Morgan Stanley's analyst report on Lehman, June 2008

"Not Broken, poised for profitability"...Yeah right.

via Reformed Broker.

Coca Cola's stock split

Coke is in the news because it has just announced a 2:1 stock split.  Predictably the price went up on the announcement, although the reasons why the price should go up are shaky at best.

Lets take a look at some of the arguments:

• Coke's CEO has argued that this will increase the liquidity of the stock.  But for a stock like KO which already has a bid-asked spread of only a penny, it is unclear how the liquidity could be increased much further.  
• An another explanation is that this somehow makes the stock more affordable for every day investors.  This is sometimes called "the optimal trading range hypothesis".   But this makes little sense really as investors can vary the number of shares that they buy.  Also, by this reckoning a $40 stock today is massively more affordable than a $40 stock 30 years ago.  Apple and Google also don't appear too bothered about this - both have stocks trading for the hundreds of dollars.
• KO has stated that the split decision is based on the board's long term positive expectations for the stock.   But for this signal (of a positive future) to be credible, it has to be costly and hard to fake.  This is not really the case for a stock split - they are pretty cheap to do and anyone can do it.   I will note however, that if you knew that your future outlook was bad, then a stock split might not be a good idea if it would result in the price being so low that the stock could be de-listed. 

There is also quite a bit of confusion about price reactions around stock splits.  The largest price reaction typically occurs on the announcement date and is on average around 2%.  On the actual pay date - the date of the split - the price reaction is much smaller, only around 0.5%.   Even 0.5% is surprising as there should be no price reaction around a previously know event (counter to what this article suggests).

In conclusion, stock splits don't make a lot of economic sense from the point of view of shareholders.  They should be non-events.  But they might make sense for executives in particular if these executives have stock and option based compensation that would increase in value from the price pop around a stock split.  In fact, this is the very result that I find in a working paper with Bill Elliott and Erik Devos.  We're currently revising the paper to expand the data set and explore some other results before we send it back to a journal.  I'll post more on the topic when we get the results written up.

Money Power and Wall Street - Tonight on Frontline

Set your DVR - tonight on Frontline: the first part of "Money Power and Wall Street".  

Speculation and Oil Prices (again).

The Grumpy Economist has an excellent piece on how speculation is unlikely to be causing oil price increases.   Read it because the author, John Cochrane, rarely pulls punches.  He's great (and also very smart).

Great quote:

It's also worth noting that on that same day, there were 146,000 May natural gas contracts traded... By what mysterious process can all this within-day buying and selling of "paper" energy be the factor that is responsible for both a price of oil in excess of $100/barrel and a price of natural gas at record lows below $2 per thousand cubic feet?  

As my regular reader will note, I've blogged on this quite a bit before, but I am sure I will blog on it again.  My guess is next in the next election cycle.

Correlation is not causation

Here's a listing of the 15 strong and spurious market correlations.  For example GM stock has a 0.97 correlation coefficient with stocks that purify water.  

The point - even a virtual 1:1 correlation doesn't imply causation.

Another (better) twitter list of finance people

Jacob over at moneyscience (an excellent site that aggregates all sorts of finance related material), has put together another list of finance tweeters.   Check it out here.

101 Finance people to follow on Twitter.

Twitter and finance.  Yet more reasons not to get your work done.

Incidentally, I didn't make the list.  I tweet occasionally, usually about the contents of this blog.  You can follow me at @richardswarr

More on volatility and the level of the market

John Cochrane (aka the Grumpy Economist) talks about volatility and the level of the market.  I blogged on this recently here.

John takes things a bit further and throws a little math at the problem.  He has some interesting analysis, although he concludes that our current state of asset pricing is able to fully account for the effect (in some many words).

So why did Apple stock drop?

Was it the thousand dollar price targets?

CDOs, cows and financial engineering.

In my MBA class this week, we talked about CDOs and how they were used to bundle sub prime tranches of mortgage backed securities into AAA rated securities because, it was argued, the risks in the tranches were uncorrelated.

