May 2, 2012

The 11.1% Occupying Earnings

The One Percent is a catchy phrase. But statistics highlight the 11.1%.

It’s earnings season. Fifty-seven percent of our clients have reported, our data show. In the past five days across the Nasdaq segment, rational investment activity – which means what you think it means – was 11.1% of volume.

Translating, just over one of ten trades in Nasdaq-listed companies (the NYSE was better but could flip-flop next week) resulted from active investment. Statistically, 88.9% of volume – not as cool as 99% but we report what the data show – was driven by something besides thoughtful investment.

Did your stock behave as you expected when you reported?

Our first client to report plunged through hedges and closed down 13%, and we hadn’t hit options expirations (Apr 18-20). A host of clients with calls before Apr 20 beat expectations and gave solid guidance. Half closed up; the other half, down.

Do the 11.1% matter? Unequivocally. So do the 88.9%. I’ll give you examples. A small-cap tech company last week closed down 6% on a miss and weak guidance, but data showed shares trading in what we call the “Midrange,” meaning money had mixed reactions. The stock’s up now.

Wait a minute, you say. How can money have mixed reactions to a miss? A lot of money doesn’t value shares on multiples alone. Any more than world markets peg the US dollar to its redemption value from the US Treasury (zero).

Shares have relative value, and speculative value. Relative value means “what’s this stock worth compared to alternatives in the group or market?” Speculative value means “will this stock help me net a profit in a portfolio of things that fluctuate?” Good answers to both questions can mean stocks rise on – or right after – misses.

Seeing how different market behaviors value shares is crucial to understanding how equity prices behave. We track how fund managers and their counterparties – by actions not names – hedge risk. That’s an important price, because it’s like knowing how much value is insured against loss.

Here’s an example of relative value. A large-cap broke a long string of rising quarterly profits. Behavioral data showed beforehand that rational investors were banking on better. Disaster? The stock slipped 2%, to the comfortable “Midrange” and started rising in two days. How? Programs. Funds and models buy industries. In this sector, there are fewer than five choices. Neighborhood value.

Rational investment behavior is only one constituency. It’s small but a big deal, like independent voters in major national elections. The swing vote sets outcomes in battleground states. Every day, your shares are a battleground state. In the Nasdaq slice of the market we follow, 11.1% of recent participants were tallying multiples of forward cash flows and reacting to them. They’re the independent voters, so to speak.

They matter. A mega cap reported outstanding results smack in the middle of options expirations. The stock declined – as behavioral data predicted. Post-call behavioral sentiment was negative and predicted more price pressure.

But then, rational investors – tempted by bargains – stepped in, resetting what we call “Rational Price.” Since then, the stock has risen and now trades higher than the pre-call level.

Two big lessons, IR folks:

IR is indispensable. The 11.1% matter. Without an effective IR program, you can’t turn the swing vote and win battleground states. It’s easy to revile the 88.9%. But they’re just constituents with different views.

Data are indispensable. Measure, measure, measure. Poll, poll, poll. Yeah, I don’t like it either. But them’s the facts. In battles of inches, you need to know who your constituents are, what they think, and how they’ll react.

The IR chair armed with good data-analytics wins campaigns and occupies earnings seasons.

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