The "fundamentals" in this example are static. But presumably they're not going to fire everyone tomorrow, so at least a good proportion of their cash on hand is as good as spent.

Then, in order to stay in business, they might need to take on massive debt, or there's a chance of severe dilution, and the likelihood of this will lower the stock value further.

To take an extreme example, if everyone assumed the company was going to run itself into the ground, mortgaging its real estate, etc., until it has zero other options, then the stock would be basically right now $0, no matter how much real estate or cash in the bank in had right now.

The price of a stock as with any other price merely reflects supply and demand and not it's intrinsic value which is generally unknowable.

If you have an opportunity expected to double your money then it makes sense to sell an asset below 'asset value' to avoid taking on missed opportunity costs.

Example:

  You have $1mm in Zynga stock @ $2.35, and no cash on hand.
  You expect the stock to trade at $2.85 in 1 year.
  You have the opportunity to buy APPL and expect AAPL to double in 1 year.

  The EV of AAPL is $2 mm
  The EV of Zynga is $1.21 mm

Therefore excluding transaction costs it's the smart play to sell Zynga stock for any price above $1.87.

Since you've probably lost heavily on Zynga you can use the tax losses from a sale to offset the gains from the APPL profit, where as holding Zynga for the EV would merely result in a reduced tax loss.

"buy APPL and expect AAPL to double in 1 year."

Big error. You can predict a stock doubling in value a year in advance?

Your numbers are less shocking when you plug in more reasonable expectations, say 6% market index instead of 200% home run.

The actual numbers here are irrelevant; gp was providing a hypothetical in which it makes sense to sell a stock.

If exaggerated numbers make the hypothetical concept easier to grasp I don't think it detracts from the example to use them.

If you're going to buy one stock it doesn't really matter how much another stock will increase in the next year ;)

(I'm prety sure that Appell Pete Corp would be psyched if enough people make this mistake).

Because no one looking for market index returns would hold Zynga in anything other than an index fund. If you hold zynga you're looking for a homerun, or a trader.

Thus I used numbers that would appeal to the type that might hold Zynga stock. The type that had a risk profile involving losing 90% of the stock's value in 6 months.

Commonly, in addition to cash burn, a company's assets are a) overstated b) will not fetch fair market value in a firesale c) have many additional costs during the bankruptcy process.

In addition, large funds cannot sell their shares instantly, therefore will depress value below net assets, in effect paying a premium to get out of the stock.

They may have $X of cash or close-to-cash assets, but the company also isn't shutting down tomorrow and liquidating. They will continue to spend into the foreseeable future, making its probably future value something less than $X.

Basically, the future value of Zynga's games is worth less than the future revenue, creating an expected net value decrease.

Do you mean why, or how?

As to "why", equity values are often more about emotion than reality (sometimes much more). Sometimes people want to bail from a stock that's become unpopular, and they don't bother to notice that the stock valuation is lower than the value of the buildings and inventory.

As to "how", there's nothing to stop a market valuation from being lower than the most basic assessment of the physical value of a company's assets, separate from present and future business prospects.

The single most important thing to remember about equities is that decisions need to be based to some extent on how stockholders think and behave, not necessarily on what makes sense. A person could on principle hold onto a stock in a company whose assets are very valuable, only to watch the stock drop to $0.01 per share, based on mass psychology rather than common sense.

The expectation is that it will continually lose money down to the point of the valuation.

For example, say in an imaginary world I have a piece of real estate and its worth 500k right now but its pretty much assumed that because of X, Y and Z real estate in the area is going down on average 20%. Because of that if you are the buyer you'd argue that a fair price to buy the house is actually 400k. Same thing with companies - on average, investors think Zynga will be a loser down to the point of its current stock price.

fundamentals are subject to change. What the market looks at is it's future value. Right now, Zynga's future value is low and dark

Stock price is the price of the last share sold, not every share. If someone tried to raid Zynga for its cash, buying up all the shares, they would buy all the shares offered at $2.35, then all the shares offered at $2.45, ... until they end up paying $3 or $5 or $100 for the 50% ownership they need to take over the company and shut it down. The total cost of the company would be more than (last share sale price) * (# of shares)

My thoughts exactly.

It's a good headline, buut won't the market correct this naturally to account for the fact it's worth "less" than it's assets or is Zynga going to just keep dropping?

> It's a good headline, buut won't the market correct this naturally to account for the fact it's worth "less" than it's assets or is Zynga going to just keep dropping?

Not unless equities investors decide to act rationally, and there's little evidence for that. Stocks falling below the true value of company assets is such a common occurrence that cagier, usually bigger, players will locate and "greenmail" such a company into buying their own stock with company assets to correct the difference between market valuation and basic value.

http://en.wikipedia.org/wiki/Greenmail

So I guess the answer to your question is "yes" but exactly how this happens is sometimes rather complicated.

Obviously if a company can be located whose physical plant and inventory value is higher than its stock valuation, such a company is vulnerable to a takeover by anyone able to detect this peculiar state of affairs and act on it.

Actually, it's quite a rational approach. As an equity investor, you have to articulate a certain expectation for cashflow. If you believed that Zynga would give up the game and liquidate itself now, you might price it to net assets. However, the expectation is that although they may have $X in net assets available, they're going to keep bleeding that out until they have less than $X. Basically, you've got a CEO with a dollar, and you don't even believe s/he is going to earn enough to make back that dollar after all the money s/he wastes.