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Commercial Awareness: Thinking like an Investor

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About The Author

Krishna Bholah (Guest Contributor)

Krishna graduated in law from the University of Southampton in 2016. He currently works in the business development team of a successful property technology start-up. During his spare time, he actively pursues other business endeavours, including investing in property developments and the stock market.

The main purpose of the stock market is to make fools of as many men as possible.

Bernard Baruch

Commercial awareness is regarded as an essential skill for a successful legal career. This is not without reason: commercial lawyers must understand the needs of their clients and the conditions they operate in. For example, if you were to advise a business on how to effectively dispose of assets held in their ownership, you must take into account the impact this may have on stakeholders. The asset sale may result in a loss of jobs, a loss of customers, and a lack of investor confidence. Alternatively, the sale could be seen as a method of streamlining, increasing efficiency and investor confidence.

How do you analyse the impact a decision may have on different stakeholders? Reading the news is an easily accessible, and primarily free resource that can help you begin to develop your understanding. In a previous article for Keep Calm Talk Law, I discussed how news stories are an effective way to begin considering the impact an economic change may have on the types of work required from a law firm.

However, analysing the news by itself can sometimes leave you with an incomplete perspective. This is why it can be useful to think like an investor. A potential investor in a company must consider all the possible effects a business decision may have on stakeholders, and therefore the value of the company. Thinking like an investor in the stock market (known as a stock trader) is a vital way of developing your commercial awareness.

Although other influences such as wider economic changes and chart pattern interpretations are important factors considered in a stock trader’s decisions, this article will concentrate on individual business news, such as profit warnings, company statements and reports. It will consider how looking at business news – from a ‘fundamentalist’ perspective, as opposed to a ‘chartist’ perspective – may impact stakeholders, with the aim of giving you a broader understanding of the impact a business decision may have and ultimately, a mature level of commercial awareness.

What are Stocks and what is the Stock Market? 

The easiest way to start to think like an investor or a trader is to begin studying the stock market like one. You are not obliged to actually invest money in stocks, nor spend money on powerful computer systems. It simply requires a device that can connect to the Internet. Then you can begin to observe the market.

What are stocks? Stocks are a collection of ‘shares’, where a company’s ownership is divided into small parts. These can be purchased by private, as well as commercial investors. There are other ‘stock’ markets such as the Foreign Exchange Market (FOREX), which deals with trading currencies, but this article will concentrate on company shares. When a company first enters the stock market, known as an Initial Public Offering (IPO), the company begins to ‘float’ on the market.

This means the company can be owned, wholly or partially, by people who purchase their shares. There are many reasons for a company wanting to be listed on the stock market. Raising finance is a key reason. The company may want to expand their market share, so requires further funding from external investors. It may be used to dilute debts, allowing greater scope to increase long-term value.

Accordingly, the ‘stock market’ is where companies are placed in different categories, where their shares can be bought, held and/or sold. For example, on the London Stock Exchange (LSE), there are several trading platforms, where a company is placed on one, dependent on their market capital. The FTSE 100 has the top-100 companies in the UK, while the FTSE 250 has the next top-250 companies in the UK. Even law firms can float on the stock market: Gateley made history in June 2015 by being the first UK law firm to do so.

Once a company has been listed on the market, it is susceptible to market fluctuations caused by a wide range of influences. This includes wider economic changes, such as commodity price fluctuations and government policies. In relation to individual business factors, changes such as an asset sale can lead to a rise or fall in the valuation of the company, and therefore the share price.

So the stock market is the system affected when you hear of good or bad news about a publically listed company. Hence why observing and anticipating trends in the stock market enables you to go further than reading initial news stories on the general facts.

Tesco Case Study

Late last year, it was reported that a possible 40,000 bank accounts owned by the UK retail giant Tesco were at risk by fraudsters. The story was first confirmed to the stock market at the start of the trading day on 7th November 2016. In order to examine the significance of a story like this for a person observing the impact it may have on the business, account must be taken of its potential effects on different stakeholders, who may have different interests. Consider the following, non-exhaustive list of examples:

Customers 

This is usually the initial perspective taken by news stories. It is clearly important to consider what impact a news story about fraud may have on customers, as these are the most affected stakeholders at first sight. So you can consider factors, such as whether consumer confidence will fall, and if this will lead to fewer people opening a current account with the Bank. 

