Sunday, February 8, 2015

Creating Company Value & Higher Share Price

Whether a company is privately owned, or publicly traded, employees are hired to make the company more valuable by managing expenses and growing revenues and profitability.  Companies are usually sold based on some multiple, which varies by industry.   It could be 3 to 10 times annual profit, or some other industry specific formula.  It does not matter if the company is for sale or not, the shareholders of the company, that have risked their money to invest in the firm, are always concerned about shareholder value.  Naturally, shareholders expect a return on their investment that could come in the form of dividends, or upon sale of the company, presumably as a capital gain. 

A company is technically not in business to create jobs; but rather to create jobs that can provide a return on investment to the shareholders.  In well run companies, employees will benefit by creating value and a higher share price, in the form of higher salaries, incentives, bonuses, commissions etc. to share in the wealth that is created.  Ineffective employees are actually a drag on shareholder value, which is why performance objectives are used not only to measure individual performance; but to determine if the employee should remain in the company. 

Rightsizing, or lay-off's occur to cut expenses in response to lower revenues than anticipated.  Sometimes employees have a hard time understanding why lay-off's are necessary, even when presented with cold hard facts that make continued employment impossible.  This is particularly confusing when the company is hiring others, at the same time it is laying people off, to fill other positions that can better create value.  However, when all is said and done, Senior Management is responsible to the shareholders of the company and must act to protect their interests as the owners of the company.  At the end of the day, profits come from subtracting expenses from revenues.  What is left over we refer to as Pre-Tax Profits. 

Some businesses, like grocery stores, are high volume; but very low margin.   Those companies may be content to earn a 3% Pre-Tax Profit.  Most companies are focused on earning a 10 - 20% Pre-Tax Profit.   Of course, there are some companies that earn much more because they offer products, or services, with little or no competition, which allows them to dictate price.  That situation usually does not last for long as other companies enter industries deemed to be lucrative.

Most important, all employees must realize that their jobs are completely dependent on creating company value, higher profits and the higher share price that results.  It may seem cruel; but in a free market capitalist economy, creating company value is what makes everything work.   And, nothing works better.  We have seen the end result of Socialist and or Communist economics, where theoretically everybody is guaranteed a job.  I say "theoretically" because ultimately those systems have led to loss of freedom, misery and poverty.   Free Market Capitalism, with all its boom and bust cycles, focused on creating company value has created more wealth for more people than any other system in the history of the world. 


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