Here is a simple example to understand what a financial bubble in the economy is and when it blows away.
We decided to create a commercial company whose activities will be related to the production and sale of products.
The authorized capital of this company was 100% formed at our own expense, and with this amount we were able to provide (purchase/build) all production (non-current assets, equipment, etc.) and non-production infrastructure (administrative building, etc.). The purchase of working capital (raw materials, materials, etc.) was provided for a short-term credit line account of a local bank.
That's how our business started spinning.
After a while, due to unfavorable business conditions and improper management, the company began to experience liquidity problems, which forced us to enter the market by converting into joint stock companies and organizations IPO for the purpose of initial public offering of shares (in the amount of our net assets) on the stock exchange. At the same time, we decided to keep the controlling stake (51%), and placed the remaining 49% on the stock exchange in order to raise funds for development (investing in expanding production).
Traders (speculators)/investors, against the background of our publications on current profitable activities and prospects for its growth, actively began to buy shares, thereby provoking their price increase. As a result, the value of the shares became 30% higher than its nominal value, which corresponds to the value of net assets (at which we initially placed them on the stock exchange).
Thus, a situation has arisen when the market value of our company (that is, its exchange price) has increased by 30% (for the part that is spinning on the stock market), only on rumors and assumptions about the effectiveness / prospects of our business.
The money that we raised was used for development, but the return on the implemented investment project did not meet our expectations, and we again began to experience problems with liquidity and the need to implement the following investment projects, which were supposed to fix the situation.
Since we do not want to sell a controlling stake, we decide to increase the value of our net assets by revaluing (indexing) our non-current assets, and by this amount to make an additional issue of shares and place them on the same exchange.
Traders still have enough money and they are motivated by this way of earning on the price difference capitalization of our company, moreover, the offer is not from anyone, but from a long-running company.
Moreover, this is the real sector, and for many traders it is not even speculation, but investment.
Traders/investors continue to believe in the success of our company, continue to buy shares, thereby provoking an increase in their price again. Plus, the resale of shares from one hand to another spurs this situation.
And this happens from year to year.
As a result, after working for 20 years, the market value of our company corresponds to the classics of its capitalization. However, in fact, the real value of our assets is 300% lower than that generated by the exchange.
And what confirms the real value of our assets, if the market, stock exchange is unreasonably overestimated?
During the normal operation of our enterprise, there should not be a situation where constant replenishment of money is necessary in conditions of constant investment.
In conditions of effective investment activity, the subsequent need for reinvestment should be carried out through the return of already working projects, and not the constant begging of money through the stock market.
As a result, at one fine moment a situation occurs when the exchange no longer provides what we are so used to (tight monetary policy reduces the appetites of exchange investors), and as a result we decide to sell our controlling stake to a direct investor - the real owner, who will directly manage our company.
What does the new owner do in such cases?
He is conducting a complete revaluation of assets, taking into account the not drawn book value of the company and the inflated stock exchange, and it determines it taking into account the current investment, labor potential, competitive field, its solvency and possible efficiency, which will allow to recoup all these assets to the maximum within the period of their residual physical and moral deterioration.
As a result, bringing all this under the assessment of a real investor, the market capitalization of the company, taking into account even our share at face value (where repeated indexing/revaluation is already sewn up), falls by about 4 times.
As a result, we are forced to sell for the price of a real investor, since other prospects are liquidation.
And as a result, should we blame the "arrogant" and "wrong" investor for this, or did we ourselves, "sheep", bring our company to such a state?
This is the situation in which the bubble formed over many years of our company's work is deflated.
This is the phenomenon of the bubble in the economy and how it deflates.
And now the information for reflection. How much has the exchange value of the same key indices of the American economy (Nasdaq and S&P 500), the Moscow Stock Exchange (IRUS) increased relative to the real value of the net assets of those companies included in their calculation?
The real value is not the book value, just in case.
Financial bubbles usually grow on the basis of speculative expectations, without sufficient reservation of real assets and results under them.
This situation illustrates how changes in the market and investor perceptions can lead to abnormally high valuations of companies. Ultimately, this can result in significant losses for investors when asset prices do not match their real value, which leads to a loss of confidence in the market and a drop in capitalization.
It is important to realize that successful investment activities should be based on real indicators and confidence in future earnings, and not only on speculation and time trends.
