Experian PLC and Market Efficiency - Case Study Example

EXPERIAN PLC AND MARKET EFFICIENCY Introduction It is the purpose of this study to determine whether the market reacts to new information in a predictable fashion and to a significant degree by affecting the price of a given security. We have taken the case of Experian, Plc, a UK listed company, for the purpose of finding out whether the market is sensitive to new information. The period of January 25, 2010 to February 19, 2010 has been chosen for study. The efficient market concept The first aspect of the market to consider is market efficiency. Investors determine stock prices on the basis of the expected cash flow returns relative to the risk involved. They use all the information available or that can be reasonably obtained - consisting of known information and beliefs about the future (inferred information). Being the determinant of stock prices, information is the central issue of the efficient market concept. An efficient market is defined as one in which the prices of securities fully reflect all known information quickly and accurately (Jones 1991). The current price of a stock incorporates or fully reflect all information that investors assimilate in the process of making their buy and sell decisions. According to this concept, it is assumed that all known information -- including past information (such as last years or quarters earnings), current information, and events that have been announced but not yet implemented, such as a stock split -- are fully reflected in the price. Other information that can be reasonably inferred such as a change in interest rates will also be reflected in the prices even before the event occurs. By "quickly and accurately" is meant the speed at which information is received by its users, instantaneously in most cases, particularly with current electronic communications availability enabling brokerage houses, institutional investors and others to obtain any information and process it for quick decisions. For individuals without such easy access, information can reach them a few hours or a day later. It is not quite easy to determine what accuracy in price adjustment means, but the theory simply assumes that an unbiased estimate of the equilibrium price is established after all investors have fully assessed the input of the information (Jones 1991). New information about a companys profitability can affect the price of its stock such that it has a positive excess return, described as that portion in the price not accounted for by the overall market movement. On an average day, the difference between the price and the overall market, the excess return, is zero. On the day of the announcement or dissemination of information, the the excess return would normally adjust to positive and then resume it previous pattern the following day. Conditions for an Efficient Market to occur Firstly, there must be a large number of rational profit-maximising participants, investors who participate in the market through the analysis, valuation of stocks, and trading. Secondly, information is widely available at the same time to all participants at no cost to them. Thirdly, Information is generated randomly, one information being independent of another. Finally, investors react quickly and accurately to the information received, causing prices to adjust according to their decisions. Under real situations, not all of these conditions can be supposed to hold. For example, rapid information costs money and only large investors can find it reasonable to pay for its acquisition, but in many cases they are free on slightly delayed basis, and most information can be obtained at the same time through the Internet, television and data feeds from real-time data providers. Many investors monitor the market on a daily basis, or several times during the day, and are willing to stake their money by buying or selling on the basis of new announcements. Information is also generated randomly in the sense that their announcement can occur unexpectedly in most cases, such as a currency devaluation, a labor strike, the death of an important national leader, and the like. Because many investors with large amounts of cash quickly act on new information, it is often observed that a sudden significant change in the price of a stock can be explained by an announced event. The independence of a piece of information from preceding information accounts for the price change that looks unrelated to the previous price level. Forms of market efficiency. The efficient market hypothesis is concerned with the extent to which security prices reflect fully all available information and information that can be inferred, and it is divided into three cumulative levels: the weak form, the semi-strong form, and the strong form of market efficiency. a. The weak form. This hypothesis explains that all historical price data are already reflected in the current prices and are of no value in predicting future price changes. Consequently, all past price changes should be unrelated to future price changes. The weak form efficient market indicates that past price information is of no value in assessing future changes in prices. b. The semi-strong form. This assumes that not only known and publicly available price data are known, but all publicly known and available data that include earnings, dividends, financing problems, product developments, among