| BUSINESSWEEK ONLINE : JUNE 7, 1999 ISSUE | ||||||||
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| FINANCE
Options, Options, Everywhere Real-options expert Robert S. Pindyck of Massachusetts Institute of Technology tells people he has a terrible disease: ''I see options everywhere.'' Companies have all kinds of options: to raise production, to buy rivals, to move into related fields. Studying a company's portfolio of options provides insight into its growth prospects and thus its market value. That's why many on Wall Street are trying to contract Pindyck's options-spotting disease. ''It's an important way of thinking about businesses and their potential,'' says Michael J. Mauboussin, a strategist at Credit Suisse First Boston (CSFB). ''The thought process itself is very valuable.'' ZEROING IN. Real-options analysis is a big step beyond static valuation measures such as price-earnings and price-to-book ratios. Comparing two companies on the basis of their p-e ratios is valid only if they have the same expected earnings growth. They hardly ever do. Real-options analysis zeroes in on what really matters: the earnings growth itself. It values companies by studying the opportunities they have for growth and whether they can cash in on them. Management's skill becomes a major focus. Take America Online Inc., whose p-e is stratospheric. AOL stock would be only about 4% of what it is today if the market expected it to maintain profits at the current level forever. Real-options analysis gets a grip on whether the other 96% of AOL's market value is justified, says Martha Amram of Glaze Creek Partners, a consultancy in Palo Alto, Calif. (She hasn't tried to do the calculations.) CSFB cable-TV analyst Laura Martin recently used real-options analysis to conclude that cable stocks are undervalued. Real-options analysis can also conclude that companies are overvalued. For instance, Amram argues that microprocessor-design outfits Advanced RISC Machines Ltd. and MIPS Technologies Inc. are overpriced because they don't have good growth options. For one thing, she says, it's hard to branch out from microprocessors to designing other kinds of chips. ''Don't look to options thinking to explain the market cap of these companies,'' says Amram, co-author with Nalin Kulatilaka of Boston University of a new book, Real Options: Managing Strategic Investment in an Uncertain World. Coming up with a target price for a company by evaluating its real options is harder than lining up companies by their p-e's or five-year sales growth. It means understanding the companies, their industries, and managers' ability to take advantage of the options open to them. Then again, who said stock picking was supposed to be easy? By Peter Coy in New York _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ BACK TO TOP |
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RELATED ITEMS Exploiting Uncertainty TABLE: The New Math in Action TABLE: Who Has Opted for Real Options--And Why Options, Options, Everywhere INTERACT E-Mail to Business Week Online | |||
