Thursday, 23 January 2014

Share price performance and average investor returns

Criminal listed investment companies create deliberately deceptive marketing materials that are used to attract more victim investors, using ridiculous metrics such as "pre-tax net assets" and "portfolio returns", and inflating assets with ramped investments, boosted receivables and fraudulent accounting treatment of options. However, even the most basic share performance metrics used in financial analysis have serious drawbacks and are useless for evaluating historic return to the average investor.

To evaluate historic performance, shill analysts typically look at total shareholder return, comparing beginning share price with the ending share price while factoring in dividends. However, shareholder return over a period is not necessarily correlated with the return realized by the average investor. Counterintuitively, an investment can have strongly positive shareholder returns over a period of time during which the average shareholder suffered catastrophic losses.

To understand this, consider the hypothetical Company A, which at year 0 issues 1m shares at $1 each to founding investors, for a market cap of $1m. Company A's share price rises to $10 in year 1, at which time Company A issues 99m shares at $10 each. Subsequently, between year 2 and 5 the share price declines to $6.

How should this company's share performance over the period be evaluated? Your friendly local share shill will tell you the share increased by 500% over the period, for a compound annual growth rate of (6/1)^(1/5) - 1 = 43%. The shill will tell you that, all things considered, over the period the investment performed very strongly, returning 43% per year on average. However, this great total shareholder return of 500% will be deeply misleading, and does not equate to positive returns for the average investor during the period.

During the period, the average price paid for Company A shares was 991/100=$9.91, since 99m shares were issued at $10 and 1m shares were issued at $1, with all other purchases and sales netting to zero. With an ending price of $6, for the average investor, Company A thus yielded a return of -39% during the period. This -39% return is the more accurate metric. 

The exact same analysis can be applied to indices. When shills tell you how the index has risen over the last thirty years, while neglecting to mention when shares were issued, they are giving you a CAGR but not an indication of the return experienced by the average investor. Moreover, the most moronic shills will tell you that superannuation contribution increases somehow imply a future rising market. These shills assume that no new shares will be issued to soak up the inflows, and that their information is not already reflected in prices. Even more idiotically, they implicitly assume that a $6t stock market can produce the same returns as a $1.5t market, i.e. will magically have four times as high aggregate profits and dividends. They implicitly assume that BHP would magically report four times as high profits if only its price was quadrupled first. This of course shows a serious mental deficiency.

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