Observing 2022’s Public & Private Capital Markets’ Activities
Price and value are two separate concepts. Price is arbitrary. Price is the amount asked, offered or paid. Once stated, price is fact. Because of the financial capabilities, motivations or special interests of a given buyer or seller, the price paid for a property may or may not have any relation to the value that could be ascribed to that asset by others. Price is typically driven by human emotions, such as fear or greed.
Value is fundamental. Valuation is a process of establishing a value for an entire or partial interest in a closely held company, taking into account both (1) quantitative and qualitative data and (2) tangible and intangible assets associated with the specific company or asset being valued.
The difference between price and value is not always immediately noticeable.
Public and Private Capital Markets
The two primary markets that play significant roles in supporting economic growth are the (1) public capital markets and (2) private capital markets. Public capital markets are made up of buyers and sellers trading equity and debt instruments, such as stocks (on the stock markets) or bonds (on the bond markets). Investors can use public capital markets to readily invest an ownership interest in a company, such as Tesla (TSLA), which is traded on the NASDAQ exchange and lost over $800 billion in market value during 2022.
Private capital markets are where privately held companies sell all or part of their equity to investors, such as private equity firms, venture capital firms or individuals. When a transaction occurs in the private capital markets sector, such activity is typically referred to as merger & acquisitions (or m&a).
Publicly traded companies are listed on an exchange, such as the S&P500 or NASDAQ, meaning that there is an active and available market for investors to purchase company stock. Privately held companies are not really available for purchase through a public market or exchange but are still made available to investors, typically through an investment bank or business broker.
The following is a short discussion of price and value depicted through my observations of the public and private capital markets’ 2022 activities.
2022 Price-Driven Public Capital Markets
After three years of gains, the S&P500 ended 2022 down almost 20 percent—its worst performance since the financial crisis in 2008. 2022 was a rollercoaster of a year as stocks had dramatic price swings (also known as volatility) from one day to the next. These price swings, however, seemed to have very little to do with a particular company’s intrinsic (or “true”) value. Rather, as too much happened too soon in 2022, price swings were impacted by investor emotions (i.e., fears) instead of fundamentals (anticipated growth, cash flows/dividends, and risk). Surging inflation, interest rate hikes and war, to name a few, made investors wonder whether companies could ultimately survive the 2022 macroeconomic environment. NYU professor Aswath Damodaran described it best when he compared valuation to getting a home inspection before buying a house; however, the house is located on the Florida coast, and a hurricane is headed its way. No longer are the home buyers concerned with when the air conditioning was replaced, but whether the house can withstand the hurricane.
2022 Value-Driven Private Capital Markets
In 2022, private capital markets’ valuations (i.e., EBITDA multiples) fell across most industries as investors exercised caution in their pursuit of targets. Although private capital market dealmakers faced the same macroeconomic challenges discussed earlier, these variables were not the dominant issues impacting lower valuations and declining deal flow. The cooldown related more to the opportunities that existed in 2022.
2021 was a frenzied year for business owners looking to exit their company via a sale. A combination of events following 2020’s global pandemic created a cyclone of activity, including (1) the CARES Act pumping trillions of dollars into the economy; and (2) aging baby boomers nearing retirement. This resulted in the strongest companies receiving the most attention and crowding out all “other” opportunities in the market. In general, strong companies can be characterized as those businesses with anticipated growth (revenue, earnings, cash flows), high profit margins, and overall low(er) specific company and industry risks. Those opportunities that were crowded out in 2021 were pushed into 2022. Accordingly, the quality of deals available to investors to choose from in 2022 was the main contributing factor to increased investor selectivity, lower valuations and decreased deal flow.
Distinguishing between price and value is an important investment strategy in both the public and private capital markets—and can be a good investment strategy.
Final Thoughts
Distinguishing between price and value is an important investment strategy in both the public and private capital markets. Finding differences between price and value (where price is less than intrinsic value) can be a good investment strategy. In 2008, Warren Buffet sent a letter to his shareholders and wrote, “Ben Graham taught me that – Price is what you pay; value is what you get.”
This strategy has achieved an immeasurable level of success for Mr. Buffet. Maybe leveraging the differences between price and value will make you a lot of money, as well.
Notwithstanding the above, this article and my opinions should not be construed as financial, investment, tax, accounting or legal advice.▪
This article was originally published in Az Attorney Magazine’s Expert Witness Guide 2023. Shared with permission.
