The crisis: Timing strategic moves

Timing is the key as companies examine whether to make investments now or wait for clear signs of recovery. Companies with healthy finances are battling the query, should they pursue acquisitions and invest in new projects or wait for recovery. A growing range of attractive opportunities has cropped up that were not available a few years ago. Investments in real estate, capital projects, R&D are much cheaper than it ever was during the economic cycle.

But many indicators suggest that the economy is yet to recover. Moving too quickly would mean catching the proverbial falling knife, in the form of equity markets falling and using the cash they will need to weather the storm.

Timing such moves is difficult, as to when the economy will recover depends upon the global capital market, business confidence, and government actions. Executives may easily give up, wait for irrefutable evidence of a recovery and this overcaution would be harmful. 

Instead, executives should make an educated decision by weighing the risks of waiting or rushing in. While better timing would result in better pricing thereby adding value, the best way to minimize risk is to ensure that the decisions are based on strong strategic rationale.

Executives must understand what lies behind valuations and earnings. Executives who wait may be failing to maximize creatin of value.

Analyzing scenarios

The prime drives of the equity markets are long -term profits and growth. Long-term profits are linked to the economy's overall performance over the long term. It is reasonable to assume that a return to normal for corporate profits would mean a return to the long-term growth of GDP. This could be treated as a benchmark to evaluate and it would be reasonable to assume that the corporate profits would revert to the long-term GDP growth. This analysis can be tailored to individual industries by developing a more detailed analysis of the linkages among GDP, earnings, and growth.

The second factor to consider would be the growth in labor and productivity. It will be reasonable to assume that it will return to its long term average once the GDP growth picks up albeit with a lag.

Finally, the historical price-earnings ratio can be used as a measure to analyze and decide on investments.

Current equity prices can be interpreted in several ways. The market may be in a state of extreme pessimism, with the same opportunities for investors and acquirers. The market may also be assigned a high probability to the decline of the long-term growth in GDP. Also, given the nature of the downturn, the old relationship between GDP, growth, profits, and equity valuations may have to be relooked.

Timing the recovery

Strong companies deciding on whether to move forward now should take into consideration the timing of the market recovery. One common analysis calculates the number of years before the market will return to normal assuming growth to be the historical growth rate. However, the markets tend to recover much quicker, and hence waiting too long can result in a missed opportunity.

Doing the above analysis would help companies in deciding whether to act now or wait. much uncertainty surrounds the timing of the end of the downturn but companies waiting for a clear trend may miss once in a lifetime opportunity t acquire or invest. Executives can learn quite a lot by examining the previous similar downturns especially concerning the valuation of corporate earnings and its relation o the economy on the whole. 

The crisis: Timing strategic moves

Richard Dobbs and Timothy M. Koller McK-Spring2019