Does the market capitalization rising above a trillion dollars change Amazon or Apple as companies? After all, $1,000,000,000,000 is only a dollar higher than $999,999,999,999 and nothing is changed fundamentally in either company by the event. That said, as human beings, we do make more of a fuss around some numbers than others, especially with age and birthdays. In some cases, the fuss is merited, as when you turn eighteen, since you will be able to vote and be treated as an adult in the legal system, or sixty five, since you may be entitled to your pension and social security benefits. In others, it is a concocted milestone, as is the case when you turn thirty or forty or fifty years old, since little changes in your life, as a consequence.
- With stock splits, where the share count changes in proportion to existing holdings, and nothing fundamentally changes about the company, the market not only reacts positively to the split but these stocks continue to do better than expected in the months after.
- When a stock approaches its 52-week high, there is some evidence that the high price acts as a barrier, making it more likely that the stock will go down than up.
- There is some evidence that support and resistance lines have price effects; one study focusing on exchange rates concluded that pricing trends in currency rates are more likely to be interrupted at support and resistance lines.
- A general study of technical analysis (and price patterns) concludes that technical indicators, such as head-and-shoulders and double bottoms do have a price impact, though it is unclear that you can make money of these price movements.
Some researchers have managed to convince themselves that the market behavior is consistent with an efficient market, with the rationale that these actions operate as signals about future fundamentals, thus explaining the price changes. A stock split, we are therefore told, is a signal to markets that companies feel that they have the cash flows to sustain higher dividends in the future, translating into higher value. I find most signaling stories to be unconvincing, reflecting almost desperate attempts to reconcile a belief in efficient markets with market behavior that is not consistent with that belief. In my experience, market triggers often affect stock prices, sometimes substantially, and it has little to do with signals. Rather than dismiss these triggers as irrational and useless, I need to understand them better, with the intent of separating ones that may be able to incorporate into my investing from those that I am better off ignoring.
Value Drivers and Pricing Catalysts
- Value effects: If a market trigger has an effect on one or more of the three drivers of value, which are cash flows, growth and business risk, it can affect value. Revenue or earnings triggers set by companies can have an effect on value, if management compensation is tied to them. With some corporate borrowings, there are covenants tied to stock prices or earnings, the violation of which may lead to consequences for the firm, sometimes taking the form of higher interest expenses and sometimes a change in control. With convertible bonds and preferred shares, the conversion price can become a trigger for a change in value, if it results in a significant increase in shares outstanding and in debt ratios. Consider the grant that Tesla’s board of directors gave Elon Musk in March 2018, where he will get billions of dollars in shares and options in the company, if he can deliver on a variety of targets, some related to market capitalization and some to operating performance. Specifically, the board of directors has listed 12 market capitalization tiggers, each of which can result in shares being granted to Mr. Mush, and 16 operating triggers, with eight relating to revenues and eight to EBITDA. For a Tesla investor, meeting each of these thresholds will be a cause for mixed feelings, joy that revenues, EBITDA and capitalization are increasing, tempered by dilution occurring at the same time.
- Pricing effects: If a market trigger has an effect on market mood or momentum, it can affect prices, even though it has no effect on fundamentals. For instance, the argument that technical analysts use for paying attention to support lines, often based upon historical prices, is that when a company’s stock price drops below its support line, it creates a negative psychological effect that can cause more selling, with prices falling even further. A pricing trigger can also have a liquidity effect, which can affect prices. This has often been the rationale used by some companies, especially those with high priced shares, for stock splits, arguing that retail investors are more likely to trade a $100 stock than a $1000 stock, and that the increased liquidity can translate into higher prices. The liquidity story can also be used the push by many start-ups to get to unicorn status, since doing so may attract more venture capital money, which, in turn, can push up pricing. Finally, there is the herd effect, where crossing a pricing or value trigger can lead people who have been sitting on the sidelines to act, pushing up prices if they decide to buy and pushing down prices when they sell.
- Gap (Catalyst) effects: There is a third and more subtle effect from market triggers, which comes from the attention garnered by crossing even an arbitrary threshold. This is especially the case with smaller and lower profile companies, which can often be ignored by investors and analysts, in a market where larger and higher profile companies garner the bulk of coverage. To the extent that these companies are being mispriced, the attention leading from hitting a trigger can lead to a reassessment of the company and perhaps a closing of the gap. Note that this reassessment can cut in both directions, with unnoticed strengths coming to the surface, and increasing the prices of some companies, and unnoticed weaknesses being unearthed in other companies, resulting in prices dropping.
So, what effect will crossing the trillion-dollar threshold have on Apple and Amazon? Neither company has options or convertibles that will unlock at the trillion dollar capitalization and thus there should be no value effect. There may be a pricing effect, but it is not clear in which direction. On the one hand, you can argue that for some long term holders of the stock, crossing the trillion dollars may be a culmination of a long and successful journey, leading to selling. On the other hand, there are others who may have resisted both stocks as overpriced, who may decide that this is the time to capitulate and buy the stock. As two of the most widely tracked and followed companies in the world already, it is not likely that there will be any major reassessments in either company, on the part of stockholders, nullifying the gap effect. There is one potential black cloud that comes with the increased attention, at least for Amazon, which is that the company's success may be drawing the attention of anti-trust and regulatory authorities, perhaps putting a crimp on its future growth plans globally. I will return to that issue in my next post.
Market Triggers and Investment Philosophies
- If you are a trader: The essence of trading is that you are playing the pricing game, and to the extent that you are, your success will depend upon how well you can ride the trend and how quickly you spot changes in momentum. Thus, it does not surprise me that charting and technical indicators are built heavily around these triggers. If you are a good trader, and I believe that they are some, your strength is in assessing how these triggers change mood and getting ahead of the market on these shifts.
- If you are a value investor: As someone focused on value, your first instinct may be to ignore market triggers, viewing them as a distraction from your central mission of valuing companies based upon their fundamentals, and then buying undervalued stocks and selling overvalued ones. While I understand that focus, I think that you should consider incorporating pricing triggers into your value mission for two reasons. The first is that a few of these triggers have value effects and ignoring them will mean that you are mis-valuing companies. The second is that to make money as a value investor, you not only have to get value right, but you have to trust the market to correct its mistake, by moving price towards value. Since the latter is often out of your control, I believe that one of the keys to being a good value investor is finding catalysts that can cause the price correction. If market triggers can operate as catalysts, incorporating them into your investment process can unlock the value mistake that you have found.
I own shares in Apple and I don’t own any (right now) in Amazon, and I have explained why in prior posts on both companies. With my Apple shares, I have been rewarded well over my almost three-year holding period, and the question then becomes whether the trillion dollar market capitalization should make a difference in whether I continue to hold the shares. With Amazon, I saw little reason to buy the stock a few months ago, as I noted in this post, where I argued that it was a great company but not a great investment. The question then becomes whether market capitalization crossing trillion dollars changes that assessment. The final judgment has to wait until the next post, where I will revalue both companies, and look at whether the trillion-dollar trigger has made a difference.
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