Equity Supply Chain

Dollar General (NYSE:DG) dropped 9% yesterday, offering a lesson to investor-relations professionals.

Before that, a plug: At NIRI National next week I’m paneling with the CEO of short-seller Tesseract Management and the head of securities-lending for Franklin Templeton on short-selling strategy and practices. Longtime NIRI fixture Theresa Molloy has organized a great discussion and will moderate. And please visit ModernIR at booth 719, our eighth straight year in the exhibit hall.

For Dollar General, revenues were light and guidance lighter, margins weakened due to the products folks were buying last quarter, and inventories rose 21%. Investors and traders can examine facts about the structure of Dollar General’s market, from margins to supply-chain, and make value judgments (which will be distorted by other market behaviors, however).

Have you considered that your equity market is also affected by logistics, supply-chain and who’s consuming the product? We perhaps never imagine that the stock market has the same characteristics and limitations of other markets. Have you gone to the shoe store and they didn’t have your size in the brand you wanted? How come that doesn’t happen in the stock market?

Oh, it does. That’s just one reason your stock can be down when your closest peer is up. Your management team thinks it’s something the IR team said. In reality, it’s about inventory – the ready supply of your shares to trade. You might think there’s a great deal. Nope. Liquidity is a thin veneer. Often it’s a negative number in fact – meaning it’s borrowed. More on that in a moment.

Think about this: If two algorithms are traveling at the same speed through your market and your peer’s market (supposing the two are related anymore, which is often not the case), and your inventory is up 21% from yesterday like the stock of things to put on shelves at Dollar General was in the quarter, while your peer’s inventory is down 10% from normal levels, your stock will decline and your peer’s will rise. It’s the supply-chain (yes, we measure that).

Since I’m discussing it next week, let’s take short volume as another example. By short volume, I mean trades occurring with borrowed shares. The market average is about 40% (I swear I’m not making that up!). One client this week had more than 80% of its daily volume short (the stock was flat by the way), while the low was 24%.

Short volume is a telling market metric. If half your volume is short, greater effort is being expended by brokers to control prices. How? Brokers working orders will constantly go long and short your stock to keep it in a trading range. That’s more expensive trading, particularly if brokers borrow inventory.

What’s that? Brokers borrow? Sure. Banks borrow money to loan to you. Brokers borrow shares to sell to holders and to make markets. When there’s a lot of it going on, the investors and traders behind it likely have short horizons or must quickly deploy capital. That’s what we watch – which behavior is gaining market-share.

The client with 80% of its volume short? The average trade-size was 104 shares the past 20 days – barely the market-making minimum! Only the most aggressive investors or traders will compete here, so clearly the bulk of short volume resulted from market-making. In other words, brokers were doing it to stabilize price.

Lesson, IR folks: Your equity market is like any other marketplace. It has logistics and a supply-chain that regularly reflect course-changes. The key to understanding your equity market is exactly the same as managing a business: identifying the drivers, which change regularly. That’s how to understand your stock’s behavior today.