Which price is right?

The positive effect of stock splits has been a talking point for many years now, although there is limited academic research looking into the relationship between stock splits and the performance of listed real estate. Fama, Fisher, Jensen, and Roll showed in their 1969 study that markets are “efficient” enough to adjust to new information very rapidly and that positive drift caused by stock splits followed increased future dividend implications. Following simple rationale, an investor should be indifferent whether he owns 10 shares of €10 or one share of €100. But one can doubt the limited impact if we zoom out and take several trading-related factors into account that help determine the right price for a single share.  

A CLOSER LOOK AT LIQUIDITY

We will step away from the literature here and focus on the effect stock splits have on stock liquidity. At the Kempen Sales Trading desk we do our best to help our clients find liquidity, a task which is growing more challenging by the day. With rising concerns about concentration risk, liquidity constraints and increased scrutiny from Risk Management, for a growing number of institutional investors it is important to have decent liquidity in a stock as more and more limits are placed on equity holdings. For example, a fund could have an internal rule to only hold positions which can be sold within two days, using no more than 20% of the daily volume. Exactly these constraints make illiquid shares cheaper than its liquid peers, because their share price contains a so called ‘liquidity discount’.

Let’s take a look at a few stocks we follow in our Real Estate niche: Warehouses de Pauw, and Cofinimmo, both Belgian companies trading in the middle segment of the EPRA developed Europe Index (widely used benchmark for listed real estate). Table 1 shows the ranking of the subgroup based on EPRA weight (all data from beginning of August), i.e. free float market capitalisation, whereas table 2 shows ranking on the 20D turnover in March 2017.

The two stocks we focus on, both trading close to or above €100 per share, are ranked 4th and 12th on market cap. Looking at the second table, they are ranked 10th and 16th based on value traded. Dropping six and four places respectively in ranking if we subtract the 20D turnover ranking in table 2 with the EPRA weight ranking in table 1, the largest declines in the subgroup.

There is a right price for a stock based on the ‘ease of trading’ 

 

So, now one could feel that higher stock prices may have a negative impact on liquidity. It is difficult to substantiate this claim with statistic data, but to feed the gut instinct that there is a right price for a stock based on the ‘ease of trading’, another table is composed. Table 3 looks to our subgroup again, were an analysis on all the tickets we received year to date is shown. I divided the group by ticket size rounded to hundreds, tens and odd lots (i.e. 7500, 750 and 75), ranked by percentage odd lots. The average shares price of our subgroup is €43.17, for your convenience I marked the stocks with a higher than average share price red. Seeing the two stocks we focus on (Cofinimmo and WdP) at the bottom of table 3, together with two other names (Aedifica and Befimmo) who are trading at a higher than average share price does not surprise me. Additionally, it is also interesting to see Fonciere de Regions and Icade losing ground compared to table 1, the EPRA rankings.

ROUND NUMBERS

It is very difficult to find supporting literature, but people tend to favour round numbers. For example, Pope and Simonsohn (2010) found that professional baseball players modify their behavior as the season is about to end, seeking to finish with a batting average just above, rather than below .300. If professional baseball players try to round up their average, then investors are certainly rounding up their holdings in the portfolio. And given the higher risk premium, equity investors have a higher risk appetite, and thus could argue they would round up, giving that extra bit of liquidity. I think the reason people do not round up the higher priced shares is that rounding up in those names will increase your investment significantly. At the table below, three €25k investments in Cofinimmo, one at the current share price and two after a stock split (five for one and eight for one). If we round to tens, the additional investment is 7% for the highly price share, only 3% and 2% after our ‘split’.

SO, WHICH PRICE IS RIGHT?

After reading this you will hopefully be left with one question: which price is right? Personally, as working with equities on a daily basis, I would say between €15 and €25. High enough to not drop into single digits, and still low enough to enjoy the benefits stated in this article. If a private company is offered to the public for the first time, a so called IPO, the company and advising investment banks can influence the shares offered and thus the offering price. Based on available data from the STOXX Europe 600 (index of 600 publicly-traded companies based in one of 18 European countries), 58 constituents had their IPO after 2002, and guess what? The average issue price was €20.14 and the median issue price €17.875… What a coincidence?

For questions or more information, please inquire via bart.lips@kempen.com 

This article was originally posted on LinkedIn. 

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