Research In Motion, A Case Study Revisited

Yesterday I used Research In Motion as a case study for several of the tools I share in my book, The Intuitive Investor: A Radical Guide for Manifesting Wealth.  But wait, there’s more!

Specifically, I wanted to talk today about:

• How “the market” is often representative of the extreme inclinations of several investors, and not necessarily every single investor
• The asymmetry between market rises and market falls

Let’s take these in turn.

The “Market”

Yesterday it was widely reported that Research In Motion’s (ticker: RIMM) sixth largest shareholder, Jarislowsky Fraser Limited (JFL), liquidated half of its position in the Canadian maker of Blackberry smartphones.  Furthermore, their chairman stated, “We are on the way out.  The stake has been reduced by more than 50% or even more.”

As of 31 March, 2011 JFL had held 10.2 million shares of Research In Motion.  So presumably the firm sold approximately 5.1 million shares on 17 June, 2011.  If so, that firm’s trading accounted for just 4.5% of total volume, or 4.5% = 5,100,000 JFL shares sold ÷ 113,269,745 total shares traded Friday.

Not only that, but yesterday’s gigantic trading volume was actually small when compared to the maximum trading volume in RIMM shares which took place back on 23 December, 2003 when a gigantic 350,252,400 shares changed hands.  So Friday’s volume was only 32.3% as large as the largest volume trading day in Research In Motion’s history, but still was able to take down RIMM shares by 21.5%!

Importantly, share prices on stock exchanges are often determined at the margin.  That is, there typically is tremendous price stability.  But when a single shareholder wants out of a position badly and is willing to accept any bid for its shares, then a single seller at the margins can set the entire market’s price.

This important point is scalable.  During the height of the dot.com era, when there was rabid buying and selling, the nightly business news (as it always does) would report “how the market did today.”  I had an intern of mine (hello Matt Schildt) conduct a piece of fascinating research to see just what “the market” meant.

He calculated average trading volumes for the S&P 500 during the period to total shares outstanding for the components of the S&P 500 stock index.  It turned out that “the market” only translated into 0.7% of total shares outstanding being traded, on average, each day!

This is hardly the vision most of us have when we hear the nightly business news.  The impression given is that everyone and his brother-in-law trades each day.  My point?  That a minority of shareholders each day actually determine the market price that the rest of us have to live with.

With Research In Motion, only a few important shareholders bailing likely tanked the price of RIMM for everyone.  It is important to note that a large shareholder may not be selling for a fundamental reason.  That is, their trading may have nothing to do with the news.

Yesterday Research In Motion did announce bad news, so the sixth largest shareholder selling was related to an actual story.  But frequently large shareholders sell shares in a business because they simply change investment strategies.

For example, they may sell RIMM because they want to “underweight tech” and “overweight manufacturing.”  If so, that selling would represent a mysterious drop in the share price of a company.  Such price declines, unrelated to news, are price distortions in the marketplace and are very often buying opportunities.

Asymmetric Rises vs. Falls

Research In Motion also serves as a nice case study for how long it takes to create value in stocks versus how rapidly value can be destroyed.  Yesterday I documented RIMM’s rise from $1.92 adjusted (for stock splits) closing price on 4 February, 1999 to a peak price on 19 June, 2008 of $147.55.  That ascent took 9.37 years.

By comparison, as of the close yesterday RIMM shares had fallen 81.2%, losing over four fifths of their maximum value.  And how long did this take?  Only a scant 2.99 years!

Another way of looking at it is: how long ago was it that Research In Motion shares traded as low as they did Friday?  You have to go back to 14 March, 2006 when the closing price that day was $27.66.  Even during the heart of the Great Recession RIMM shares did not trade below this price!  So in 2.99 years 5.26 years of value creation was eliminated.

So we can create an asymmetry ratio that demonstrates just how much longer it takes to create value than to destroy it:

Value creation ÷ value destruction = asymmetry ratio

5.26 years ÷ 2.99 years = 1.76x

Let’s have some fun and run the asymmetry ratio for the S&P 500 during a full market cycle, that is from trough to peak to trough again.

On 24 March, 2000 the S&P 500 hit a high of 1,527.46 and it was all down hill until it reached a trough on 9 October, 2002 of 776.76.  That decline from peak to trough took 2.54 years.  But how many years had it taken to rise up to that 1,527.46 level?  On 28 April, 1997 the S&P 500 closed at a level of 772.96.  So the ascent up to 1,527.46 took 2.90 years.

So our asymmetry ratio for the period of 28 April, 1997 to 24 March, 2000 would be: 1.14x = 2.90 years of ascent ÷ 2.54 years of decline.  This is one market cycle, and an unusually low one at that, so let’s take a look at several others.

How long did it take the S&P 500 to regain that level of 1,527.46?  On 6 July, 2007 it closed at 1,530.44 and finally exceeded the level it had established 7.28 years earlier!  So our asymmetry ratio here is 7.28 years ÷ 2.54 years = 2.9x.

On 9 October, 2007 the S&P 500 hit an all time high when it closed at 1,565.15.  So it took 4.74 years to rise to this level from the previous low of 9 October, 2002.  Then the S&P 500 experienced a cyclical low on 9 March, 2009 when it closed at 676.53, or a period of 1.42 years.  That gives us an asymmetry ratio of 3.4x!

The average of these three asymmetry ratios is: 2.48x.  Another way of putting this is that market declines are 248% faster than ascents.  Since percentages are often difficult to understand for people consider that if you climb the investment hill at 60 miles per hour, you descend it at approximately 150 miles per hour.

I hope that this amply illustrates that it usually takes much more time to create value than it does to destroy value.  Keep this is mind in the future if you are tempted to invest in a certifiable Rocket Ship, like Research In Motion!

Jason