This Dilbert cartoon explains the concept beautifully.

When a split isn't a split.

Google just conducted what some are calling a 2:1 stock split, but this really isn't a true stock split.  What GOOG has done is created a new class of voting stock and issued one share of these to every stock holder.  In effect doubling the number of shares outstanding.  But the new non-voting shares are obviously inferior to the original shares.

There are plenty of reasons offered for why firms split their stock - the most common is that there is some sort of desirable trading range that investors want.  Firms split to keep their stock prices in this trading range.

But in Google's case I don't think that this is the reason.  The reality is that Google's management is seeking to reduce the opportunity for outsiders to gain a controlling stake in the company.  In effect Larry and Sergey are taking steps to increase their entrenchment.   Their rationale is simple - we know what's best for Google in the long run and those of you who've invested in our company can go and ...(well you get the idea).

Here are a couple of great blog postings on this.  First Felix, and then Kid Dynamite.

Google's motto is do no evil.   Yeah right.

A couple on investment banking...

...from my colleague, Craig Newmark's most excellent blog.

First, what you need on your resume if you want to work on Wall Street.  In particular, note the importance of excel skills, quant skills (math, stats) and the CFA designation.

Second, what high powered advice gets you.   Notably, even the evil geniuses at Goldman Sachs can't predict the market.

Surplus cash, managerial discipline and Instagram

So Facebook just dropped a cool $1 billion for Instagram (the app that turns your 5MP iPhone 4S camera into a crappy 1970s Polaroid).   Apart from the fact that posting faded pictures of your dog on Facebook is going to get old pretty soon once everyone does it, there is actually a finance issue here.

Back in 1986, Michael Jensen argued that excessive free cash flow can lead to agency problems where managers use the cash to expand their empires (American Economic Review).  This seems to be applicable in this case.

Instagram has no revenue to speak of, although it does have 30 million users (actually 30 million downloads of the app).  There are currently 12 people working there (12 very rich people).  While it is clear that Instagram must be worth something, $1billion seems a very convenient round number, and a rather high one at that.

When I consider other companies currently worth about a billion dollars:  Strayer, Scholastic, Cooper Tire, I am forced to conclude that Facebook overpaid.  But I am not surprised.  Facebook is a classic case of what Jensen talked about in his seminal paper.  The company has a huge amount of cash, it has no need to go to the market (and thus face market discipline), and the CEO has few limits on his decision making.  As a result it will continue to burn money like there is no tomorrow.

Here's my Instagram tribute to the deal.  A $10 bill (1/100,000,000 of the deal) on my copy of the classic corporate finance text that discusses managerial agency issues.

Pension fund risky bets fail to pay off.

Pension Funds are increasingly chasing risky bets to try to hit return targets.   These investments are frequently highly illiquid, expensive, and as it turns out, not that high returning.

The shocking quote:

The $26.3 billion Pennsylvania State Employees’ Retirement System has more than 46 percent of its assets in riskier alternatives, including nearly 400 private equity, venture capital and real estate funds. The system paid about $1.35 billion in management fees in the last five years and reported a five-year annualized return of 3.6 percent. That is below the 8 percent target needed to meet its financing requirements, and it also lags behind a 4.9 percent median return among public pension systems.  (emphasis added) .

If those numbers are correct, then the State of Penn is paying more than 1% in fees per year.  That is appalling mismanagement.  (I say "if" because I can't believe that they are that bad).

This isn't just a problem for Pennsylvania.  My own state of North Carolina pays close to 0.5% a year in fees on its $75 billion pension fund, which while not as bad, is still a pretty terrible waste of taxpayers money.

Boomerang (book)

I'm currently reading Michael Lewis' book "Boomerang - travels in the new third world".   This is an excellent and very amusing discussion of what went wrong in Iceland, Greece and Ireland (and others).  It's not a detailed macroeconomic exposition, but if you want a fun and relevant read, I recommend it.