What Investment Bankers Should Know about Stock Pricing - dummies

What Investment Bankers Should Know about Stock Pricing

By Matt Krantz, Robert R. Johnson

Stock trading is part of the financial services offered by some of the largest investment banking firms. But trading is also a matter for investment bankers to be aware of because it can affect the perception of what assets are worth. Investment bankers may dutifully calculate what they think an investment is truly worth, using prudent financial analysis. That means nothing when investors and markets value the asset differently.

The value of assets, especially shares of a company, is determined by the market bringing together willing buyers and sellers. This process creates a price at which sellers are willing to part with the asset and buyers are willing to pay for that same asset. Knowing the market price of an asset is valuable, especially when the market price is different from the value that the investment bankers’ models say.

When the value being placed on companies varies wildly from what investment bankers think companies are worth, it can be a huge opportunity. During the dot-com boom of the late 1990s and 2000, investors were willing to pay astronomical sums for Internet companies that often didn’t have earnings much less revenue. Investment bankers’ models would have shown that these companies were long on promise, but short on real value.

Nonetheless, investment bankers made fortunes preparing these companies to sell stock to the public that had a voracious appetite to own a piece of what they thought was the future. The curious thing is that these investors were correct in a sense — the Internet was an innovation that transformed the way everyone does business.

However, many of the Internet companies simply weren’t good investments. Even to this day, some observers of the initial public offering (IPO) market believe the market will never be as active as it was during the Internet boom.