Business models

Questioning market cap as a measure of value

By October 29, 2008 9 Comments

Since the bankruptcy of Lehman Brothers wiped out $47bn in market cap I have been thinking that somehow we must be doing something wrong when we look to share price as a measure of value.

Now that VW shares have gone through the roof making it briefly the largest company in the world by market capitalisation I feel compelled to explore this point in a blog post.

First some numbers – VW shares are up 286% this week and 444% for the year.  By comparison the other 29 stocks in Germany’s Dax index are down.

Critically for my argument here this share price move has nothing to do with the performance of the underlying company.  Rather it is the result of Porsche building it’s stake in VW and precipitating a short squeeze.

Something is amiss here – value is being created (VW) and destroyed (Lehman’s) extremely rapidly on a massive, massive, scale in ways that have little to do with the underlying purpose of business and the economy in general – i.e. to sell products and services, employ people and make profits (hopefully).  Real people’s lives and jobs get caught up in all this.

That is the problem statement.  But I am reminded of when I shared a political science book I liked with a philosophy teacher at school – he read it and described it as “typically useless political science – all problem statement and no solution”.  I am conscious of being equally useless here.

I have no idea what the answer is, but I am pretty sure that something has to change, and that it will happen slowly and over a long period of time.

I am a believer in appropriately regulated free markets and I’m reasonably sure that short selling is an overall positive influence, helping assets to find their natural price more quickly.  So radical change doesn’t seem sensible.  Yet finding some way to reflect the fact that the value of these big companies doesn’t change that quickly seems to me to be important.  Greater transparency would obviously help.