Will Additional Rules Help the Long-Term Investor?
A Chartist's Perspective
by Martin Goldberg CMT. September 18, 2003
In general, corporate managements already practice strategies that are consistent with the so-called shareholders. Additional corporate governance rules will not be very effective. Just as casinos exist because there is demand for them, desire to speculate provides similar demand that will not be changed by additional rules. Eventually the market will purge the excesses and shareholder value will be the goal of more corporate managements; but there is no telling when (not if) this will occur. It will have to change from the shareholder side before it changes at all. For corporate managements to focus on long-term shareholder value, they must have long-term shareholders
The table below is a compilation of the hold time of floating shares of selected stocks (calculated by the author using volume statistics found in Yahoo Finance).
(%) per year
|Hold Time per Floating Share (days)|
|Blue Chip Companies|
|Procter and Gamble||PG||64||570|
|Johnson & Johnson||JNJ||73||502|
|Large Cap Technology|
|Large Cap Internet|
|Nos. 27-30 "IBD 100" 15 Sept. 'O3|
|Accredited Home Lenders||LEND||2,042||18|
|Jos. A. Bank Clothiers||JOSB||915||40|
As you can see, the selected blue chip companies' shares are liquid but do not fly back and forth from one shareholder to another. However as we progress down the risk/degree-of-speculation curve, we can see that there are progressively shorter average share hold times. The average share of a large cap Internet stock is held for less than 2 months. Think about that!
I'm sure that Enron and World Com were manically traded before and through their collapses. If the time horizon of the shareholder was short, then may be the management activities although alleged to be criminal, were actually appropriate to align with these short-minded traders that flipped the stock. Imagine management teams so dedicated to their shareholders that they would cheat and steal in their behalf! When the collapse occurred, share flippers should have understood the risks of trading in manically traded stocks. Additional regulation will do very little to change that. However, long-term investors only have caveat emptor (let the buyer beware) to rely upon.
Most management behavior of manically traded companies is logical given the shareholder base and probably stops short of fraud. If I was the CEO of a company with a manic shareholder base in this market environment, my management style may include carefully managing earnings expectations and guidance, reporting pro-forma and C.R.A.P. earnings, issuing mid-quarter updates, making frequent celebrity appearances on CNBC and Bloomberg TV, and always trying to "beat-by-a-penny" with sales and profits that are "better-than-expected". I would dismiss any negative business irregularity as a "one time event", and take full credit for the positive ones. These tactics would all take priority over providing my shareholders with ANY long-term vision of company that extended over a period of years. There would be no need to provide shareholders with the company's long view. What purpose would it serve in the short term (that encompasses the average shareholder's term)? When was the last time you heard a CEO of a highly traded company provide the viewers with any long-term vision of the company's future that went out more than 6-months? It's also rare for Wall Street and media lap dogs to ask these tough questions regarding long-term company vision and expectations. But management will only seek true long-term shareholder value when there are significant long-term shareholders. The obvious fact is that the long-term prospects for many of these companies may be robust but their long-term growth would not even come close to justifying their irrational valuations. With a shareholder base drunk with speculation, why state the obvious?
Warren Buffett commented in his 1988 letter to shareholders regarding Berkshire Hathaway's new listing in the NYSE (The Essays of Warren Buffett: Lessons for Corporate America, first revised edition),
"Consistently rational prices are produced by rational owners, both current and perspective. All of our policies and communications are designed to attract the business-oriented long-term owner and filter out possible buyers whose focus is short-term and market-oriented. Second, we wish for very little trading activity. If we ran private business with a few passive partners, we would be disappointed if those partners, and their replacements, frequently wanted to leave the partnership. Running a public company, we feel the same way. We don't understand the CEO who wants lots of stock activity, for that can be achieved only if many of his owners are constantly exiting. At what other organization – school, club, church, etc. – do leaders cheer when members leave?"
CEOs of some manically traded companies may, after being forced to drink truth serum, utter a corollary to Mr. Buffett's statement above,
"Consistently irrational prices are produced by irrational owners, both current and perspective. All of our policies and communications are designed to attract the stock market-oriented short-term owner and filter out possible buyers whose focus is long-term and business-oriented."
