What Are The Two Most Important Driving Forces Of Metamorphism – The art of development is to maintain order in the midst of change and to maintain change in the midst of order. —Alfred North Whitehead
Alfred North Whitehead was a philosopher and mathematician, but with that kind of perspective on the subject of innovation, he could also have been a CEO. Today’s business leaders must worry about meeting customer needs in a fast-paced environment affected by social, economic, political and cultural changes. In today’s business environment, the ever-evolving presence of change is almost the only thing that stays the same.
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Organizations and their managers need to learn how to effectively anticipate and implement change. Managers must find ways to overcome their employees’ natural reluctance to change, because effective change management can mean the difference between staying in business and becoming irrelevant to their customers. The first step in effective change management is to understand what change is and where it comes from.
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Organizational change is the change or adjustment in the way an organization functions. Organizations adjust to small changes all the time, possibly looking to improve productivity, meet a new regulation, hire a new employee, or something similar. But besides these small adjustments we make at work all the time, there are bigger pressures around us, like competition, technology, or customer demands. Greater pressures sometimes require greater reactions.
External forces are the changing parts of an organization’s general and business environment. There are several types of external forces that an organization can face:
Firms may also experience internal forces of change, which may often be related to external forces, but are significant enough to be considered separately. Internal forces of change come from within the organization and relate to the internal functioning of the organization. These may include low performance, low satisfaction, conflict, or the introduction of a new mission, new leadership.
Low performance within an organization must be clearly addressed by change that facilitates higher performance. When low performance results in low quality or inefficiencies, customers complain and organizations must change.
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Perhaps one of the most famous examples of a company that succeeded in this situation is Harley-Davison. In 1980, nobody wanted a Harley. They were a poor quality bike that even leaked oil onto the showroom floor. Their parent company, AMF, could not find a buyer for them, and thirteen Harley managers ended up buying the company.
Dramatic changes were needed, and the new CEO approached them with supreme authority. First, they laid off 40% of the workforce—salaried and hourly—and the remaining employees took a 9% pay cut. Their design team developed the Evolution Engine and, with the sleek design of their new Softail product line, sales began to improve. Perhaps most importantly, they formed HOG (the Harley Owners Group) as a way to communicate with their customers. Operational improvements were made, and dealers began to regard Harley as a reliable partner. When they went public in 1986, underwriters were surprised that their IPO raised $25 million more than expected.
Companies often respond to external forces by taking on new missions and new leaders. Facebook’s original mission statement was “Make the world more open and connected.” CEO Mark Zuckerberg spent much of 2017 marred by scandals (including accusations of a data breach and Facebook’s potential to influence the 2016 US election).
As the world continued to divide, he led the company in unveiling a new mission statement. That statement, “Empower people to build community and bring the world together”, was accompanied by the release of new group management tools in the app and a goal to help one billion people join – the new communities. Zuckerberg also recognizes that Facebook is no longer a simple platform that connects friends and family, but rather a powerhouse that can have a significant influence on individuals and how they interact with the world.
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When a company brings in a new CEO, that’s often an internal force for change. In July 2018, Home Depot veteran Marvin Ellison became CEO of faltering Lowe’s, a competing big-box home improvement retailer. In his first months as CEO, he set out to improve store productivity and customer service in stores, closed a division of smaller Lowe’s stores and eliminated $500 million in capital projects to free up cash for earnings to -shareholders. Also let the Chief Financial Officer and Head of Operations of the company. Undoubtedly, the company is confused by the changes, but it may be what they need to get back on track. Time will tell.
More often than not, these forces of change are outside of an organization’s control, but without exception, all of them must be managed if an organization is to be successful. Stock prices are determined in the market, where the seller’s supply meets the buyer’s demand. But have you ever wondered what drives the stock market—that is, what factors affect a stock’s price? Unfortunately, there is no neat equation that tells us exactly how the price of a stock will behave. That said, we know a few things about the forces that move a stock up or down. These forces fall into three categories: fundamental factors, technical factors, and market sentiment.
In an efficient market, stock prices are determined primarily by fundamentals, which, at a basic level, refer to a combination of two things:
An owner of common shares has a claim on earnings, and earnings per share (EPS) is the owner’s return on their investment. When you buy a stock, you buy a proportional share of the entire future earnings stream. That’s the valuation multiple for: It’s the price you’re willing to pay for a future stream of earnings.
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Part of these earnings can be distributed as dividends, while the rest is retained by the company (on your behalf) for reinvestment. We can imagine the future revenue stream as a function of both the current level of revenue and the expected growth in this revenue base.
As shown in the diagram, the valuation multiple (P/E), or stock price as some multiple of EPS, is a way of representing the discounted present value of the expected future earnings stream.
Although we use EPS, an accounting measure, to illustrate the concept of the earnings base, there are other measures of earnings power. Many argue that liquidity-based measures are superior. For example, free cash flow per share is used as an alternative measure of earnings power.
The way earnings power is measured may also depend on the type of company being evaluated. Many industries have their own custom metrics. Real estate investment trusts (REITs), for example, use a special measure of earning power called funds from operations (FFO). Relatively mature companies are often measured by dividends per share, which represent what the shareholder actually receives.
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The valuation multiple expresses expectations about the future. As we have already explained, it is fundamentally based on the discounted present value of a future stream of earnings. So, the two main factors here are:
A higher growth rate will get the stock a higher multiple, but a higher discount rate will get a lower multiple.
What determines the discount rate? First, it is a function of perceived risk. A riskier stock earns a higher discount rate, which, in turn, earns a lower multiple. Second, it is a function of inflation (or interest rates, perhaps). Higher inflation gets a higher discount rate, earning a lower multiple (ie future earnings will be worth less in inflationary environments).
Things would be easier if only fundamental factors set stock prices. Technical factors are the combination of external conditions that change the supply and demand for a company’s stock. Some of them do not directly affect the basics. For example, economic growth does not directly contribute to income growth.
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We mentioned this earlier as an input to valuation multiples, but inflation is a big driver from a technical perspective. Historically, low inflation has had a strong inverse relationship with valuations (low inflation drives high multiples and high inflation drives low multiples). Deflation, on the other hand, is generally bad for stocks because it implies a loss of pricing power for companies.
Company stocks tend to track the market and their sector or industry peers. Some prominent investment firms argue that the combination of overall market and sector movements—as opposed to individual company performance—determines most stock movement. (Research suggests that economic/market factors account for 90% of this.) For example, a sudden negative outlook for one retail stock often hurts other retail stocks because “guilt by association” brings it down demand for the whole sector.
Companies compete for investment dollars with other asset classes on a global stage. These include corporate bonds, government bonds, commodities, real estate, and foreign equities. The relationship between the demand for US stocks and their substitutes are difficult to know, but it plays an important role.
Implied transactions are purchases or sales of stock motivated by something other than belief in the intrinsic value of the stock. These transactions include insider trading transactions, which are often pre-scheduled or managed
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