May 20, 2015

The Cube

Investor-relations is an itinerant profession. We’re on the road a lot.

If you’ve had one of those three-hour flights, say from Denver to Atlanta, in a cramped regional jet (we’ve vowed to avoid them but United interdicts our solemn ecclesiastical commitments), you may utter profanities.

You might also ponder the supply chain. It takes work to match plane to demand so well that a body is wedged into every seat, leaving no logistical slack. Give airlines credit (or the finger) for it.

Like seats on planes, there’s a finite supply of your shares. If long-term holders never sell, who supplies them to new buyers, and how can your owners drive trading volume? The Investment Company Institute (ICI) in 2013 measured median portfolio turnover at 29%, meaning most big investors sold just a third of holdings over the year. Supposing a seller must exist for every buyer, you should see roughly a 7% change in ownership on a net basis in a typical quarter.

Go to Whalewisdom.com and look up your own ticker (or pick one of your choosing).  At the top of ownership data you’ll see net increase or decrease between the two most recent periods (December 2014 to Mar 2015).

There’s a company in Basic Materials, market-cap over $30 billion. The IRO and I have talked about Market Structure Analytics (our proprietary software and algorithms for measuring the composition and price-setting activity behind daily volume).  I checked: Net institutional change period-over-period was 40,000 shares.

Even I, an inveterate student of market mechanics, raised an eyebrow. I went to Google and pulled data for Oct 1, 2014-Mar 31, 2015. The stock traded over a million shares daily and in the period had composite volume topping 163 million shares.

Holy cow. Hidden inside 163 million shares of volume was real ownership-change of a few thousand shares over 130 trading days. They’ve only got 214 million shares out.

“Wait a minute, Quast,” you say.  “You’re looking at this wrong. There’s a lot of musical chairs, people jumping up and sitting down again across those quarters.”

No, that would contradict the ICI data indicating many investors sit on positions. Picture a Rubik’s Cube. (Am I dating myself again?) The multi-colored tiles comprising the puzzle never change.  They just trade places, like your institutional owners. What determines the outcome isn’t fluctuation in tile-count but how tiles are manipulated.

Without Market Structure Analytics, you’re measuring tiles, not what moves them.  Suppose your CEO said, “You’re telling me we traded 163 million shares over two quarters, and the net result of all that movement was 40,000 shares?”

Telling your executives the truth carries a measure of risk, sure. They may challenge you. They’ll ask you questions. The facts about market-function demand a corresponding change in perception and measurement, and you, IR, keep that gate. The alternative is perpetuating a myth. Choose wisely.

Back before we were vacuum-packed like camping rations into aircraft – “we hope you have a pleasant flight” – a lot of airlines went broke.  You leave too much space free and it takes a toll on finance when you’re in the business of moving people around.

Today in the brokerage business, about 30 firms control 90% of volume and half of those are the biggest banks the world has ever seen. The truth is your share-price is set by them.  The supply chain. In the past week 45% of all market volume came from borrowed shares. Indexes trade back and forth with the ETFs tracking them. How that movement nets out at quarter-end is often a random act with no connection to fundamentals.

You’d think the suppliers and the consumers would get together and change the distribution model.  But that’ll never happen so long as the C-suite believes owners set prices. There’s only one constituency capable of changing that: You. The IR profession. It begins with redefining what you tell Management and Boards, so they know the difference between 40,000 and 163 million.

The math doesn’t lie.  But it raises questions deserving answers (which we have—and for which you can get credit!). Ask yourself:  Is an executive team that never asks IR questions better or worse for you – and your value – than one with lots of questions?  Ponder it.

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