Unleashing Risk Capital is Key to Stock Market Appreciation

     Stocks may be cheap, and bonds may be expensive according to most fundamental models, but it just doesn’t seem to matter to “Mr. Market” right now.  There are a lot of hypotheses out there as to why stocks are trading at such a discount by historical standards.  Some of the reasons center on US politics, Europe’s deleveraging, consumer confidence, geopolitical risks, and unemployment.  These are all legitimate risks that need to be factored, yet I believe there may be a more basic theme that ties all of these reasons together.

     A recent conversation with a colleague sparked a very fruitful conversation regarding how best to discount the value of a particular business so that we could come up with an accurate intrinsic value for the publicly traded shares of its common stock.  As we finally arrived at the best discount rate to use in our pricing model, and we plugged in our numbers, we concluded that this stock was trading at a very large discount to its intrinsic value.  Usually, by using consensus numbers to input into our model, we elevate our probability of being correct. 

     Finding discounted stock prices in high quality, growing businesses is not that difficult to do these days.  This begs the question:  Why are investors backing away from their fundamental models and failing to put their capital to work where it will be rewarded?  Answer:  A lack of visibility.

     I think an example of the answer can be found in a story that I read last night regarding the NFL and its recent deal with ESPN.  The division of Disney will invest 15.2 billion dollars to secure the rights to Monday Night Football through the 2021 season.  This is a significant amount of capital that Disney has decided to risk in order to secure the rights to broadcast approximately 160 regular season NFL games over the next ten years, especially when you consider that ESPN generates only about 5 billion dollars for Disney on all of its sports programming each year.  Bottom line…ESPN is making a big bet on Monday Night football’s success and the return it can produce on more than 15 billion dollars.

     This deal is a good example of putting real capital at risk.  So why is ESPN willing to do it?   The answer is found in the recent contract negotiations between the Players’ Union and the NFL.  Whether or not you agree with all of the details of the deal, the fact that the deal was a long-term (10 year) deal allows for ESPN to make this kind of investment. 

      The moral of the story…If we want the private sector to create more jobs, if we want more growth in our economy, and if we want assets to get priced more closely to their intrinsic values, then we need our leaders to start solving economic woes with a focus on long-term solutions, not short-term fixes. 

     The big issues of our day cannot continue to remain in flux.  Whether it is our federal tax policy, healthcare policy, or budget, our leaders must stop injecting uncertainty into the “rules of the game”.  Simply put, risk capital needs some measure of certainty over time to allow for a calculation of return to take place.  Without the ability to have conviction in a business or pricing model, business people will continue to remain cautious and economic growth will suffer.  On the other hand, if we can give business people a long-term set of rules that allow for a reasonable return on investment, risk capital will come off the sidelines and “Mr. Market” will begin to price assets more closely to historical standards.