What's a company really worth? Business people agonise over this question all the time. Sometimes we need the answer: when we're hunting bargains in the stock market or cashing in the family firm before retirement. Other times we're just nosey, jealously wondering how rich the boss is. Whatever. We want to know.
But coming up with a number is tricky. We can look at fundamentals such as earnings and book value, but they tell us about the past, not the future. Technical analysis seeks clues in market trading patterns but has earned the less than flattering nickname "voodoo" finance. Then there's financial economics, also called rocket science - geniuses with physics PhDs building seemingly foolproof investment contraptions (to see how this story ends, perform a Google search on "Long-Term Capital Management". It's not pretty).
Refreshingly honest help was at hand on Saturday night in the form of Bob Ryan, a professor at Manchester Business School. He pulled few punches during a public lecture in Dubai. Take his comments on chartered financial analysts: "They have no more skill, in effect, than the monkey throwing darts at the Financial Times."
Before Dubai's army of CFAs form a lynch mob, be aware that Prof Ryan was simply citing an academic study published in The Accounting Reviewin 2009. It found that, despite spending three hard years at night school to earn the coveted qualification, analysts with the CFA charter fare little better than mere mortals in forecasting important stuff such as revenue, profit and share values. The research did find that investors trust CFAs more - an interesting study in the educational theories of credentialism and signalling, but we'll save that for another day.
So, what's the alternative to primates chucking arrows? Prof Ryan says we should tell stories. "The financial information that you read is a very limited reflection of the underlying reality of the business. To be really successful at this business of analysis and valuation, you've got to be prepared to get under the financials, to be able to understand what is going on. The way I describe it is a process of almost storytelling, building the narrative."
One of his favourite examples is Disney. "It has been said of Disney that its primary objective is to manufacture and sell happiness, which it does very well. Disney had a wonderful phrase for this. They called it imagineering. Disney used to get its people building new theme parks or designing new films to imagineer, to create a new reality. In a sense, what I'm arguing is that financial analysts need to be able to use their imagination, to imagine what is going on within a business."
Just to recap, this is a finance guru speaking. Bob Ryan has published five books and more than 100 articles on financial analysis and accounting. He's founded not one but two business schools. He is, in short, a numbers geek.
A roomful of MBA students from across the UAE have given up their weekend to learn about 21st-century financial wizardry from the acclaimed master. And here he is banging on about Mickey Mouse and Donald Duck.
Ultimately, he wins them over by marrying his intuitive approach with a healthy dose of number crunching. He is not saying the financial data does not work - just that it does not work on its own. Mickey and Donald live happily ever after with Fischer Black and Myron Scholes, prize-winning economists famous for their options pricing model (For more on Bob's technical work, find him on blogspot).
What does all this mean for the Middle East? That's a question I put to my old buddy Amin El Kholy, the managing director of asset management at Arqaam Capital in Dubai and a Manchester MBA alumnus. He says the combination of rigorous statistical analysis with a storytelling approach can work in the region.
Take the recently launched Arqaam Value Fund. First, it strips out the 50 to 90 most active and well-covered regional companies. "They are better covered, and the markets have become more and more efficient over the past five years," he explains. It also strips out 750 tiny stocks from the bottom. That leaves about 600 stocks in the Middle East and North Africa and Turkey.
Arqaam built a computer model that screens these stocks using key fundamental ratios such as price to earnings and price to book. "Then the analysts and fund managers dig a little deeper." Many of these mid-level stocks are ignored by fund managers and analysts, not because they're bad companies but because they're too small or illiquid. Arqaam's fund, taking a more long-term view, can afford to take positions in unloved gems.
Already, the managers are taking this a step further by becoming activist investors, advising companies in their portfolio.
"Maybe if the company can take a slightly different approach to its balance sheet, by taking on more debt, raising more equity or looking at its receivables, it can boost its dividend - which in turn can be a driver of the stock price for investors," says Mr El Kholy.
That's not just understanding the story - it's writing it.
*Richard Dean hosts Tonight on Dubai Eye 103.8 FM and is the author of Sink or Swim? How to Stay Afloat in Tough Economic Times: Business Lessons from the UAE. He does not own any of the shares mentioned in this article.
