Self-Directed IRA Investing

The issue of how to value “hard to value” assets is now of concern to
regulators and those who are currently asked to make these assessments on
behalf of investors. Discussions are currently going on in the government,
because of the need to protect investors, particularly those who are
investing their retirement savings, from the surprises of Enron, Wordcom and
dot.bomb.

The difficulty of determining the “fair market value” or the “true market
value”, the current terms for the type of value determination to be
achieved, has also to be put into perspective. While the intent to apply
such standards is worthy (that is to protect investors from
surprises), actually doing so is an imperfect effort at best, and more an art
than a science. Whether you choose to determine value by selecting the last
price on a public stock sold in the public markets, or choose to spend
$40,000 to have an external valuation by a professional valuation company,
there is no pure method that can determine the actual value of any company,
public or private. The best one can accomplish is to derive an “approximate
value”. In choosing to use the price of a public stock (an “easier to
value” asset type), on a given day, you are inherently deciding that “price”
represents “value”. If that were truly the case, there wouldn’t be
discussion of “value” stocks, which are generally defined as stocks being
sold at less than the intrinsic value of the company they have a share of.
In some cases, such public stock is exchanged at less than the book value of
the company and far less than would be appropriate based on income, sales,
good will, competitive advantage, market trends, etc. It may just be that
an event such as September 11th or a jump in the price of oil, artificially
(that is, independent of the actual or perceived value of someone who would
perform an independent and in-depth valuation of the same company would
arrive at) signals and causes a drop in in the “price” of company’s stock.

So far then, one might accept the fact that fair market value based on price
is really an approximation of a company’s value based on the intersection of
supply and demand at a moment in time. And we all know from experience
that the price of a public stock can change dramatically within minutes and
seconds in the public market. Assume there is a sudden turn of events the
next morning when someone announces the discovery of 55 billion gallons of
oil in Arkansas, and the same stock that plummeted the day before sees a 15%
price increase, and the DOW rises 8%. Has the value of the company actually
changed? Maybe, and maybe not. When Enron sold on the NYSE the day before
it collapsed, was the price at which it sold a true representation of its
“fair market value”. Absolutely not, just as the fact that Arthur Andersen
stock prices on the same day did not represent the true “value” of its
stock. So selecting the price of a public stock as an estimate of value is
only arbitrary to the saver or investor, except, if they are liquidating
their investment at that price. At that point, “price” equals “value”,
because wealth transferred is equal to the price times the number of shares
of the asset in question. So much for the determination of value of a
“public” stock.

So what about the value of private companies and their stock? The formation
and funding of new businesses is essential to America’s economy and the
well-being of every citizen, isn’t it? I would think so since approximately
90% (approximately 23 million) of American businesses are non-public.
Shouldn’t the valuation be given the same level of attention as with public
companies. Certainly, but given the fact that there is not a convenient
yardstick like a public market to use to approximate value, different
approaches must be utilized. But, because a company, without earnings, in
the second year of its existence (and whose cost basis is based on the
founder’s stock purchased at pennies on the dollar) may be harder to value
with no stock conveniently being exchanged for a price on a public or
private market, does that make that company any less valuable than Enron one
month before its demise? Interesting question? Right. Well if that private
company turns out to be the next Google a year later, its stockholders may
be quite pleased in a $10,000 investment made at the ground floor that turns
into $500 million, despite the fact that no “true” fair market value could
have been practically determined a year earlier. So what’ is my point?
Simply that while there is a need to periodically assess the value of assets
held in retirement accounts for a variety of reasons, the processes by which
that can be accomplished are imperfect and that the choice between which
process and their associated costs, has to be evaluated against the benefits
to be derived, recognizing the results of all current methods will only be
approximations of “value”. The processes are the means and not the ends of
determining value, so that if a given process won’t get you any closer to
your goal, and costs you more in time and money, it probably shouldn’t be
applied. Because the benefit to the investor will not outweigh the cost.

So the question to be asked is why do we accept the price of a public stock
on a given day to be an acceptable representation of a company’s value. The
answer, I think is quite simple; that is, it is convenient, economical,
practical and timely way to get an approximation of what might be the value
of the company if someone did a thorough, expensive, and time consuming
analysis of the past, present, and future prospects of the company in
question. Of course, if such a full evaluation were practical to perform ,
you’d know the true market value. Wouldn’t you? Not really. If you ever
seen one of the evaluations which have to make assumptions about current and
future competition, regulatory, environmental, and demographic change,
quality of management and a myriad of other factors, they conclude with
several pages of caveats, which are just another way of saying that this is
the author’s best guess of the company’s value. They are not representative of
whether a “true” or “fair” market value but rather a value based on
assumptions about a company’s current strengths and its prospects. You can
spend $40,000 on a third party evaluation and not come necessarily any
closer to the “value” of any company. Presumably, Arthur Andersen charged
more than $40,000 for its services each year to essentially assess the
financial condition on Enron. No one in Arthur Andersen went to jail
accused and found guilty of deliberately distorting the facts. The company
died of essentially its inability to determine a true value because the
process is so difficult and complex in the real world. As the economy
becomes more global, the determination of “value” will not get any easier.
So what is one who is charged with the responsibility determine “fair market
value” to do to satisfy the underlying purpose of obtaining values of assets
held in retirement accounts; that is to serve the needs of investors relying
on estimates of value to help them determine whether and when they can
afford to retire? I would say it depends. That is that judgment has to
applied to an assessment of whether it is economically feasible in a given
circumstance to get closer than a reasonable approximation based on “best
efforts” (with information that is readily available) applied in a manner
that balances the extent of effort to further perfect a value (recognizing
like infinity one will never arrive there) with the cost benefit for doing
so.