The wealth trap

When one looks at a balance sheet, the value of the business attributable to the shareholders is the difference between the assets and the liabilities, the net asset value (NAV). The market value (MV) of a listed company is the value attributable to the shareholders. For companies that are growing, profitable, and high-tech the MV is usually a lot higher than the NAV.

A large proportion of the difference is a function of the growth, and when that starts to drop off, even though the company is still very profitable, the MV drops.

So the senior executives cannot afford for growth to drop off, otherwise the shareholders lose money and that makes them unhappy.

High growth is normal in the early stages of a market. The same is true for a company with a smart idea coming into an established market. As the market becomes saturated and the smart company starts to dominate, growth naturally tails off. After that growth is dependent on price increases, which at some point starts to chase customers away.

When executives start running out of ideas to keep the growth going they sometimes resort to dishonesty.

There have been a few examples recently: Barclays and the other banks manipulating LIBOR. GlaxoSmithKline paying $3 billion fine for committing healthcare fraud.

One company’s growth falling off is an unhappy event. Many companies sharing that fate is a crash. That mythical wealth is what underpins the stock markets.  As long as we keep believing the myth, we’ll be fine.

Just don’t stop.

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