others. A market that quickly assimilates such information into the price shows semi-strong form efficiency. Because the market acts quickly on such information, an investor cannot act on such information and expect to achieve above-average risk-adjusted returns; otherwise, if there is a lag in the price adjustments, the market is not efficient. c. The strong form. This form of market efficiency is the most rigorous of all, asserting that stock prices reflect all available information, both public and nonpublic. This means that the availability of publicly known information and information available only to corporate officers and insiders as well as specialists in the exchanges does not give investors having such information a decided advantage. However, many practitioners assail this assertion in view of SEC regulations about insider trading (See Malkiel 1991). The Value of information. This paper focuses on the second type of market efficiency because our aim is to determine how prices are affected by information of both historical prices and developments within the company and in its macro environment. Because there are many investors monitoring developments and are willing to act quickly and promptly on new information, it is expected that one who intends to gain above-average returns must be quicker than others to act on new knowledge. Otherwise, the market can be described as efficient, and investment analysis would be "an expensive exercise in wishful thinking." (Hagin 1979). A lag in the information processing and incorporation of information into the prices - indicating lack of market efficiency -- can provide an opportunity for achieving superior returns, given the particular risk level. Certain types of information can cause prices to move, namely, a) Economy-related information. A bear market when most stocks are reaching new lows can drag down even the well- managed companies. b) Industry-related information. Certain types of news can impact specific industries only without affecting companies in other industries. News about the health benefits of coffee can have a positive effect on the sales that use coffee as beverage and those using it as an ingredient. c) Company-related information. Announcements regarding a companys earnings, dividends, new product developments, patents, merger plans, stock splits, and so on, will affect the price of the companys stock but not those of the other members of the industry or of the market as a whole. A good investment analyst studying a particular company would have to determine which of these types of information have the greater impact on the price and would allocate his efforts accordingly. For example, if economy and industry factors have the preponderant effects on the companys stock prices, more efforts should be expended in accessing and analysing the economy and the industry compared to events within the company. Price movements: How are they determined? In a 33-year study conducted by Benjamin King (1970, cited in Hagin 1979 ), of 63 NYSE stocks, it was determined that there is a strong tendency for stocks to move with the overall market. Also, it was found that stock price movements corresponded closely to industry classifications. Moreover, only a minor proportion of the overall price movements can be attributed to company-related factors. On the average, the investing public believed that price changes were attributable to four components in the following proportions: 1) the market as a whole, 31 percent; 2) the industry or sector, 12 percent; 3) the industry, 37 percent; and 4) the particular company, 20 percent. What is evident is that only one-fifth of the price is specific to the company, while nearly half of the price is accounted for by the sector and industry jointly, and nearly a third is attributable to macroeconomic factors. This information should reliably guide the analyst in his choice of data that can impact the price despite the fact that it is a generalisation. Specific data that are important for monitoring are the following: a) The economy: production, trade, prices indexes, monetary and fiscal policy, consumer confidence surveys, forecasts. b) Sector: Production and inventory statistics, wages, price levels, finance and credit, and consumer preference surveys. c) Industry: Production and inventory statistics, sales and deliveries, profit margins, growth forecasts. d) Company. Earnings, dividends, stock splits, new issues, new listing, mergers and acquisitions, finance and credit problems. We now turn to the application of these concepts through a specific Ireland-based global company. Experian Plc The company is a global credit information company operating from its headquarters in Dublin, Ireland, and doing business in more than 30 countries all over the world. Formerly known as CCN Systems , it also has operational headquarters in England (Nottingham) and the United States (Costa Mesa, California). It is listed in the London Stock Exchange (symbol: EXPN.L) and is one of the companies constituting the FTSE 100 Index. Since the mid 1990s, it has expanded considerably through the acquisition of such companies as TRW Information Services, CheetahMail, PriceGrabber, Hitwise, and others (experian, Answers.com) In 2008, the it acquired SearchAmerica, Inc, a provider of payment prediction data and analytics to the US healthcare industry. The following year it acquired United MailSolutions