And higher relative valuations are critical, not just for the listed companies and stock investors but also for the nation as a whole. High-quality companies — with the best stories and growth prospects — can and will choose to list in the market that gives them the highest valuations. This perpetuates a virtuous cycle — good stories attract investors and improve liquidity, generate momentum and raise valuations that in turn attract more companies with good stories. An efficient and robust equity market has the ability to attract and retain capital — foreign and domestic — that goes to fund investments, create jobs and drive economic growth, innovation and prosperity. There is no better example than the US stock market.
Equity markets are driven by not only underlying earnings but also the momentum generated from storytelling. We know that the intrinsic value of stocks — and, accordingly, valuations for the broader market — is determined by its discounted future cash flows. This is what we are taught in school. Yet, observations of the real world also tell us that some markets (and stocks) always trade at higher relative valuations while others can stay cheap for a very long time. We are fundamentally driven analysts, but we cannot deny that markets need good stories to thrive.
Last week, we wrote about how very good storytelling successfully attracted massive investor — and speculator — interest in Nvidia Corp and Tesla, lifting their valuations far higher and for far longer than underlying earnings could rationalise or justify (see “Nvidia and Tesla — the gods of storytelling — and speculative gambling”, The Edge, Sept 23). Liquidity and momentum matter because the equity market is a market for stocks — prices and valuations are driven by demand and supply. In short, markets with higher liquidity tend to trade at higher relative valuations.
