Spin-offs, Ticker Symbols and Other Investment Anomalies
Do you think that equity asset prices are always fair? If so, then you’re a proponent of the Efficient Market Hypothesis (EMH) which states that prices accurately reflect all the available information out there.1
This sounds appealing—and democratic to boot—except that in the real world, it just ain’t so. Market prices exhibit all kinds of weird and wonderful anomalies. Two familiar ones include the January Effect where asset prices pop, especially among the small caps; and the Santa Claus Rally, where values tick upward from late-December into the first few weeks of January. Here are some other lesser-known anomalies that may be of interest to investors going long—or short.
Money spinner
What happens when a large company does a spin off? Answer: Good things happen.
Spun-off companies tend to outperform the broader market in the years immediately after they get the chop. In the past 15 years, from 2002 to 2017, the Bloomberg US Spun-Off Index returned nearly 1,000% compared to the S&P 500 Index which returned 203.9%.2
Why do spin-offs outperform? One theory is that once they’re released from the shackles of the mother corporation, these now-smaller businesses are nimbler and more entrepreneurial. Key personnel may have financial incentives through new stock option grants, giving them the extra motivation to keep costs under control, make bold investments, and raise productivity. Another possible reason for the market’s enthusiasm is that the division had been undervalued within the larger conglomerate and is now more fairly priced. In some cases, a company spins-off a fast-growing division from its more mature and slower-growth business.2
What’s in a name?
Would you be more likely to invest in a company with the ticker symbol LEAF or ASNT? If you’re like most people, you’d spring for the company whose ticker symbol is easier to say.
Researchers have found that stocks with easily pronounceable names outperform those that are less “fluent”. If you invested $1,000 in the companies with the most fluent names, you would be ahead by 33% over a similar investment in the 10 least fluent names. This effect applies regardless of other company attributes, such as size, sector, and country of origin. While the effect is strongest directly after an Initial Public Offering (IPO), the fluency advantage persists over time.3,4
Why would we pay more for snappy tickers? This could be an example of the mental short-cuts, called heuristics, that investors use in making decisions. Decision-making is hard and eats up a lot of energy. Fluency is less mentally taxing. Fluency also makes us perceive the company as more familiar and therefore, less risky. Despite the reams of financial data available, many investors will ultimately choose a stock based on the company’s name or ticker instead—similar to buying a wine based on the label. 3,4
Here in Canada, now that the ticker POT is available again, after the merger of Potash Corp. and Agrium formed Nutrien, Canadian stock exchanges were forced to hold a lottery due to the immense interest from cannabis companies to acquire the popular— and fluent—stock symbol. (Weekend Unlimited snagged the ticker on January 30th, 2019.)5,6
Popularity premium
Do popular stocks provide the best returns? Equities command the largest risk premium because investors expect a payoff for taking on the uncertain return from equities compared to bonds or risk-free assets. The Capital Asset Pricing Model (CAPM) assumes that investors are rational and risk-averse. Oops!
It may not come as a great surprise that investors—that’s you and me—are not completely rational, and certainly not so all the time. We have something called “bounded” rationality. This is a polite way of saying that we make decisions that are sometimes rational and other times irrational.
Take the issue of popularity, for example. Investors have definite preferences in companies and are willing to pay up for them. Some of these include companies with high brand value, large economic moats, and those with better reputations. It’s no surprise that investing in these companies leads to underperformance. (By comparison, companies that have low-volatility, low-beta, are less popular, less liquid, or that are small caps, outperform their more popular brethren.) Because this investment anomaly isn’t captured by the classical CAPM theory, researchers have updated CAPM and developed a new model called Popularity Asset Pricing Model (PAPM) that accounts for both rational and irrational investor preferences.7
Payday heyday
TGIF, right? Research shows that stock markets have a positive bias on Fridays. This is called the “Days of the Week” anomaly. Possible reasons for it are people feeling upbeat about the impending weekend.8
A new discovery is the “Payday Effect” where markets have stronger returns at the end of the month, as well as days 1, 2, and 16 going back as far as 1950 and which reflect bi-monthly pay schedules. (The worst performance day of the month is the 19th, by the way.)9
“Woo Woo” effects
Investors are a superstitious group and sometimes we base investment decisions on beliefs we have about days of the month, moon phases, or “lucky” numbers. Take the numbers “4” and “8”. In the Chinese language, the number eight sounds like the word for prosperity, whereas the number four sound likes the word for death. Naturally, Chinese investors favour investments that include the number eight and eschew the number four. Researchers calculated that this “number anomaly” costs investors an average of over 9 percent annually in forfeited returns.
Another anomaly concerns the phases of the moon. Researchers found that in 38 countries, markets decrease by 3-5 percent during full moons, which many cultures consider to be unlucky, and increase during new moons.9
Rita Silvan, CIM® is the editor-in-chief of GoldenGirlFinance.com. She is a Toronto-based financial and lifestyle journalist and consultant specializing in women and money.