GmbH. In early 2010, the Group acquired control of A-Care Systems, a Japanese e-mail marketing company. (See Annual Report) The Company’s business The 2009 Experian Annual Report describes the business of the company as that of providing information, analytical tools, and marketing services to organisations worldwide of all sizes, from small start-up businesses to multinationals. These services are useful to companies in managing risk, finding and retaining customers, and automating decision making. They also help individuals manage their credit relationships and minimise identity theft. The geographical scope of the company’s business activities includes North America, where business volume is greatest, Latin America, UK and Ireland, and EMEA/Asia Pacific. It is difficult to compare Experian Plc with other companies because it operates in its four principle business lines –credit information, , decision analytics, and marketing services, and interactive – without any single competitor that competes in all of these lines. Because of its size and reach, the Experian Group is nearly twice as large as its closest competitor and thus enjoys significant competitive advantage and a relative degree of protection from cyclical adversities. It has some 100,000 clients across the world with no single client accounting for more than 2 percent of its revenue. North America accounts for more than half of its total annual revenues, followed by the UK and Ireland with just over one-fifth. Latin America and and the EMEA/Asia Pacific regions account for the balance. In terms of revenue by activity, in FY2009, 42 percent came from credit services, 13 percent from decision analytics, 20 percent from marketing services, and 25 percent from Interactive. In terms of customer base, financial services clients account for 41 percent, 18 percent from direct to consumer, and the rest going to retail, telecommunications, public sector, and others.(See Annual Report) The sector under which the Group is classified is technology (Reuters) and the industry is software and programming. (Note, however, that FT.com classifies it as Industrial (sector), and commercial services and supplies (industry)). In business information, its only global competitor is Dun & Bradstreet. In credit-related analytics and software, it is the industry leader globally, with the exception of the United States where Fair Isaac is dominant. In consumer-credit information, Experian is the market leader in UK and Ireland, Brazil and other countries, but has significant competition in Equifax and TransUnion in the United States. In direct marketing services the competitors are Acxiom and Harte-Hanks although there are other that are smaller, specialist and fragmented. In terms of direct-to-consumer credit information business, its main US competitors are Equifax, TransUnion, Fair Isaac, whereas in the UK, Equifax is its major competitor.(Annual Report). Financial performance According to Reuters, the Groups revenues for the six-month period ending September 2009 decreased 7 percent to $1.9 billion and net income dropped 2 percent to $257 million. The decreases in costs of sales and operating expenses enabled the company to minimise the drop in income. A study of the financial statements over the last five years shows a significant drop in revenues from 2007 to 2008 due to the global recession. Chart analysis The aim of this study was to establish whether the market was efficient with regard to the pricing of the Experian Plc stock in the London Stock Exchange. Where the market is efficient, the current price fully reflects all the historical price and public information affecting the stock. Such information could include sector and industry-related , macroeconomic, and company-related information. The investors would react to new information by either buying or selling the stock, causing the price to rise when buying pressure exceeds supply and to fall when there are more buyers than sellers. The price data and price charts would therefore show how investors react to new information. For example, when economic data as reported show that there is optimism of recovery in the company’s major markets, the price of the stock would tend to rise immediately after the data are digested by the market. The direction could also reverse if there is a negative announcement of an economic indicator, such as inflation or currency depreciation. The period chosen for observation were the trading days beginning January 25, 2010 and ending February 19, 2010. There would be a comparison in the movements of prices of the stock and the movements in the sector and industry indexes, where available. If there is congruence in the movements of the prices and indexes, then the new information affected not just the company itself but also other sectors. Another comparison to be made would be that between the price of the stock and the movements in the larger market as proxied by the FT100 Index and FT All-Share Index. As mentioned earlier, there is a lack of unanimity about the sector under which Experian, a business with diversified activities, can be classified. It is either Technology or Industrial.. We therefore attempted to show both indexes through the charts (actual numerical data are unavailable), as follows: Fig. 1 Graphical comparisons between Experian price movements and movements in the technology and industrial sectors.