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Perception, right or wrong, affects price of both houses and of your favorite stock | |||
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By DAVID MOON, Moon Capital
Management Assume you purchased your house a week ago for $200,000, a price you considered fair at the time. You didn't feel as if you got a bargain, but you didn't feel cheated, either. You thought you paid a fair price for the house. If someone came to you a week after you purchased it and offered you $120,000 for the house, did the value of the house decline 40 percent in one week? Even if your calculations were a bit astray and you slightly overpaid for the house, house values don't change that rapidly. But what if the house was located in rural Hazel Green, Alabama, where you had just moved from New York City? In New York, you may have rented an 800 square foot apartment overlooking a crack house and a garbage dumpster for $1,500 a month. In Alabama, however, you found a 2,000 square foot house on a full acre for only $200,000. Your payments to own this palace would only be $1,200 a month. It seemed like a bargain, so you jumped at the opportunity. Knowing the history, now assume someone comes by a week later and offers you only $120,000 for the house. You rationalize the act as some dumb country bumpkin trying to take advantage of a newcomer. Then someone else offers you $115,000. You begin to wonder if there is a 'sucker' sign on your back. After researching the local real estate market a bit (something you are beginning to think you should have done before buying the house) and discover houses similar to yours in Dump Hole, Alabama sell for about $60 a square foot. (As a former resident of Hazel Green, Alabama. I am comfortable taking this literary liberty.) The house that you thought was a bargain at $200,000 really is only worth about $120,000. In this scenario, did the house value decline $80,000 (or 40 percent) in a single week? Of course not. The house was never worth $200,000, even though you, as an ill-informed or emotional buyer, were willing to pay that price. Home values simply do not change that rapidly. Company values do not change that rapidly either, though their prices often do. In the two years from August 2000 to July 2002, the price of General Electric stock declined from $60 to $23.01 a share. In total, the stock market reassessed GE's value downward by $371 billion. But did the value of GE actually change that much during those 24 months? General Electric is about as diversified as a company could be. Home appliances and airplane engines. Lighting products and plastics. Financial and engineering services. They owned Internet and cable television businesses. GE even went into the faux football business, partnering with the World Wrestling Federation to create the XFL, a stand-alone football league, complete with Minnesota governor Jesse Ventura as an analyst and strippers masquerading as cheerleaders. (I just can't imagine why the XFL didn't work.) GE's businesses generated annual revenues of $122.9 billion in the twelve months ending June 2000. Twenty-four months later, GE's revenues had increased to $127.2 billion. The market's evaluation of General Electric was different, not the value of General Electric. The value of GE might have been a bit different in 2002 than it was in 2000. Based on a 3.5 percent increase in revenues, one might even conclude GE was more valuable in 2002. The primary factor precipitating the 61 percent decline in GE's stock price was the illogical level at which the GE shares traded in 2000. The company did not decline in value by almost two-thirds, even though the stock price did. The stock price was simply too high and eventually had to decline. David Moon is president of Moon Capital Management, a Knoxville-based investment management firm. This article originally appeared in the News Sentinel (Knoxville, TN).
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