Traditionally, price discovery — determining a company’s fair value price — is based on the interactions of buyers and sellers in a marketplace. The publicly quoted share price demonstrates how capital markets value a company, and it’s the basis upon which the company issues debt and equity. It also helps determine how the company allocates capital towards paying dividends, buying back company shares, compensating employees, paying down debt or reinvesting in the enterprise for future growth.
But today, five trends are colliding to distort how markets are pricing companies. The dangers of this distortion, especially at a time of buoyant stock markets, is that company executives and investors use these incorrect valuations as a basis to enter unaffordable M&A transactions and/or overleverage the company. The five trends are:
1. Low Interest Rates
Historically low interest rates, massive stimulus in…