Anyway lets just say your projection is coming from the glass half full perspective, with a price target of 160/share. This is where I want to come from to, but in this present market environment, the glass half empty perspective is winning peoples votes.
Hey Shaw, (mutual kudos on the great name!) But the half-full, half-empty psychological factor is largely irrelevant in the analysis. It is just a matter of time.
In the market money will move away from over-valued opportunities (relative to risk) to undervalued opportunities (relative to risk). The valuation I calculated is based on actual earnings 5 years out (assuming AVNX performs similar to the assumptions I made. I think most of us assume it will succeed somewhat along the line of my assumptions more or less). This being the case, then at sometime the market will begin to see how undervalued the company is (based on its risk factor - and this risk factor will come down overtime as the company continues to perform, making the company even more valuable) and the natural arbitrage function of the market will bid AVNX back up to its present value. Probably even higher. But it will yo-yo with its present value somewhere in the middle of its oscillations.
If the market is even remotely efficient this result has to occur.
The uncertainties are (1) just what risk factor is the market giving AVNX, (2) what are the markets expectations of AVNX's future growth, and (3) will AVNX actual perform up to expectations.
But if the assumptions are correct the market will inevitably bring the company back to its present value.
A quick example. One bank says that it will give you $100 in 5 years if you give them $70 now. That is a 7.3% rate of return. The risk free-rate of interest is 5% and you consider this investment nearly risk-free requiring only a 2.3% risk premium.
Suddenly CSCO opens up, it promises to give you $100 in 5 years if you give them $10 now. A 58% annual return. You figure the risk on this company requires a 30% return per year. So you get a 28% return premium investing here; Ie, a better place to put your money relative to the risk than the bank account above is.
Thus you will move money out of the bank account and into CSCO until such time as the price of CSCO = $26.90 (ie, when your return on the investment is merely expected to be 30% per year). At this time you are indifferent between keeping your money in Cisco and in the bank account because both give you exactly a $0 return beyond your required risk premium for each investment.
In the grand scheme of things this is what the market is. As you can see there are a lot of variables and perceptions can change, and do, but over time, if the market is efficient at all, it will move money to where the capital returns are best relative to risk. So the half-full, half-empty analogy is only accurate in the short-term. Money will move to where it is more profitable in the long-run.
Tinker
Honestly, this is the way it works; it stumbles its way along, overshoots, undershoots, panics in the short-term, gets euphoric in the short-term, but in the end it must center around some equilibrium based on present value. If AVNX lives up to expectations it will recover. It just takes the market a while to work out the inefficiencies and reallocate money more efficiently.
Yeah, I'm at Duke MBA and also a lawyer so I kind of live this stuff. But from a clouds eye view this is why it must work as long as the assumptions pan out.
ONE CAVEAT: That is unless the total system breaks down and liquidity leaves the market. This is a very, very, very, rare event. Last time this truly happened in the U.S. was 1929. |
