One of the most common mistakes in starting a new business is to make an assumption that the marketplace is very capricious and unpredictable. Often times this assumption is right, but the actual timing and financial impact can be much different than anyone anticipates. Market conditions change on a daily basis and business cycles do not occur in a vacuum. To understand what does exploiting misvaluation mean for the business you are starting, you must understand what it means for the investor who funded your business startup. In this article, we will explore what this means for an individual business and what the implications of misvaluation are for the company.
Investing in a new business startup when the market value is considered to be below book value is called misvaluation. Investors typically wait until the company is near bankruptcy before they become aware of the potential losses. Once an enterprise files for bankruptcy protection, there is a mandatory 90-day waiting period in which the proceeds of its debt must be distributed. If the corporation,s stock loses too much value during that period, then the value of the entire business may have been reduced by the lenders. This condition is referred to as the debt discount. It can lead to a catastrophic decline in the market value of the enterprise, and if the company is not able to raise new capital to restore its financial solvency, it can be forced into liquidation. What does this mean to the investors? It means that their investment has been significantly reduced.
What is meant by value of a company is the price at which the stock can be bought by an average investor in the open market. What does average mean? That is, it means that while every investor will pay a slightly different price for the same stock, there will be many small differences between the bids and offers. These differences are what cause stock prices to vary between the bids and offers. The margins on these stocks will give the retail investor an excellent opportunity to buy a stock at a bargain price and sell it for a profit to increase his net profits. Conversely, a company that is experiencing what is called misvaluation will have a depressed market price, and therefore will only be able to take advantage of small profits from the few buyers who are prepared to pay the high prices.
Exploiting misvaluation is not an uncommon occurrence in the stock market today. Many companies will be in distress for reasons beyond their control, but they will still manage to take advantage of some degree of market inefficiencies. Some companies will indulge in all manner of businesslike practices such as writing off unimportant assets, misleading their investors about management expenses, and ignoring financial information that might cause their stock to decline. They may also engage in accounting tricks to inflate their earnings before the actual taxes have been paid. As a result of these inefficiencies, many companies will be able to increase their market values by offering generous dividends.