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How Operational Challenges Can Affect Stock Performance
Public companies have one overarching legally-mandated goal: maximize shareholder value. Of course, this is easier said than done. Stock prices are fundamentally irrational, influenced by a wide variety of internal and external factors.
Since companies can’t do anything about external factors, their main focus is on operational challenges within the organization. How well a company manages these challenges has a significant effect on stock performance. Read on to learn more.
About Stock Performance
If anyone knew exactly why stock prices went up or down, they’d be fantastically wealthy.
Instead, stock performance is ultimately irrational, determined through various overlapping inputs such as company performance, investor expectations, earning predictions, public perception, market conditions, the weather, astrology, geopolitics, and more.
From the company’s perspective, fundamental performance is most important because it’s within their control.
If you run a company well, it will generate profit. Companies that generate profits consistently will eventually be highly valued by the market, which is the core concept behind value investing.
However, even simple businesses must manage several operational challenges to provide goods or services to the marketplace successfully.
Failure to address these challenges effectively will – sooner or later – result in decreased stock performance.
Every company has a theoretically ideal business model that describes how the company is going to generate value for customers.
In reality, operational challenges inevitably arise and add friction to this process. In a sense, profit is the theoretical ideal minus all the mistakes.
And remember, perception is a reality in the stock market. It doesn’t matter if these operational challenges are real or not.
Perception is enough to apply negative pressure to stock prices. The entire job of a trader is to guess what might happen next in the market.
If they see smoke, they don’t have time to wait for the fire. They need to move now.
Poor management is the root cause of all operational problems. Sometimes companies just get bad luck, but then again, the best managers don’t put their companies at the mercy of luck and have contingencies in place to avoid trouble when bad luck strikes.
While no company is perfect, the competition for investment is fierce and unforgiving. If enough management problems arise, the market is going to take notice and react accordingly.
Companies exist to provide goods and services to customers. As long as they can do this, they can generate profit.
Even if the company is otherwise beset with problems, it can stay alive if the needs of the customer continue to be met.
For public companies, this means setting and meeting (or exceeding) earnings projections. If a company fails to generate revenue at a level promised to shareholders, the market will react by shifting investment to other stocks.
Additionally, lack of innovation, excessive equipment downtime, and failed products or services are all common productivity challenges.
For most businesses, standing still means falling behind. If the market senses a company in stasis, selloffs will follow.
Efficiency problems are not about catastrophic defeat but more like death by a thousand cuts. Fraud, inventory management, and waste can all eat away at profits.
If a company is spending 99 cents to make a dollar, the market will identify this inefficiency and devalue the stock.
For example, consider chargeback fraud. While companies work to create effective shipping and charge solutions, some customers will take advantage of those systems for personal gain.
This siphons off profits and eats into earnings.
Financial data about public companies is readily available, allowing investors to make independent judgments about the financial health of the company.
If a company is struggling financially, the market is going to know about it.
For example, a company might be carrying excessive debt. Even if management thinks the debt level is reasonable, investors might disagree – and investors set the stock price.
While debt alone is unlikely to tank a stock, it can be a contributing factor.
Making the best products in the world won’t matter if those products don’t end up in the hands of customers. Even if logistics failures aren’t technically the responsibility of the company, the customer won’t care.
They will just stop buying and write bad reviews, which can lead to poor performance and eventually to stock price declines.
An example of a logistics challenge is long lead times. In the age of next-day shipping, nobody wants to wait two weeks for a product.
If a company develops a reputation for being slow, customers will look for an alternative, and investors will soon follow.
Labor relations are critical for successful business operations. The more labor-intensive the production process, the more this is true.
Excess labor erodes profits, while insufficient labor limits productivity. Finding the right labor balance is a critical responsibility of management.
For example, if workers strike, it could be catastrophic for both productivity and market perception, leading to inevitable declines in stock performance.
Supply Chain Challenges
If a company can’t get the raw materials needed to make products, it can’t make any money. Good managers will have redundant supply chains in place, but this isn’t always possible.
Even if it’s not technically the company’s fault, disrupted supply chains will be interpreted by the market as a management failure, and stock prices will drop accordingly.
We hope you have a better idea about how operational challenges can affect stock performance.
While stock prices are often irrational, prices are at least partly dictated by how well the company performs on a fundamental level.
Managing operational challenges successfully is a key aspect of fundamental performance.
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