We all know that stocks are sometimes undervalued or, for the fortunate, sometimes overvalued.
In most situations, this can be from general market conditions, such as a trending industry sector. The positive side can be enormous if you are fortunate enough to be in an industry in the news.
Nothing excites investors more than a rising share price. Such situations can become self-fulfilling prophecies when an increasing stock price attracts more investors willing to pay more for the stock. Momentum traders buy stocks simply on the assumption that once an uptrend starts, it will likely continue.
Most CEOs or CFOs never 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 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 market’s peak. In the peak stock market year of 2007, many members of the S&P 500 index bought back billions worth of their stock, which was much more than they repurchased in 2009 when the S&P 500 index hit its 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 company running hot or cold.
It’s troubling that even when the overall market is hot, most senior executives tend to believe their 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 words such as “fully valued.”
If your company is fortunate enough to have an overvalued share price, now is the time to “strike the match” Following these four actions can increase shareholder value when the share price is high.
- Issue Shares. This can also help build the financing capacity needed to make opportunistic acquisitions when stocks again become undervalued in bad times. It is better to have more leverage during an up-cycle to increase the share-price appreciation and less leverage during a downturn to dampen the decline.
But be careful; since investors may react negatively in the short term, management must have a disciplined process of making only investments that truly create value.
- Issue Convertible Debt. For management concerns that they cannot convince investors of the merits of stock issuance, issuing convertible debt is an excellent 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, so convertible debt is less likely to convert — making this an 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 company’s overvalued stock for the acquired company mitigates the risk of overpaying.
This strategy can lead a company that believes they are particularly overvalued to seek acquisitions to take advantage of its shares’ high-valued currency.
- 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.
Continually assess your valuation and maintain objectivity. If the company appears overvalued or undervalued, make sure to take strategic action. At OTC PR Group, we can help you capitalize on any given condition and help increase shareholder value.