One could argue that its not management's fault that their stocks trade so manically. But consider that in many cases, management has split these stocks over and over during the biggest stock market bubble of all time. Clearly, these excessive splits were arranged with expenses paid out of company coffers to Wall Street firms in order to satisfy management's desire to achieve a lot of "stock activity". Buffett also points out that transaction costs of actively traded stocks are high, amounting to about 10% of corporate profits in 1988. You must note the consistently high level of insider selling in the manically traded companies, especially in recent months. Are these insiders taking advantage of "irrational prospective owners"?
As I said in the beginning, management's style and focus seems to generally correlate with the holding time of its shareholder base. Therefore, there is not a need to change the current system by further regulating such items as stock options compensation accounting. Do you really think that such changes would bring about more rational or fairer markets? The fundamental businesses of these companies would not change along with the regulatory rules. So companies would likely just find a way to spin the newly required numbers in a ways that would be totally supported by the Wall Street and the media. More requirements like financial statement sign off by CEOs will not significantly change anything.
In the absence of more rigorous (but ineffective) requirements from regulators, what's the best practical approach for the long-term investor? Consider the plight of the long-term investors that held Enron and World Com through their collapses. The long-term investor first must know the time horizon of his co-shareholders. This can be calculated by dividing the number of floating shares by the average trading volume of shares. If you find yourself with a long term holding with a very short-term shareholder base, you should consider that these companies are capable of either producing some of the most spectacular gains or painful losses in the stock market. They may be either Enrons, overvalued like Oracle in 2000, or undervalued like Microsoft in 1992. You wouldn't want to miss the potential upside of a Microsoft, but you would need to avoid the losses of an Enron, or Oracle. However, your objective and time horizon for owning highly traded stock must change. Therefore, you would have to make your sell/hold decision based mostly on the technical chart (and of course, tax implications). If you don't feel confident owning such risky stocks or using technical charts, find help or sell.
But understand when your long-term share holdings are being flipped like so many poker chips at the Wall Street casino.
Everyone Knows The NASDAQ Is Going Up
Today's market action was quite bullish as all three indices moved higher throughout the day on heavy volume. Each was up over 1.2 percent. With three positive pieces of economic data from the government, traders had a good reason to become "shareholders". It surprises me how responsive the market still is to economic data from the government and monetary policy announcements. From what I'm seeing here in a Philadelphia western suburb, "the recovery" is not a recovery at all. May be I'm just as blind as most corporate insiders that are selling. I welcome e-mails with personal first hand anecdotal evidence describing tangible economic improvement or any real world leading economic indicator of improvements to come.
Finally, here is a really crazy idea. I see many characteristics in the NASDAQ chart that suggests shorting it with a stop loss might just work. I don't have the time or the space to describe each piece of evidence here so I will just list them in bullet format:
- 4-day Corollary as described last Thursday.
- A suspected exhaustion gap between the first two trading days in September.
- A breaking of the up trend that was broken by the gap down that occurred last Wednesday.
- A testing of the 1,888.64 NASDAQ high on Tuesday and Wednesday. It broke above that level today. (A suggested short "2B" entry point per Trader Vic -- Methods of a Wall Street Master, Victor Sperandeo would be if the NASDAQ breaks below 1,870).
- A possible entry point for intermediate term shorting if the NASDAQ breaks below 1,818. ("1, 2, 3 short" per Sperandeo)
- A 3rd NASDAQ "Distribution Day" per Investors Business Daily (although the extremely bullish IBD says, "it didn't have the feel of a distribution day").
Be careful! You would want to mind your stop losses of course. If they could bid the NASDAQ to over 5,100, there's no telling what could happen this time. All of the technical characteristics above are based on the bull move from March of 2003 being a secondary correction about to end in a secular bear market. It won't work in a new secular bull. I have tons of evidence to suggest it’s a bull correction in a secular bear, but this is for another day.
Have a great evening.
Disclosure – Mr. Goldberg owns shares in Johnson and Johnson. He has no current position in any of the other stocks referenced.
© 2003 Martin Goldberg