A Stitch in Haste

The wires, and Drudge, are carrying the report that ExxonMobil is now the “most valuable” company, surpassing perennial leader General Electric:

Exxon Mobil Corp. (XOM) Friday knocked General Electric Co. (GE) from its perch as the world’s most valuable public company ranked by stock market capitalization.

Riding the tide of high oil prices, tight U.S. refining capacity and market enthusiasm for its dynamic cash flow growth, Exxon Mobil shares have risen more than 40 percent over the last year, outperforming all of the major U.S. stock indexes and GE by nearly 4 to 1. GE is up just 10.3 percent over the same period.

Um, not exactly. I suspect that, had it not been an oil company, no one would have really bothered to note this change in rankings, mainly because it really doesn’t mean anything.

The true (nominal) measure of a company’s value is not equity capitalization (i.e., the total number of shares of stock outstanding times the current market price), but total capitalization, (i.e., equity capitalization plus outstanding debt). On this metric, GE is still far and away the leader, with a total market capitalization of $600 billion compared to $377 billion for ExxonMobil (by way of comparison, Microsoft’s total market cap is $242 billion and Wal-Mart’s is $252 billion). (Source: Yahoo! Finance.)

Consider a simple example: suppose I follow through on my post-retirement dream of opening a nationwide chain of gay-oriented casual dining restaurants (working title: either “Thank Gay It’s Friday” or “AppleGays“). I determine I need $10 million to start my company. I have two options:

1. Sell 1 million shares of stock at $10 per share.
2. Sell 500,000 shares of stock at $10 and issue $5,000,000 in bonds.

Either way, on Opening Day my company is “worth” $10,000,000 (since I spent $10 million building it), but option #1 would represent twice as much equity value. Does it make any sense to argue that option #1 would result in “twice as valuable” a company as option #2? Of course not.

Equity market cap is not an unimportant metric, but it is a meaningless proxy for a business’ “value.”

Yet the story ran on AP, Fox, Bloomberg and of course Drudge, with not a one offering any clarification, opting instead for the eye-catching headline.

Meanwhile, these same MSM sources tend to decry the lack of “standards” and “fact-checking” and “editorial oversight” by blogs.

Go figure. Literally.

For Discussion #1: A primal assumption of neo-classical economics is that corporate managements strive to run their companies in such a way as to maximize profits (more correctly, the net present value of all future profits). Yet we constantly see evidence that, in the real world, CEOs often manage their firms with the goal of maximizing other metrics, such as equity market cap or simply the stock price. Are such CEOs therefore being irrational? Are they breaching their fiduciary duty to the board of directors (and, indirectly, to shareholders)?

For Discussion #2: A very powerful, and controversial, theory in finance is the Miller-Modigliani Theorem, which states that, given some very restrictive assumptions, there is no difference between choosing Option #1 and Option #2. Let’s say you’re not an investment banker, just a guy/gal with an idea. How does the Theorem strike you? Strictly off the cuff, which financing option would you prefer? Why?

For Discussion #3: Why did I write “true (nominal) measure of a company’s value…” What’s the true real measure of a company’s value? (Hint: I identified it in “For Discussion #1“).

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Filed under: Economics & Finance