Citi’s 1-to-10 Punch a Split Decision

05/08/2011 12:01 am EST


Buff Dormeier

Senior Vice President - Investment Officer, Wells Fargo Advisors

While bulls and bears both have their reasons to celebrate the banking giant’s reverse split, of bigger note is the deal’s effect on trading volume...depending on whom you ask, writes Buff Dormeier.

Citigroup’s reverse stock split took effect after Friday’s close, and trading began again today, May 9.

There are many interesting facets to this 1-to-10 transaction that are interesting—but very importantly, it’s a perfect opportunity to clear up some of the confusion regarding the trading-volume totals reported in the media. Although price indexes have evolved, virtually every media outlet still reports market volume using the same methods that were used in the 1920’s.

The Highlights
Citigroup (C) is reducing the number of common stock shares outstanding by a factor of ten, from 29 billion to 2.9 billion. This will cause the price per share to increase tenfold.

Citigroup’s trading volume should therefore decrease to 1/10 of previous levels. Investors with fractional shares will receive cash in lieu of those shares.

This will have a major impact upon market volumes, but views differ on how much the impact will be. Opinions range anywhere from as low 1% to as high as 50% or more.

So who is correct? The answer depends on what one means by market volume:

  • NYSE Exchange Volume—volume of just the stocks traded on the NYSE (narrow)
  • NYSE Composite Volume—volume of all stocks listed on the NYSE ( broader)
  • Total Composite Volume – volume of all stocks exchanged on the primary exchanges (broadest)

Let’s take a look at each one...

NYSE Exchange Volume
An important variable to consider is how a stock’s volume is related to the exchange totals. While stocks trade on multiple exchanges, their volume is recorded to the exchange on which the stock is listed.

This can make the accounting muddled. For example, shares of Citigroup may also trade on the Nasdaq or other markets, but its volume statistics are attributed to the NYSE composite volume.

So what good is the NYSE exchange volume? Good question—it may be helpful for statistical purposes, if one is employed by or competes against the NYSE, but it is virtually worthless when it comes to using this data for practical volume analysis.

When you hear reports of Citigroup affecting the volume by 40% or more, they are probably comparing Citigroup’s total volume to only the physical shares traded on the NYSE exchange. Thus, this reporting is seriously flawed.

The NYSE exchange volume is just the shares facilitated by the NYSE. Since Citigroup’s shares traded on other exchanges are not listed in the NYSE exchange volume, the Citigroup volume could be higher than all the shares facilitated by the NYSE.

NEXT: NYSE Composite Volume


NYSE Composite Volume
 Moving from worst to just bad, the NYSE composite volume is the trading volume of all the issues who are members of the NYSE (Tape A). This is what most people think of when looking at volume.

It includes all the shares of NYSE listed stocks no matter where the trades were facilitated. So the effect of Citigroup’s split will be somewhat muted, but still significant, attributing typically close to 10% of the total NYSE composite volume.

Total Composite Volume
When referring to the market volume, other media outlets may reference the total composite volume of all shares traded on all the major exchanges (Tapes A, B, and C). Using this view, Citigroup’s split should decrease the total by about 4%.

These are the three common methodologies. Keep in mind that these are generalities. Each data provider may modify the data by being either over inclusive (adding exchanges) or restrictive (subtracting issues such as ADRs, ETFs, non-operating companies, etc.). 

Many acknowledge the predictive benefits of using volume data, yet few actually apply the data correctly. However, serious volume watchers use either dollar totals or capital-weighted figures in analyzing volumes.

Dollar Volume
Dollar volume is the total dollar value of the shares being traded. Dollar volume equals the price of the shares traded multiplied by the number of shares traded. So as Citigroup’s stock price rises tenfold, the share volume will also drop 90%, negating any impact.

Dollar volume is a significant improvement over the other methodologies. However, a problem with dollar volume is that it is an “apples to crab apples” comparison.

This problem with dollar volume is that like the other volume-totaling methods, it is a tally of all the shares traded. But price indexes are not tallies but indexes, with each member having a defined weighting. Thus, the more shares the stock trades, the bigger impact it has on the dollar volume.

A high-volume stock like Citigroup will have an excessively large impact on dollar volume, whereas a low-volume stock will have a disproportionately small impact.

Most practitioners analyzing the market use the S&P 500 price index combined with the NYSE composite volume. Although the majority of S&P 500 stocks are traded on the NYSE, other components—including the largest one, Apple—are listed on the NASDAQ.

Additionally, the NYSE volume contains many other issues, some of which are not even stocks.

Capital Weighted Volume
The best methodology to analyze volume relative to price is capital-weighted volume. In a price index, each component has a percentage weighting, usually based upon its capitalization. Cap-weighted volume gives the security’s volume the same representation that the price index gives to the member’s capitalization, thus harmonizing the relationship between price and volume.

For example, Citigroup’s cap weighting is 0.7% of the S&P 500 index. This weighting also represents 0.7% of the total S&P 500 volume. As with dollar volume, after the split Citigroup’s cap weighting will remain exactly the same. So with capital-weighted volume, the volume remains directly proportional to Citigroup’s capital weighting in the S&P 500 index.

So what will be the measurable impact of the split be on the stock?

NEXT: The Bullish Impact


The Bullish Impact
The stock is evidently splitting because its directors feel it is in the best interest of shareholders. Why?

Perhaps they are attempting to attract institutions. Penny stocks are commonly defined as securities under $5 per share. Some institutions can not buy or hold penny stocks. The impact of raising the share price ten-fold would be bullish.

Additionally, the trading costs for Citigroup stock may be lowered as many institutions charge by the share, which is also bullish in attracting new investors. Finally, having the stock at a higher price may improve option trading, with the potential availability of more option strikes.

The Bearish Impact
Many investors bought Citigroup at $5 a share thinking “it can’t go any lower.” But at $45 a share, they may no longer feel that way. This behavioral impact could be bearish.

Similarly, many people believe a spilt is always good. Retail investors may feel that the company is growing. With the same mindset, many investors feel a reverse split is bad, as a public acknowledgement that the company is contracting. This is typically the psychological effect of a reverse split.

Whatever direction the stock should move, the smaller float should allow the stock to move more easily. Think of stock float as the width of a pipe, and the narrower the pipe, the stronger the pressure. A lower number of total shares outstanding may allow the stock to move up or down faster.

The Impact on High-Frequency Traders
At times, Citigroup traded more than 100,000 shares per second. Some theorize that high-frequency traders (HFT) are keeping the stock from appreciating. This is a myth as HFT trade for liquidity, not position—meaning they make money on the spread, not by taking bullish or bearish positions.

So, in theory, HFT should not keep stocks from moving directionally, no matter how much liquidity they provide. HFT make their profit by keeping spreads tight (scalping) or by compensation received from the exchanges by posting liquidity through rebates. The spilt could lead to less profit for those HFT working the Citigroup stock.

So are you serious about volume analysis? You can test your dedication to this social science by knowing the type of volume data you employ. While many in the media will debate the impact of volume upon the market in the headlines, now you know the real story.

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