Investor Relations: Determining your Stock’s Downside Risk in Rugged Markets

Boo! That’s our Halloween surprise.

Speaking of surprises, do you try to quantify downside risk in your stock resulting from either marketwide technical shifts or specific Street disappointment? We are not saying rising oil futures, gilded gold prices and the sudden cachet of commodities traders should scare you. Nor or we saying they shouldn’t.

It used to be that benchmarking potential price pressure was fairly simple: Miss your number by 5% and you could see 20 points of price slippage based on multiples in models and the bias toward growth or value among your holders. But when 65% of volume moves through quant models and trading systems and ETFs – conditions we observed in our internal data pool last week – is there any way to quantify the size of the future Street reaction?

At ModernIR, we would be the first to say it’s not easy. But we can also tell you that it’s definitely not about the type of your holders alone. You might have a bad quarter and, if traders are vested in derivatives or variance swaps to capture volatility, your stock might have an artificially tepid response followed by quick recovery. This might lead you to conclude that investors are okay with results when in fact speculators are simply creating the equivalent of a forward avalanche: a hollow pocket supporting big impending changes in models.

Here’s what you can do: First, find out which broker-dealers drive the bulk of algorithmic order flow. UBS? Credit Suisse? Bear Stearns? Merrill Lynch? The banks behind steady volume are the key to determining risk. They may regularly perform similar functions for crossover clients – but they ALSO distinguish themselves in particular ways. If you’ve got large derivatives-oriented order flow behind your volume, your stock will behave differently than it will if shorter-term traders like Goldman Sachs are at work.

Tracking and analyzing this activity can be the difference between telling management “I have no idea,” and saying, “We think the market won’t respond much at first, but we’re likely to go into a prolonged slide after options because all these derivatives strategies will reset lower. Therefore, we’re going to retool our message to highlight core value drivers and concentrate our effort over the next quarter on long-term value investors.”

Which would you prefer?

There’s much more to this whole market structure thing. But we still have to bulk up on Halloween candy. Enjoy the festivities!