Objective research and reviews to aid investing decisions
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Ed in Boston MA sent the following comments and questions:
"I was at a quant conference yesterday, and they had an academic present a paper that basically shows that the stocks of companies issuing (secondaries, etc.) underperform after doing so. Duh. I've been in this biz for 15+ years, and it struck me that this research was at least ten years old, i.e. rehashing known stuff. I've seen studies on this and actually did one or two on my own many years ago. The reasoning behind it is sound and frankly fairly obvious. Do you recall any such studies over the years?
"Also...do you know of studies that show you don't want to buy stocks after issuance of convertibles?"
After reviewing our own blog and others and performing some quick searches of the Social Science Research Network (SSRN), we find:
There are several recent examples of research confirming Ed's view of the effect of secondary equity offerings on subsequent stock returns:
Our blog entry of 5/11/05 summarizes academic research concluding that public companies, on average, intelligently manage their stock float according to investor demand for their stocks. They buy low (buybacks) and sell high (issue secondaries).
Our blog entry of 2/4/05 summarizes academic research concluding that significant marketwide capital inflows (including secondary offerings), in aggregate, lead to low overall stock returns.
The June 2002 paper entitled "The Long-Run Performance of Secondary Equity Issues: A Test of the Windows of Opportunity Hypothesis" finds that secondary issues are bad signs for both issuing company stock returns and operating results, probably because managers of such companies are exploiting "windows of opportunity" by issuing overvalued shares.
Regarding the effect of convertible offerings on subsequent stock returns, we also found recent applicable research:
The April 2002 paper entitled "Long-Run Abnormal Performance Following Convertible Bond and Convertible Preference Share Issues: Evidence from the UK" finds significant evidence of negative post-offer, long-term abnormal raw performance relative to a stock index. The risk-adjusted results are not so clear.
The January 2004 paper entitled "New Evidence on the Market Impact of Convertible Bond Issues in the U.S." finds that firms experience negative abnormal returns around the announcement of new issues of convertible bonds, and that investors could take advantage of these negative abnormal returns by going long on the firm's convertible bond and short on the firm's stock at the issue date.
See also Victor Niederhoffer's ongoing Buyback Study for up-to-date tracking of the performance of companies buying back their stocks (the mirror image of issuing secondaries).
Ed is likely right about there being relevant research much older than that cited above. The lists of references in some of the above papers should identify prior items.
In summary, research indicates that dilution (secondary offerings) and potential dilution (issuance of convertibles) correlate with abnormally low future stock returns.
For related research, see Blog Synthesis: Buybacks and Secondaries.
