Share and Share Dislike

The takes industry works overtime during earnings season and between EA reporting sales for Battlefield V and Activision Blizzard announcing layoffs, there was no shortage of material. Earnings should not generate the kind of hyperventilation they do, since they are a standard measure intended to provide everyone access to the same information at the same time with an accompanying presentation from management to explain what is going on. These numbers should be fundamentally boring, but that does not stop everyone from firing off a 280 character analysis that can’t pass The Big Lebowski Test. This article is going to be about measurement, and if you have ever wondered why stocks go down when earnings are up, this article is for you.

What does a share price measure? The price at which a claim on a company’s future earnings my be bought or sold. What does it mean if a stock price suddenly falls to half its value? Not many people would guess that a stock split has occurred, even though this the most likely reason for a game publisher. What if a company’s market capitalization (share price multiplied by number of shares) falls by half? Then it might have split into two separate entities of equal value. These events illustrate how a share price can be uninformative in isolation. Today, Electronic Arts’ (EA) shares trade for $97.41, Take-Two’s (TTWO) trade for $88.32, and Activision Blizzard’s (ATVI) trade for $42.84. Which is the most valuable company? Activision Blizzard, because its market capitalization $32.69 Billion (EA is $29.18 Billion and Take-Two is $9.99 Billion). In order to answer the question of “Which game company is the most valuable?” we needed another piece of information: the number of shares outstanding.

A common comparison is the current share price against a previous price, since this indicates an increase or decrease in value. Changes in share price useful because they allow comparisons between two companies without worrying about the overall level. Activision Blizzard’s shares were up 1.66% from yesterday, while EA was up 1.70% and Take-Two was up 1.21%. What does this mean? Very little. Share prices are sometimes used as a proxy for investor sentiment, since the price will fall if more people want to sell than buy, and the price will rise if more people want to buy than sell. What is lost in this measure is that investor sentiment considers all their other alternatives including investments outside of the gaming. If Take-Two falls 20% on negative news, then it’s fair to say that investors have diminished expectations for that company’s future profits, but if EA and Activision Blizzard fell 40% on the same news, then it also means that investors are more confident in Take-Two than the other publishers.

Short term price movements rarely communicate meaningful information. It’s fun to pretend that EA waved a magic wand and created half a billion dollars today, but that isn’t what happened. Prices should reflect the underlying value in the long run, but there is no law that makes this so. There is more than a casual overlap between the “reviews should be objective” crowd and people who cite stock prices as evidence, and yet stock prices are one of the most subjective measures anyone can choose. If on Monday every Activision Blizzard shareholder was imbued with the unshakeable conviction that if they kept their shares a sperm whale would burst out of their chest like some terrifying Ridley Scott/Herman Melville crossover, the resulting stock price would not reflect the underlying value of the company. As a rhetorical technique, even if one were to grant the assumption that the price activity is caused by whatever someone is claiming (I’m sure politics in video games is among the top risks Goldman Sachs is factoring into their price models), it is tantamount to saying “and lots of people agree with me!” To see the wisdom of the market at play, consider EA’s share price over the last month:EAEA’s earnings were announced on Feburary 5th (at the end of the trading day). That analysis is not hard to write “EA underperformed expectations and the share price fell.” Two days later share prices are higher than the previous ‘optimistic’ values. An armchair analysis might be “Apex Legends was released the day before earnings.” If that’s the right explanation then it takes the market 4 days to assess that the unexpected success of a new battle royale title, after which it is unambiguously more than enough to make up for the lowered guidance.

EA cited competition from titles like Red Dead Redemption 2 (RDR2) as one of the reasons for its lower than expected earnings. Take-Two owns Rockstar, and so what happens to the share price of the company that has the top selling game when they announce earnings (Feburary 6th)?

ttwoIt goes down obviously.

There is a sensible reason for this behaviour. Just as drivers do not exclusively use the rear view mirror, investors are concerned with the future performance of their investments. RDR2’s success was well known and common knowledge by the time earnings were announced, and so was already factored into the share price. However, Take-Two did not raise its guidance as much as investors anticipated, and so the price fell, meaning that Take-Two had been previously overvalued.

Public companies report lots of useful numbers that can be analyzed. If you want to know how much a company sold, they tell you. If you want to know how well those sales translated into profits, they tell you. They tell you how many people are working there and how much the CEO is making (a lot. Always a lot). Even if you could isolate external factors and you wanted to ignore other measures of investor sentiment, the examples above invite a question as to how informative investor sentiment actually is.

Unless you’re thinking about investing in the company or concerned with its ability to raise money for its operations, you probably shouldn’t care too much about what the share price is doing. Share prices will not tell you if political correctness is destroying the games industry or if Fortnite will kill us all. Share price takes during earnings season are especially frustrating because the price movements are in response to the release of information that is actually relevant to the subject. It’s fine to ignore this information if you want, but it’s just your opinion man, not the shareholders.

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