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Banking & Capital Markets

Nine Things Affecting Your Stock Price

Why is your company trading at a relative premium or discount to its peer group? Consider these nine factors, says OCE Interactive.

Vincent Ryan
March 3, 2011 | CFO.com | US
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The way Jonathan Greenberg sees it, CFOs of publicly traded companies are preoccupied with two questions: “How can I raise our stock price?” and “Why is our valuation where it is relative to our peers?”

Often, though, stock-price performance mystifies finance chiefs, and they can be forgiven for believing that some kind of gremlin is driving share prices. But Greenberg, chief executive of OCE Interactive, thinks otherwise. His company, a provider of tools for equity valuation, sells a software platform for stock analysis that normalizes trading multiples for factors that are in a CFO’s control — including dividend policy, debt load, and earnings-growth expectations. Called Market Topographer, the platform also shows how stocks with a similar risk profile have been priced historically.

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Whether or not they use this particular tool, finance chiefs who gain a better grasp of what influences a company’s stock price can do a number of things better in turn, says Greenberg, such as valuing takeover alternatives, projecting how much the market will penalize or reward a given financial strategy, and communicating relative valuation to buy-side investors.

Of course, there will always be a portion of the premium or discount in a stock that is unexplained, concedes Greenberg. Nevertheless, he says, based on OCE’s research, the following nine factors can significantly affect a company’s stock-price performance, irrespective of current market conditions:

1. Financial leverage. This factor may be obvious, but which ratio should be used to measure it? Market Topographer uses net debt to market capitalization to capture how the market prices in debt levels.

2. Normalized dividend payout ratio. This is the percentage of earnings paid in cash to shareholders. Market Topographer uses the company’s latest indicated annual dividend and an average of consensus earnings-per-share estimates for future years.

3. Latent operating leverage. This proprietary metric shows unrealized earnings capacity tied to fixed investment by comparing earnings with depreciation charges. “The market tends to reward companies for the greater potential upside associated with higher latent operating leverage,” says OCE.

4. Historical earnings stability. “Companies exhibiting this tend to trade at a premium because investors are comfortable in the predictability of future earnings,” says OCE.

5. Investment clarity. OCE measures this using one-year relative historical stock-price volatility. The clearer a stock’s story and outlook to investors, the less volatile the price tends to be.

6. Information availability. Bad news for companies with few or no analysts covering their stock: investors will pay a premium for a stock if more information is available about it and if that information is widely disseminated.

7. Sales cushion. This is a measure of gross profit margin that takes into account all operating expenses except depreciation and some corporate overhead. According to the market’s logic, companies with greater sales cushions “can better withstand increased pricing pressure,” says OCE.

8. Fixed-cost moat. This aptly named factor is based on a company’s total asset-turnover ratio. Companies with a high fixed-cost moat (a positive from the market’s perspective) have a lower asset turnover ratio — they require more assets to achieve a given level of projected earnings. They thus “run a lower risk that competitors will enter the market and drive down returns,” says OCE.

9. Size of earnings base. In this case, bigger is worse. All things being equal, explains OCE, “the market tends to penalize larger companies relative to smaller companies, based on an expectation of diminishing returns — [that is,] the increasing difficulty for a company to sustain a given level of growth as the size of its earnings base increases.”

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