CFA Institute

What about the Anatomy of the Stock?Author(s): James F. ColeSource: Financial Analysts Journal, Vol. 33, No. 6 (Nov. - Dec., 1977), pp. 63-64Published by: CFA InstituteStable URL: http://www.jstor.org/stable/4478084 .

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by James F. Cole

What About the Anatomy

of the STOCK?

o. Most investment research material is devoted to the characteristics of the company, rather than to the characteristics of the company's common stock. Yet the investor needs to know about the stock: Who owns it? Who has owned it in the past? Who is likely to own it in the f uture?

Information about a company's stock-such as the float, the number of shares owned by manage- ment, the number of shares owned by institutions and the number of institutions holding shares-is publicly available. Some services even provide names of the institutional holders. Analysts would be doing their clients a favor if they took advantage of this information in preparing their research reports. o.

W E ALL know that when we buy shares of IBM we aren't buying machines and engi- neers, or a stake in the rental revenue.

We're buying pieces of paper. We're buying stock certificates that vary in price with changes in the market climate as well as with changes in the com- pany. The stock has an anatomy of its own.

Most investment research material is devoted to the characteristics of a company, rather than (except for perhaps a chart or two) to the characteristics of its stock. Yet it's important to know about the stock: Who owns it now? Who has owned it in the past? Who is likely to own it in the future? Everyone knows that IBM is (and has been for many years) the stock most widely held by institutions. As we move down the list to the lesser known securities, however,

we are less likely to encounter a research report about the company that contains essential informa- tion about the stock itself.

Many research reports now discuss the percentage of stock owned by insiders and derive the number of shares that "float." (Some float more buoyantly than others- and some float face down.) Value Line, Standard & Poor's and others give the number of shares owned by management and identify the signif- icant control blocks. Vickers Favorite Fifty reports for each company the number of shares held by in- stitutions (as defined), the number of institutions holding the shares and, more significantly, the num- ber of institutions owning shares as of three months ago, 12 months ago and five years ago. Thus you can trace the evolution of the institutional popularity of a company, or an entire industry, over a period of time, and appraise the likelihood of your being that unfortunate gentleman Zachary Zzylch, the last man in the phone book, the last man to hear the story.

Some services, like Wiesenberger and O'Neil, go further and give the actual names of the institutions that owned the stock at different points in time. If you think a particular institution is smart, you can use these services to follow its lead. If no institution owned the stock, but it seems to qualify for institu- tional ownership, you may want to be the first kid on your block to buy it, in the hope that the institutions will take it off your hands at a higher price-the old game that, back in the heyday of the mutual funds, we used to call "beat the funds."

If every institution in the country owns the stock (i.e., if it's "overowned") and it seems to be selling high in relation to its prospects, we now know, if we didn't before, that the stock is particularly vulner- able to a change in sentiment among the institutions. The stock will have to decline a lot in price before it is de-institutionalized, or disowned- in other words, before it is absorbed by the general public. We all know that the process of accumulation-of

James Cole, an Associate Editor of this magazine, is Vice President of Guardian Capital Group Ltd., Toronto, and heads its Pension Fund Management team.

FINANCIAL ANALYSTS JOURNAL / NOVEMBER-DECEMBER 1977 E 63

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the stock moving from many hands to few-usually enhances the relative price of the shares and that dis- tribution, the opposite process, reduces their relative price. The research report should tell that part of the story, when it is significant.

In their 1 0-K reports, individual companies show their number of shareholders at each recent year- end. In an increasingly institutionalized stock market, this information is not very helpful unless the trend of the company in question differs from that of others. Some companies give the number of shares held by certain classes of investors, but those numbers still don't tell what is happening over a pe- riod of time- and they lack romance.

A lot of information about the ownership of a company-past and present- is available, and I would like to see analysts incorporate this informa- tion in their research reports. (Sometimes I suspect they haven't even looked for it.) To illustrate, a re- port on XYZ Company might include a section like this:

Management of the XYZ Company owns 2.4 per cent of the stock, up from 1.2 per cent three years ago. Effective option plans give them a call on another three per cent.

- The Mr. X Foundation, endowed by the late founder of the company, holds 21 per cent, hav- ing sold five per cent in the past five years and having announced plans to dispose of the re- mainder by 1980.

- Institutional holdings of stock amounted to 27 per cent at the end of 1974, 30 per cent at the end of 1975 and 33 per cent at the end of 1976.

- The number of shareholders has diminished in the past five years from 11,300 to 8,100, many of whom are resident in California, where the company had its start.

- The share capital was reduced in 1974 when the company purchased, at his retirement, 209,000 shares at $48 from the estate of Mr. Y, the co- founder of the company.

- Last public offering of the shares, in July 1972, was 1,000,000 shares at $58.50, of which 600,000 shares were for the account of the com- pany.

- The company has a dividend reinvestment plan that buys about two per cent of the stock yearly.

Such information is probably best located below a chart showing historical market price, relative strength, volume and other factors applicable to the stock itself. a

Securities Law

and Regulation continued from page 62

ever, that an amendment to the 1933 Act, adopted by the Senate in 1934, would have exempted certain em- ployee benefit plans from registra- tion. Although the amendment was dropped in conference, an SEC Com- missioner stated in 1941 that the re- jection of the amendment required the SEC to interpret the 1933 Act as applying to employee benefit plans that involve the sale of securities as investment contracts. The same Com- missioner (Purcell) also stated that an employee pension plan is an "invest- ment company" within the meaning of Section 2 (a) (13) of the Investment Company Act of 1940, and is regu- lated by that act unless it falls within an exemption from registration. The

Court further relied on a more recent statement by former Chairman Manuel Cohen to the effect that it is a ''common understanding of a number of institutional investors that interest in a pension plan falls within the definition of a security in the 1933 Act."

Finally, the Court indicated that Congress recognized in 1970 that in- terests in an employee pension fund are securities by deciding to exempt from the registration requirements of Section 5 of the 1933 Act funds main- tained by a bank or an insurance company (Section 3(a)2). It noted that this exemption codified a long es- tablished administrative practice of the Commission. The 1934 Act, in Section 3(a) 1 2, provided a similar ex- emption.

The Court concluded that, if the Local 705 pension fund is maintained by a bank (and apparently a large por- tion of it is), the interest involved would be a security exempt from the registration requirement. "However,

exemption from registration reporting requirements does not mean exemp- tion from Section 17(a) of the 1933 Act, Section 10(b) of the 1934 Act and Rule 1 Ob-5 thereunder."

Disposition of Interest

The Court next turned to the ques- tion of whether the plaintiffs security (i.e., interest in the pension fund) was acquired in a "sale" as required by Section 17(a) of the 1933 Act and Section 10(b) of the 1934 Act. It de- termined that the crucial question was whether there had been a "disposi- tion" of an interest in a pension fund.

The Court rejected the argument, made by the defendants, that because the contribution to the pension fund was compulsory and non-contribu- tory, it was not a sale. The Court noted that (1) the definitions of "sale" do not require volition and (2) in any event, the members' process of voting on acceptance of the collective bar- gaining contracts containing the pen-

concluded on page 70

64 O FINANCIAL ANALYSTS JOURNAL / NOVEMBER-DECEMBER 1977

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