Harnessing volatility to drive momentum.
I don't know about you, but reading my social media feeds this week has been a polarising affair. Half of the people I take seriously predict we'll soon be in a recession, and the other half are predicting that good economic times are ahead!
Although my personal outlook is optimistic (recessions can do 4-5x more damage than inflation, inflation is the lesser of two evils), I'm no Nostradamus (does that make me Yestradamus?).
Whilst there is high uncertainty as to whether or not the economic outlook is bullish or bearish, one thing feels certain: we're in for a period of high volatility.
For the majority of issuers, volatility is bad. The equation, "high volatility = low stability = negative market signals", seems to be an ingrained belief around these parts. Whilst upwards volatility has its obvious benefits, the negatives press coverage and investor sentiment during selloffs appears to outweigh the positives.
Today, I want to flip the script on your perceptions of volatility and present some research that presents volatility as a step-change opportunity. This article is about the benefits of volatility and how you can harness it to grow your market cap and raise better capital.
Neglected stocks are valued incorrectly.
In 1986, American economist Robert C. Merton identified an intriguing characteristic of the Efficient Market Hypothesis (EMH). For those needing a refresher, EMH is an economic theory that dictates that a share's price reflects all known (and, in some cases, unknown) information about a stock. The more data we have, the more accurately we can price the stock.
Merton identified a subset of stocks called "neglected stocks" that do not receive as much investor, analyst, or media attention. As a result of their neglect, applying EMH means that the relative lack of information regarding these stocks means that they're likely to be incorrectly valued. In other words, the market's valuation of these stocks is akin to valuing the antiques you inherited from your great grandma. Until you go on Antiques Roadshow, you will have no idea.
With a small shareholder base and low trading volume, neglected stocks can result in companies being undervalued or overvalued for long periods. Many CEOs I speak to think that their share price is too low, and looking at Merton's work, we can now articulate why: not enough people know about the company!
When you're a neglected stock, volatility is good
In 2017, two Swedish researchers with, quite frankly, some badass surnames, discovered that if you're a neglected stock, you want volatility.
Jankensgård & Vilhelmsson found that when neglected stocks experience high periods of volatility, the increase in investor, media, and analyst attention can kickstart the Efficient Markets Hypothesis to create a "fair valuation" of the stock. The argument is that volatility is like the makeover reveal scenes in Beauty and the Geek. Whilst we’re all shocked at the transformation of the "geeks", their mothers insist that they always knew how handsome they were.
The takeaway from this research is that if you feel like the market is undervaluing you, then you may just not be getting enough attention. Periods of volatility can short circuit the market's attention and give your long-term share price a makeover.
What can you do about volatility?
As usual, I'm here with the experience of 2,000+ transactions and over $1bn in supported market cap to give you some practical tips for harnessing the power of volatility:
- Identify those that contribute to volatility
During periods of volatility, identifying high-frequency traders within your registry will give you an accurate understanding of the relative percentage of your registry that contributes to volatility. This is important to know because it helps you identify the percentage of your registry that have long-term intentions. - Tuck in your holders
A large majority of your shareholders will continue to hold through periods of volatility. Over time, these shareholders can get spooked and downsize or close their position. It is wise to communicate directly with them to remind them that the vision, strategy, and plan remain the same as when they chose to invest. - Build on your media attention, but steer clear of your share price
With more attention on your company, now is the time to release investor updates, press releases, and even interactive announcements to promote your strategy, results, team, or other company updates. Avoid discussing your volatility directly, I find that phrases like "the share price can be impacted by so many external factors - like yesterday's closing NYSE market - which is why I focus on growing our fundamentals so we can continue to outperform the market", can help to deflect any attention turned towards your share price. - Convert attention into emails
I have said it many times before, and I'll say it again, acquiring email addresses is one of the best outcomes your IR strategy can achieve (it increases SPP participation by 280%).