spend generating investor interest in their stock, it would be very hard for them to ever see, much less say, their stock is overvalued.
First and foremost is the desire to buy back shares at the peak of the market. In the peak stock market year of 2007, many members of the S&P 500 index bought back billions worth of their own stock, which was much more stock than they repurchased in 2009 when the S&P 500 index hit their lows.
The problem of course is that investors used the same approach, however, undervalued most stocks were during the credit crisis of 2009. The problem is often recognizing this at the time. Overvaluation or undervaluation can also be applied to an industry or individual company that is running hot or cold.
It’s troubling that even when the overall market is hot, most senior executives tend to believe their own stock is undervalued. This mindset is often reinforced by investment bankers who won’t even use the term “overvalued,” preferring instead to refer to companies using terms such as “fully valued.”
- Issue Shares. This might be a good time to reduce leverage below the long-term target to build in a cushion to soften the next downturn. This can also help build the financing capacity needed to make opportunistic acquisitions when stocks again become undervalued in bad times. As a general rule, it is better to have more leverage during an up-cycle to increase the share-price appreciation and to have less leverage during a downturn to dampen the decline.
But be careful, since investors may react negatively in the short term, it’s crucial that management have a disciplined process of making only investments that truly create value.
- Issue Convertible Debt. For managements concerns that they cannot convince investors of the merits of stock issuance, issuing convertible debt is a good way to at least take some advantage of an unusually high share price.
When stock prices are at cyclical peaks, they are less likely to rise in the coming years and so convertible debt is less likely to convert — making this a attractive form of financing when stock prices are high.
- Use Your Stock to Make Acquisitions. Cash acquisitions usually don’t create value at the top of the stock market cycle. In many cases exchanging your companies overvalued stock for the stock of the acquired company mitigates the risk of overpaying.
This strategy can lead a company that believes they are particularly overvalued to actually seek acquisitions to take advantage of the high-valued currency their shares represent.
- Avoid Buybacks. Companies that buy back stock when the price is high earn much lower returns on their buybacks than those that buy when the price is low. Refraining from share repurchases should go without saying. But it’s worth repeating that most companies should avoid the temptation to buy back stock when the market is high.
Always assess your valuation and maintain objectivity. If the company appears overvalued or undervalued, make sure to take strategic actions. At OTC PR Group we can help you capitalize on any given condition and help increase shareholder value.