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Jul 04

Google IPO Pricing

Jason Kottke mentions that the per share price of the Google float is largely irrelevant. He emphasises the more important question is whether the valuation of the company is accurate because the market capitalisation of a company is meant to be a representation of that company’s worth. However, he neglects to account for other factors that should be considered in purchasing stocks. One of the other major considerations is liquidity, and the absolute price of a stock is connected to this. The lower-priced a share is, the easier it is to offload and the more liquid it tends to be. There’s no point in having oodles of shares you can’t get rid of in a hurry; look at Berkshire Hathaway, for example. Secondly, there are adverse psychological factors involved when looking at a high stock price (especially for the individual investor) which further impact on liquidity. That’s why companies do stock splits: the market is not completely efficient, and investors are not all rational.

For those wanting to make a quick buck, the issue is predicting what market sentiment is, as much as it is about valuing a company accurately. This is because unless you are a huge institutional investor, everyone else in the market is determining where the price for a stock heads, and market sentiment reacts irrationally, especially in a weakly efficient market. The very psychological factors Kottke points out as silly are yet very relevant.

Splitting stocks may also carry connotations that a company is doing a roaring trade (Microsoft has had numerous splits). So, although mathematically speaking, a split will double share holdings and exactly halve the price, the funny thing is after a stock split the price may rise a little due to these connotations.