Unexplained volatility

I’ve owned Regional Express’ (REX) for a while now and lately I’ve noticed that the share price movements have been more volatile than usual. After yesterday’s massive 11.3% gain, I wanted to see whether the recent share price volatility made any sense.

In terms of significant announcements made by the company; the FY17 financial results, final dividend for FY17 and profit before tax (PBT) growth forecast for FY18 were announced on 28 August 2017. At the AGM yesterday, management gave an update for the FY18 PBT growth forecast. Between 28 Aug and 22 Nov there were no significant announcements and the ex-dividend date was 23 Oct 2017.

Rather than chart the share price, I have charted the company’s market capitalisation over the last 37 days to give a better perspective of the swings in the company’s value.  There were four big moves over this period which I will foolishly attempt to rationalise. The aggregate value (whether up or down) of these big movements was $89.2 million (on a sub $200 million market capitalisation company). Now over the same period, the ASX 200 went up 4% and market volatility was not remarkable (the biggest market moves were up 1%), so this suggests that the four big moves were not influenced by the general market.

The first big move increased the company’s value by $28.6 million (18.3%) over twelve trading days. Prior to this move, the market had a month to absorb the FY17 results and FY18 profit forecast announced at the end of August 2017. I’m speculating here but it appears to me that there was a rush to buy the stock before the ex-dividend date. However, this also doesn’t quite make sense to me as market participants had ample to buy the shares and the total dividend being paid out was only $11 million (10 cents per share) fully franked; far less than the $28.6 million being added to the company’s value.

The second big move resulted in a single day fall in the company’s value of $19.8 million. As Rex went ex-dividend on this date, a fall equivalent to the value of the dividend is expected. Typically, this happens due to investors competing away an arbitrage opportunity where an investor can buy shares before the ex-dividend date, sell it the next day, collect the dividend and make a profit. Rex’s dividend payout was $11.0 million (10 cents per share) which was fully franked or equivalent to $15.7 million (14.3 cents per share) grossed up. The market fell by $19.8 million exceeding both the cash value and the grossed up value of the dividend. So the dividend arbitrage strategy actually lost money here?

The third big move caused a drop in company value of $23.1 million (-13.6%) in six trading days. Over this period, the general market was flat and the only announcement by the company was an AGM date announcement. I don’t even know where to start in trying to explain this.

The fourth big move was a one day increase in market capitalisation of $17.6 million (11.3%). The AGM was held on the day and management’s  presentation showed that growth in FY18 PBT was expected to be over 20%, which was an improvement on their previous mid-teen PBT growth forecast. Using 15% as a proxy for “mid-teen”, I did some calculations to find out whether this huge movement could be explained by a 5% (20% vs 15%) uplift in FY18’s PBT. My calculations show that the difference between 15% and 20% growth in PBT is $890k. Even if I applied a 10x multiple to capitalise this PBT uplift, it would only result in a company value uplift of $8.9 million, far less than the observed market capitalisation increase of $17.6 million.

These large movements in share price are not uncommon especially outside the ASX 100 companies. It shows market psychology and momentum factors are powerful short term drivers of share price. If you are investing on a fundamental basis, it is hard to make any sense or logic for these massive moves in company value. So ….. I think the efficient market purists must also believe in the tooth fairy.

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