Investors all over the planet begin their day reviewing the financial news. In an age of information overload sorting through the often-breathless headlines can be a daunting task.
Yet serious investors know that news moves market prices up or down and ignoring the news can have undesirable consequences. News affects market sentiment that drives the prices of individual stocks or even entire sectors. In theory there should be some underlying reality to the news, but in practice the market perception of the news outweighs reality.
The field of engineering introduced the measurement of “signal to noise ratio” that has now entered the lexicon of stock market investing, courtesy of a paper by economist Fisher Black published in 1986.
The concept as adopted for share market investing warns investors that despite the catalytic effect on share prices, not all news contains useful information. In practice the distinction between what is useful and what is useless information depends more on the investing approach of those reading the news.
While investors of all stripes have the common goal of making a profit on their investment, there is a distinct difference in approach. Some purists maintain that only those buying stocks for long-term gains can be considered investors. Short termers are considered “active traders.”
The perception of the utility of a given news announcement is influenced by the investing approach. However, both approaches need to assess the news for its utility to their strategy. Long-term investors view news that has little discernible impact on the future earnings and cash flow growth of the company as “noise.” Active-traders view news through the prism of its catalytic impact. What is “noise” to the long termer is often “signal” to the active trader if the share price begins to rocket up, creating the opportunity for a momentum trade. The active trader jumps in on the way up and exits once market sentiment takes the time to evaluate the news, switching perception from signal to noise.
A worthy example is the tale of a “penny dreadful” producer of medicinal, health and beauty applications using its stem cells technology, Stem Cell United (SCU).
On 8 March of 2017 Aussie investors awoke to the news the company had added a recognised marijuana expert to its board of directors as a strategic advisor when pot stocks were all the rage, igniting a wild rush to invest in the stock.
Active traders who smelled the coffee here could have gotten in at multiple points on the way up and bailed out in the three-month slide at a profit. Long term investors would wait until something actually happened that would impact the company’s earnings.
This past week multiple ASX stocks have been in the news, with differing impact on their share price.
The best known among them would be gold-miner Northern Star Resources (NST).
ASX gold stocks are subject to the ups and downs of the price of gold but the latest news sending the price of NST lower was about missed expectations, which can be interpreted by some as signal but to others is noise. Northern Star climbed into the top tier of ASX gold miners through an aggressive acquisition strategy at a time when the world’s premier gold miners were looking to shed non-productive assets.
Flash forward to August of 2018 when Northern Star announced the acquisition of the Pogo Gold Mine in the US state of Alaska, the eighth largest gold mine in the US. Expectations were high but, in the company’s most recent quarterly update, Pogo disappointed investors, apparently ignoring management’s explanation for the results and an additional acquisition during the quarter of Echo Resources (EAR).
In its Full Year 2019 Financial Results, net profit declined due to investments in the Pogo operation, with the stock price rising slightly. In the quarterly update Northern Star management expressed the opinion Pogo is well on its way to being “the top asset in the company’s portfolio.” Investors willing to wait took the news as noise while others took it as a buy or sell signal, depending on investing strategy.
Regulatory risk for miners and other companies operating outside of Australia is always a concern. Oceana Gold (OGC) has been engaged in an ongoing battle with the government of the Philippines over the licensing of the company’s Dipidio gold mine there. Access to the mine has been blocked since July and on 16 October Oceana announced a downgrade in its full year production forecast for both copper and gold. Given the news will affect earnings, it is hard to interpret the event as noise. Although the news should not have come as a surprise, investors headed for the exits.
Tiny junior vanadium miner (market cap of $4 million) QEM Limited (QEM) made the news on 14 October, announcing a 62% increase in the size of the company’s flagship Julia Creek exploration project. The resource upgrade could vault the company into the league of major players, with QEM touting the Julia Creek vanadium resource as “one of the world’s largest resources of vanadium.” This news came as a buy signal to some investors, with the thinly traded stock price jumping.
Investors familiar with the work of Fisher Black know that in the strictest sense, news like this remains noise until something affecting earnings happens. Scores of Aussie investors were burned badly during the glory days of the mining boom in iron ore, investing in tiny junior miners announcing a discovery or a resource upgrade, only to see the potential wither away without the capital necessary to extract the ore from the ground, process it, and transport it to buyers. QEM is brand new to the ASX and although the news is preferable to poor drilling results, the company has $3.43 million cash on hand, as of the most recent quarter.
One news item of the week that casts real doubt on interpreting news that has yet to affect earnings is the accounting irregularities laid out against ASX market darling Wisetech Global (WTC) by US based research accounting firm J Capital.
Wisetech has gone into a trading halt, awaiting a response from management. In a fashion customary to share markets everywhere, investors chose to “shoot first and ask questions later,” giving credence to the report rather than awaiting management response.
J Capital recently targeted a Chinese biotech trading on the US NasdaqGS with similar claims, bordering on outright fraud. Company management of Beigne responded forcefully, calling the accusations “wild speculation.” J Capital has targeted other ASX firms with criticism appealing to short sellers, including Rural Funds Management, Cimic Construction, Treasury Wine Estates, and Corporate Travel Management, according to the Sydney Morning Herald.
The Beigne response righted the slide and although the share price has not fully recovered; the response did attract some investors who may have interpreted the news as noise opening a buying opportunity.
Investors who responded to the Wisetech news by holding their fire and asking questions first may have been troubled to learn the supposed “hit piece” on Wisetech was not the first time the company’s financials have come under scrutiny, according to an article in the Australian Financial Review.
No sector is more susceptible to wild price movements following a particular type of news than biotechnology. These companies operate under the extreme burden of having their products undergo a grueling series of clinical trials from regulatory agencies around the world prior to receiving approval to bring the treatment to market.
The “holy grail” of global markets for medical treatments is the US where the Food and Drug Administration (FDA) clinical trial process seals the fate of candidates. News headlines including words like “positive” or “successful” typically generate a shooting response before questions are asked.
There are two recent cases in point.
First, microcap Immutep Limited (IMM) announced the results of a Phase 1 FDA clinical trial, with the financial press applying headlines like this one from Yahoo Finance Australia and other outlets:
- Immutep Reports Positive Final Efficacy Data from TACTI-mel Trial in Melanoma
The stock price of this microcap company jumped on the news.
Obviously positive results are better than negative, but the key question to be asked is how long before the treatments begin to generate revenue and profit.
First, the US FDA tells us about 70% of drugs make it into Phase 2 trials with only 33% moving to Phase 3.
Second, many microcaps like Immutep do not have ready cash to bring a drug to market, assuming full approvals. As of the most recent quarter (MRQ) Immutep has total cash of $16.57 million with existing total debts of $7.64 million.
Mesoblast Limited (MSB) is another ASX biotechnology stock exploding following a news release on 17 October. Here is the title from the company’s press release:
- MESOBLAST AND LONZA ENTER INTO AGREEMENT FOR COMMERCIAL MANUFACTURE OF MESOBLAST’S POTENTIAL FIRST UNITED STATES ALLOGENEIC CELL THERAPY
Investors interpreting the news as signal, not noise, were buoyed by the confidence displayed by Swiss multinational chemicals and biotechnology company, Lonza Group.
Financial news headlines following the Mesoblast press release highlighted the manufacturing agreement between the two companies for commercial distribution in the US.
Investors in the “shoot first” mode bought while investors who believe in asking questions first dug deeper and learned the product in question is awaiting FDA filing as a Fast Track drug candidate and final FDA approval.