In a fair and just world, the only way to build wealth is to generate value for others.
If you can enhance the subjective well-being of someone — either through your direct labour or by producing a good they desire — you can demand payment. Either in kind, or more likely money; that wonderful, civilisation-unlocking technology that has allowed human cooperation and coordination to scale to immense, world-dominating proportions.
The same is true for companies, which are just legal entities under which humans collaborate in pursuit of a common goal. Those that succeed do so because they deliver genuine value to their customers. Sure, you might be able to fool people for a time, but for any enduring prosperity there must be true value creation.
The more value a business provides, relative to competing alternatives, the more pricing power it will enjoy, and the more profit it will generate.
This is probably not an especially illuminating insight, but it is one that can be easy for investors to overlook. And it should be fundamental to any due diligence.
To invert things; if you can’t understand a company’s value proposition, and how that can be delivered in an economically accretive manner, you should probably avoid investing in it.
Of course, here in the real world, which is far from fair and just, there are other ways to build wealth for yourself, and they can be far more expedient than the laborious process of improving the welfare of others.
Theft and grift are the obvious candidates, but things don’t need to be so obviously nefarious. When it comes to equity markets, people long ago worked out that instead of delivering actual value, it’s far easier just to make a promise of future value — so long as you can cash out before you ever need to make good on that pledge.
The market may be a weighing machine in the long run, but in the short run it’s a voting machine. And for a lot of players in financial markets, the short term is all that matters.
Little wonder, then, why so many companies devote considerable resources towards ‘investor relations’. It’s not necessarily so insiders can “pump and dump” (which is, after all, highly illegal), but rather due to the simple reality that a higher share price reduces the cost of capital, and access to cheap capital is a competitive advantage.
And if you just so happen to be able to facilitate a raise or similar, well, there’s a decent fee you can charge for that.
Needless to say, a higher share price also goes a long way in helping to justify a bigger salary for senior management, not to mention unlocking those juicy short-term bonuses. It sure doesn’t hurt the ego either.
To be fair, a lot of the hype from company insiders can be well intentioned. The prizes these companies are chasing are often legitimately exciting and it’s not a bad thing if management are enthusiastic about the potential. Indeed, many of the most successful companies out there are run by people who dared to dream big, and could motivate employees and investors with ambitious goals.
But we also know that most businesses tend to fail, eventually. Not because a con is exposed — though that is sometimes the case — but because the gladiatorial arena of capitalism is ruthless and unforgiving. Usually it is the most ambitious that fall hardest.
Anyway, the point of all this is not to fill you with cynicism, but rather to remind you of the incentives at play. And the incentives for the various middlemen in this game tend to be very different to what we’d like them to be.
There’s no point in trying to work out if shares are good value if you don’t first understand exactly what value the underlying company is itself delivering, or likely to deliver in the not-too-distant future. And you need to work this out for yourself, with a healthy dose of scepticism, rather than rely on what many in the financial services space want you to believe.
The reality is, most actors in this space (although certainly not all) are far more concerned with generating a fee for themselves today, rather than building enduring wealth for you tomorrow.
Act accordingly.
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