Yet you can also consider the knock-on effects to consumers. What impact will the story have on other areas of the company’s operations? Could this result in smaller interim and full-year profits? If customers lack confidence, will shareholders start to sell their shares, creating a downward spiral effect on the share price?

Analysis

On first sight, news of 40,000 people’s bank accounts being at risk appears to be of general public concern. It was even claimed that this was ‘one of the largest cyber attacks on a bank in history.’ This may be an accurate description, warranting the alarming headlines published on the day. However, looking at the proportion of individuals at risk compared to the total number of Tesco Bank customers shows an alternative viewpoint. At the end of financial year 2015/16, there were 7.6 million bank accounts registered with Tesco.

This is a nominal proportion of 0.00527% (rounded up) of people potentially affected by the threat of fraud. From this perspective, the possible impact on Tesco Bank customers is minimal. This is suggestive that there will be no long-term decline or downward spiral effect in Tesco’s share price.

Following on from this analyses, it does not appear likely that food, drink and/or homeware customers will be reluctant to shop with Tesco as a result of this news story. There is no direct impact on the general retail customer base. Moreover, while there were 40,000 accounts at risk of fraud, it was also reported that there were 78 million shopping trips made per week to Tesco. This is a far way from the ambition of Tesco Bank to be the ‘bank for people who shop at Tesco’. Consequently, the likely impact on other areas of Tesco’s operations may be minimal in the long-run.

Stock Market Day-Traders

A day-trader is a stock trader who will buy and sell based on small price changes during each day. These traders primarily deal in FOREX markets, but the same analysis can be applied to markets like the LSE. Day traders will often make decisions based on trading signals that can come from identifying and anticipating continuing or changing trends from charts. This is known as a largely ‘chartist’ perspective. On the day the Tesco news story broke out, there was a notably volatile fluctuation in its share price.

The highest price the stock reached during the day was 205.55 (meaning £2.0555). The lowest price the stock reached was 195.80 (£1.9580). This is a significant price difference of 4.98%. In the previous 4 weeks, Tesco share prices on a weekly average had moved only 2.57% upwards (rounded up). While the average share price fluctuation for the previous 5 days were 2.62% 2.09% 1.24% 2.09% and 2.96% (Monday 31st October to Friday 4th November 2016). The most well-timed trader may have purchased at the day’s low and sold at the day’s high. If he or she had purchased 100,000 stocks at the low, and sold all of his or her shares at the day’s high, a profit of £9,750 would have been made (minus trading fees). This profit made in a single trade could have occurred within minutes, or even seconds.

It is also possible for a trader to ‘sell’ stocks at a high price, and subsequently ‘buy’ the stock back at a lower price. This is known as ‘shorting’ shares. Even if a trader purchased at the day’s opening price of 204.75, and sold at the day’s closing price (200.20), a profit of £4,550 would have been made from the 2.22% price change.

Therefore, ‘shorting’ allows traders to take advantage of negative news, profiting from the fall in the stock price. With traders shorting shares and therefore buying shares back at a lower price before the end of the day, the closing price may actually bounce closer towards the opening price, despite the negative news being released. So day-traders can take advantage of both positive and negative news, and influence its change in value.

Medium to Long-Term Stock Market Traders

For longer-term traders, bad news may lead to the sale of shares. It is dependent on their confidence in the company recovering from the situation. They may decide to sell, hold, or even buy more shares at the lower closing price (from those traders ‘shorting’ shares) in anticipation of a long-term increase in value.

Assessing the future prospects of a company requires a greater understanding of the general potential of a company to succeed financially. This can be achieved by examining previous news and company reports, for example. This is why medium-long term traders are more aligned with the ‘fundamentalist’ perspective, where there is more emphasis on the core features of a business. Greater qualitative information is collected, instead of acting purely on the basis of charting signals. For instance, not only whether a recently released product has increased revenue, but whether it is likely this product will continue to be successful when compared with other goods on the market.

To demonstrate the considerations made by medium-long term traders further, consider Tesco shares again. In late October 2016, 125 institutional funds made £100m worth of damage claims against Tesco for misleading and over-estimating profit statements. This could be seen as a warning sign, suggesting that the profits of the company are not as successful as they claim to be. So forecasts may also be over-estimated, giving a less successful outlook for the foreseeable future.

