The equity markets, as we once knew them at least, were a creation aimed at helping corporations raise capital through the sale of common stock and the issuance of preferred shares to investors. Shareholders are supposed to benefit from this arrangement since the firms they bought equity in made it their primary goal to earn the strongest stock price possible and reward their investors with healthy returns.
But ConvergEx Group chief market strategist Nicholas Colas contends that in an era dominated by high-frequency trading, exchange-traded funds, mediocre returns and a lack of interest from retail investors, the game has changed. As a result, the market structure for U.S. equities no longer provides an accurate reflection of a stock's intrinsic value, he writes in a column published by Tabb Forum.
This view makes a ton of sense considering that nearly half of all the trades in the nation's largest stocks come not as a result of careful decision-making by investors, but rather by high-frequency traders who do virtually no evaluations of the stocks they trade prior to execution. There is a major disconnect in the true values of publicly-traded companies – which are based on concrete things like revenue and EBITDA - and how those values are now reflected on the stock markets.
Because of this, Colas says it no longer makes sense for chief executives and their boards to make the stock price the primary element of corporate strategy. He also breaks down some potential solutions to this conundrum. Here are some points Colas says firm should consider when moving away from having the share price as the central fixture of their corporate strategy.
From Tabb Forum:
• Studies by virtually every large Wall Street firm repeatedly show that more than half of all the trading in domestic stocks (including XYZ) are the result of high frequency market making operations, which include little-to-no fundamental evaluation of the stocks they trade.
• Mutual fund managers, who traditionally have held more than half your stock, have seen over $500 billion of net outflows since 2007. In their place, investors have purchased Exchange Traded Funds, almost all of which allocate capital by tracking indices of stocks rather than by evaluating the merits of a company on fundamental measures.
• The S&P 500, the most commonly used measure of U.S. stock performance, has returned exactly 0 percent to investors since 2000. Your own stock's price-earnings multiple has gone from 20x forward earnings 12 years ago (just about where the S&P was at the same time) down to 13x now (again, pretty much where the broad index is currently valued). Over the same time, all relevant metrics of corporate management for XYZ – profit margins, ROE, earnings power - are flat or higher.
As the Senior Editor of Advanced Trading, Justin Grant plays a key role in steering the magazine's coverage of the latest issues affecting the buy-side trading community. Since joining Advanced Trading in 2010, Grant's news analysis has touched on everything from the latest ... View Full Bio