In my first blog post I touched briefly on stock market efficiency,
this blog will compare the effects of a profit announcement on two company’s
share prices; Balfour Beatty in 2015 and Moneysupermarket.com in 2013.
Pricing efficiency in stock markets has divided opinions
among academics and investors, this concept dictates that all security prices
fully and fairly reflects all information regarding both past and future events
in the marketplace, therefore they are fairly priced (Watson and Head,
2013). Fama (1970) identified three
forms of market efficiency
Weak form effeciency: share price fully reflects information in historical prices
Semi strong effeciency: share price fully reflects all information that is publicly available
Strong form effeciency: share price fully reflects all information that is publicly and privately available
Weak form effeciency: share price fully reflects information in historical prices
Semi strong effeciency: share price fully reflects all information that is publicly available
Strong form effeciency: share price fully reflects all information that is publicly and privately available
On March 25th 2015 construction company Balfour
Beatty reported a pre-tax loss of £304m,
the total shrank to £59m once profits from discounted operations including the
sale of its US business Parsons Brinckerhoff were included (The Telegraph,
2015). Balfour Beatty also announced
that due to the financial difficulties they were facing they would not be
paying shareholders an annual dividend (BBC News, 2015). We can see from Graph 1 below that Balfour
Beatty’s share price dropped significantly on the day of the announcement. This I believe demonstrates a semi strong
form of efficiency, as the share price reflects all publicly held information
and not just historical price movements (Fama, 1970). The fall in share price could reflect
shareholders discontent at the news that dividends will be axed! (wouldn’t you
be annoyed if you were a shareholder in Balfour Beatty?!)
Graph 1: Share price of Balfour Beatty from 25th
March until the 30th March
The chief executive of Balfour Beatty, Leo Quinn announced
the company were facing a variety of legal challenges in a number of
construction projects and stated they were facing ‘major short term problems
(BBC News, 2015). This announcement was
publicly available to the market and may have encouraged investors to sell
their shares in the company as the short term future of Balfour Beatty doesn’t look
positive, suggesting they will not be reinstating a dividend policy anytime
soon!
A contrasting story to Balfour Beatty is that of
moneysupermarket.com, who on the 31st of July 2013 announced half
year profits were up 70% from £11.6m to £19.8m (BBC News, 2013). In the six months previous to the announcement
EBITDA had risen 29% to £39.9m and revenue grew 10% to £112.3m (BBC News,
2013). You would have thought if you
were a shareholder in moneysupermarket.com you would be delighted (or laughing
all the way to the bank as they say).. well your wrong! Despite the announcement
of an increase in profit share price fell 15%!
Graph 2: Share price of moneysupermarket.com on 31st
July 2013
Source: London Stock Exchange
In an efficient market you would assume that the market
would react positively to news of improved performance, thus impacting the
share price of moneysupermarket.com, which we can see in the graph above didn’t
happen. This in my opinion shows a lack
of efficiency in a market place, as this reflects share price of historical
information and not positive publicly held information.
Does this mean that share prices are entirely random? Well
that was what Kendall (1953) proposed in a theory of random walks, highlighting
that share prices change in a random manner arguing there was no link between
share prices. However Kendall (1953)
did acknowledge that share prices were random because they only changed when
new information entered a market place, which in itself can be entirely
random. The fall in share price of
Balfour Beatty would support this theory, as shareholders did respond to
information that entered into the market place at a random time, however it doesn’t
explain the fall in moneysupermarket.com’s shares. Could it be because Balfour Beatty’s announcement
was concerned with dividend payments and moneysupermarkets was only an increase
in profit?
Even though Kendall (1953) proposes that the stock market is entirely
random, how do investors make so much money from it? Is it simply luck? Or
maybe insider information that isn’t publicly available. If the latter were true it would suggest that
different people are investing in different markets in theory, an investor with
insider information would be investing in a market which by Fama’s (1970) definition
is a strong market.
In my overall opinion I don’t believe you can predict the stock market
(no matter how much I wish I could), because I think share prices are
subjective to any news which is released publicly. I don’t think anyone can predict the future
and no one can tell what is going to happen tomorrow, therefore how could
someone predict what news will be announced and the effect this will have on
share prices. It should also be noted
that as demonstrated by the dip in moneysupermarket.coms share prices that not
all information is relevant to shareholders, it seems information which will
directly affect investors such as dividend policy causes more of a market
reaction than other pieces of news.
I think it is vital that stock markets are efficient, if they were not
then it would be hard for directors and managers to know what strategies and steps
to take to create shareholder wealth wouldn’t it? I can’t imagine the look on
moneysupermarket.com manager’s faces when share prices dipped as they announced
an increase in profit! Managers will
rely on an efficient market in order to ensure they make wealth creating
financial decisions (Arnold, 2013).
References:
Arnold, G. (2013). Corporate
Financial Management. (5th ed.), Harlow:
Pearson.
BBC News. (2013, July 31). Moneysupermarket.com share price
drops despite 70% profit rise - BBC News. Retrieved from
http://www.bbc.co.uk/news/uk-wales-north-east-wales-23517365
BBC News. (2015, March 25). Balfour Beatty reports £59m
loss and axes dividend - BBC News. Retrieved from
http://www.bbc.co.uk/news/business-32046614
Financial times. (2013, July 31). Moneysupermarket hit
by change to Google algorithm. Retrieved from
http://www.ft.com/cms/s/0/aedcccfc-f9c7-11e2-98e0-00144feabdc0.html#axzz3Vy4TuXbb
London Stock Exchange. (2013, July 30). MONY
MONEYSUPERMARKET.COM GROUP PLC ORD 0.02P. Retrieved from
www.londonstockexchange.com/exchange/prices-and-markets/stocks/summary/company-summary-chart.html?fourWayKey=GB00B1ZBKY84GBGBXSTMM
London Stock Exchange. (2015, March 25). BBY BALFOUR
BEATTY PLC ORD 50P. Retrieved from
www.londonstockexchange.com/exchange/prices-and-markets/stocks/summary/company-summary-chart.html?fourWayKey=GB0000961622GBGBXSTMM
The Telegraph. (2015, March 25). Balfour Beatty scraps
its dividend for a year after falling into the red - Telegraph. Retrieved from
http://www.telegraph.co.uk/finance/newsbysector/constructionandproperty/11493591/Balfour-Beatty-scraps-its-dividend-for-a-year-after-falling-into-the-red.html
Watson, D. & Head, A. (2013). Corporate
Finance: Principles and Practice. (6TH ed.),
Harlow: Pearson