From a legal perspective, it is clear how advising a client on a business decision requires careful consideration about how the decision is represented. It requires a balance of interests. In the interest of the business, statements must be drafted in a positive light. This can help to reassure traders that the positive long-term value of the company continues. Yet statements must not be misconstrued to an unacceptable level, or your law firm may itself be at risk of a court case!

From a trader’s perspective, it is important to recognise that company reports are likely to be constructed in the most positive way acceptable. So initial reports may be presented with unsupportable reassurances. A trader must study the reports and distinguish the realities of the company’s situation to avoid undue influence, as in the case of media reports.

Analysis

To illustrate a distinction between facts and optimistic or pessimistic opinion, consider Tesco’s Interim Report 2016/17. The report, as expected, is drafted in a positive light, highlighting all the successes and future plans of the business. However, there is also reference to the market remaining ‘challenging and uncertain’. This, alongside the announcement of the business to sell off international assets operating in Turkey, may be suggestive of worry, and the need to rejuvenate Tesco’s core business based in the UK. As some report, this decision can be interpreted as a U-turn when compared with the diversification strategy announced only three years before. What impact does the sale of these assets have on the company’s overall balance sheet? Is Tesco exposed to a less optimistic profit report?

On 10 January 2017, it was reported that more than 1,000 jobs at Tesco were at risk after ‘planning to close two distribution centres “in order to run its business more simply.” Additionally, on 27 January 2017, Tesco announced plans to take over the wholesaler, Booker, as a means of returning Tesco’s focus to ‘good old market share’. These developments confirm the anticipation that Tesco needs to concentrate on and rejuvenate their core business in the UK.  

Alongside company-specific considerations, there are other wider economic considerations which should be taken into account. For instance, the impact that Brexit may have on the retail market and Tesco in particular; the exchange rate, and the Bank of England’s base rate.

How this Analysis can be Useful when Practising Law

As you can begin to see, there are numerous stakeholder interests, which should be taken into account when considering what impact a business news story can have on a company’s share price. Building up a case study on a company, identifying and analysing all relevant news, will enable you to consider and weigh up the significance of each story on particular stakeholders. The bank account story of Tesco was a particularly consumer-driven example, but there are many other stakeholders that could be discussed.

For instance, what impact could the misleading financial report have on the willingness of institutional lenders to Tesco? Suppliers, industry regulators and the press could also be affected stakeholders. Their reaction can have a positive or negative knock-on effect on short-term, and long-term traders - who could amplify or diminish the ultimate share price.

As you can see, greater commercial awareness can develop by analysing the impact business stories may have on your analyses as an investor. By considering a number of companies that take your interest, you will greatly broaden your general business understanding. In turn, you will be better suited to advising clients, considering all the possible consequences your advice may have. This can enable you to minimise possibly negative consequences and facilitate positive ones.

Where to Begin Observing the Stock Market

There are numerous platforms, many of which are freely available, providing news on the performance of stock markets generally, particular industries, commodity prices, as well as particular companies. You can begin to observe and anticipate stock market trends that are shaped by news stories. Looking back in hindsight, you can see whether your anticipations were correct. As you follow these stories in real-time, reading different investor perspectives, you will begin to improve your ability to read and anticipate the market.

ADVFN is a well-recommended website, that provides daily updates on the markets in the morning and after trading closes. You can also set up alerts for companies you take a particular interest in. Many newspapers contain useful business sections, including The Times and The Independent. There are also many useful investment magazines such as the Investors Chronicle, and daily trading news websites, including CityAM and Morningstar. Another useful tool that can be used to get up-to-date news on particular businesses, markets and even law firms, is Google Alerts. The tool will update you with any new publications made online with a particular keyword or phrase. These can even be emailed to you as soon as they are published.

Conclusion

A great level of commercial awareness can be developed by considering the possible impact news reports can have on stakeholders, the stock market and therefore the value of the company. This article has hopefully explained how the stock market works on a basic level, and how thinking like an investor can enable you to broaden your commercial awareness.

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Tagged: Banking & Finance, Commercial Awareness, Legal Business, Legal Careers, Trade

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