As we have previously noted, the Share Price system relates to the Asset and Business systems, but this relationship is not perfect. Generally an unstable Asset or Business System will contribute to an unstable Share Price system, but not always. Valuation will be a key consideration in this mapping. As the Transurban example above higlights a very stable Asset mapped to a highly unstable Share Price due to a combination of financial leverage and an extreme valuation.
A key consideration in the instability of share prices is the polarisation of the existing and potential shareholder base. If beliefs are evenly distributed then share price moves will be cushioned even as the mean opinion changes. However, in situations where beliefs are polarised strongly between bull and bear cases, the transition between these two states (particularly bull to bear) can be sudden and dramatic.
Understanding the Systemic nature of the investment opportunity is a key analytical tool. A starting point is to distinguish between the stability of the underlying system and its volatility. One step in this process is to break down the systems being analysed into a classification of Asset/Business/Share Price.
In future posts we will look at other elements to consider in this analysis:
- What shock is that? – Distinguishing between different types of shocks and their impact on these systems;
- Where’s that System at? – Distinguishing the different states a system might be in.
- What feedback loop is that? – Understanding the various feedback loops that drive systemic behaviour.