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Is Buying Just-delisted Stocks a Profitable Strategy?

February 27, 2010 • Posted in Short Selling

A reader asked: “I read a few papers that suggest buying delisted stocks when they begin trading OTC is a profitable strategy. Do you have any evidence to support this claim?”

Searches of the Social Science Research Network on “delisted” and “delisting” generate a few dozen matches. These studies largely view delisting as the end of the analysis road, probably because data for unlisted stocks is difficult to track. In other words, the studies generally focus on the immediate effect of delisting on returns, volatility and liquidity, but they do not investigate subsequent stock performance.

The study most relevant to your question is:

“Off But Not Gone: A Study of Nasdaq Delistings”: “We examine 1,098 Nasdaq firms delisted in 1999-2002 that subsequently traded in the OTC Bulletin Board and/or the Pink Sheets. Market quality deteriorates significantly after delisting: share volume declines by two-thirds; quoted spreads almost triple from 12.1 to 33.9 percent; and effective spreads triple from 3.3 to 9.9 percent. Volatility triples from 4.4 to 14.3 percent, but quickly reverts to slightly elevated levels. Deterioration is significantly larger for more severe violations (e.g. bankruptcy) than for lesser infractions (e.g. minimum bid price). We find the OTC Bulletin Board provides a “soft landing” for delisted firms relative to the Pink Sheets. Although the delisting process takes at least 90 days, the drop in market quality is concentrated on the delisting date…”

This study focuses on a six-month window centered on the delisting event and finds that [underlining added]:

  • “[T]he drop in number of trades, trading volume, quoting activity and stock price are…immediate, but do not significantly revert following delisting…”
  • “On a value-weighted basis, delisted stocks lose nearly 20 percent of value upon delisting. Delisted firms continue to lose value over the subsequent 60 trading days, showing that the lost value is not transitory.”

The following table, extracted from the paper, tracks the value of an event-based portfolio of delisted stocks, with initial value $100, from the close on the day before delisting (-1) to the close 60 trading days after delisting.

The following chart, also from the paper, illustrates the equally-weighted case.

This evidence does not support a belief that “buying stocks when they begin trading OTC is a profitable strategy.” However, the sample period is short and potentially confounded by the effects of the dot-com bubble burst. The authors appear not to have adjusted returns for the contemporaneous performance of the overall stock market. Results from other sample periods might be different.

It seems that any study of trading delisted stocks would have to address large trading frictions (bid-ask spread and impact of trading) due to lack of liquidity.

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