Why Does Management’s Credibility Affect Stock Prices?
Below are Tesla’s financial strength indicators from GuruFocus.com (as of today). This site provides numerous interesting metrics, but I want to focus on the last two indicators shown in the image:
- Beneish M-Score: As you can see, it indicates the degree to which management may be manipulating financial results.
- WACC vs. ROIC: It shows how wisely management is investing in new projects. (WACC – Weighted Average Cost of Capital, which is the cost of resources for the company. ROIC – Return on Invested Capital).
The issue is that these two indicators reflect a fundamental problem in corporate financial management. This problem pertains to the conflicting interests between management and owners (investors).
No matter how many investors there are, they all agree that the common interest is to increase the value of the company’s capital. However, for management, this is not always the case. Managers often (though not always) invest in projects where ROIC < WACC due to narcissistic ambitions. This means that the NPV (Net Present Value) is negative.
For example, the majority of decisions regarding mergers with other organizations or acquisitions of other companies are often based on romantic ambitions rather than financial rationality. As a result, we witness a decline in the value of owners’ assets – a drop in stock prices.
In general, there are two fundamental questions in corporate finance: In what projects should I invest? And where should I finance these projects from? The first is called investment decisions, and the second is called financing decisions. The reality is that 80% of value is created through investment decisions. Therefore, when management engages in irrational investments, it does not create value but rather destroys it.
Despite numerous regulations aimed at controlling the transparency of publicly traded companies, management with psychopathic and adventurous approaches always manages to manipulate for personal gain. This is precisely why, personally, when making a decision about buying stock, I pay close attention to the honesty of management.
https://www.gurufocus.com/stock/TSLA/summary?search=tesla
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