\\ Source: Reuters A general observation can be made that there is a general coincidence in the movements of the three sets of data. The industrial sector, however, shows greater robustness than technology, but the latter appears to be more consonant with the stock price movements. The stock shows earlier and more rapid reversals than the sector indexes. Numerical comparisons are not possible here because the website did not provide numerical information. Comparison with the market The chart below shows a comparison of stock price and the FT100 and the FT All-Share indexes over a 3-month period which has a portion containing the period of observation stated in this study. The FT All-Share index has been observed to be extremely close to the FT100. The comparison uses a growth rate method based on a starting point not shown in the chart. The company has shown superior performance compared to the FT100 index overall, with the exception of a portion in the first half of January 2010. Fig.2 Comparison between Experian stock and the FT100 Index. Source: Reuters Reaction of Prices to new information News and announcements that could affect the stock’s price were scant, considering the short period of time that the observations were to be conducted. The interactive charts of the Reuters and Yahoo websites can provide the analyst good insights as regards market reaction to new information and they have been used in trying to form evaluations. The following articles from Reuters will be indicated and the price reaction, if any, described. Jan. 15. News At 0932 GMT, the FTSEurofirst 300 .FTEU3 index of top European shares was up 0.6 percent at 1,069.53 points, near a 15-month high. . . . as several major economies have emerged from recession, and corporate profitability has improved.” Market reaction News about the rise in the FTSE Eurofirst 300 index caused the upturn, begun a day earlier, to continue. It is possible that most investors had learned of the good news earlier and took advantage of it. Both technology and FT300 indexes showed positive reaction on the day of the news. Jan 22, News: Experian finance Plc bond pricing of 500m euros was announced. Market reaction: No effect on the downtrend on the stock and the indexes. Prior direction was sustained. February 9 News: The company launched Experian Hiwise in France thus expanding its marketing services portfolio It aims to improve online marketing, content development, among others. Market reaction: The market and industry had begun an uptrend three days earlier. The company stock reacted with a slight dip, followed by a sharp upturn which proved temporary. Effect could be considered slightly negative or neutral, with other factors possibly affecting the price. 11 Feb  News: If anticipated by the market, economic news states that FTSE 100 slipped on somber economic outlook because of fall in US consumer confidence for the month. But there were tentative signs that the US economy could “pull away from Europe for the time being.” Because much of the company’s revenue is derived from the US, . . ., its price rose 5.5 to 624p. News on February 11 says that UK industrial stocks would be boosted by M&A activity this year. Experian was mentioned as having an attractive risk-reward ratio with potential 50 to 60 percent upside with resumption of credit growth . It was trading at low multiple and attractive cash flow characteristics Market reaction: The effect was a sudden rise in the stock price that lasted for only one day before resuming the normal uptrend which was prevailing in the market. Stock price rose 14 points from 600 to 614. 18 February News Experian awarded full licence to operate Indian credit bureau Market reaction: Stock price continued its slight uptrend that started several days before, conjointly with the movements in the technology and FT100 index. The effect of the news was neutral. Earlier, the mixed news on positive performance in Latin America and the downturn in UK revenues caused a slight upturn in prices. Both the FT and technology indexes also rose. Conclusion It has been demonstrated that investors generally react to new information rather quickly. Although it is not easy to isolate a specific piece of information as being responsible for a price change or movement, still in some cases it can have a major influence. At times the nformation that comes out of the media have already been discounted because investors had inferred or foreseen them before the news became known. The Experian case shows that some items of new information have no impact on the price trends, while others are quite significant in their effects. Bibliography Annual Report 2009, Experian Plc. Viewed 28 February 2010 at http://www.experiangroup.com experian, Answers.com. Viewed 28 February 2010 http://www.answers.com/topic/experian Hagin, RL 1979, The Dow Jones guide to modern portfolio theory, Dow Jones Irwin, New York Jones, CP 1991, Investments: Analysis and management, 3rd edn., John Wiley & Sons, NY Malkiel, BG 1990, A random walk down Wall Street, 5th edn., W.W. Norton & Co., New York Other websites: http://www.google.co.uk/finance?q=LON:EXPN http://uk.finance.yahoo.com/q/ta?s=EXPN.L&t=3m&l=on&z=m&q=l&p=m10,m5&a=&c= http://uk.reuters.com/business/quotes/chart?symbol=EXPN.L http://uk.reuters.com/business/quotes/chart?symbol=EXPN. http://uk.reuters.com/business/quotes/companyProfile?symbol=EXPN.L http://uk.reuters.com/business/quotes/chart?symbol=EXPN.L Read More