Code JDMBA: Gravity Trading Activity Today

Thursday, July 28, 2005

Gravity Trading Activity Today

Here is my impression of the Gravity news and resulting trading activity today: As a backdrop please note that GRVY:

  1. Has a relatively low float (number of shares available to trade) which increases volatility.
  2. Is not covered by many professional analysts or professional traders (I believe they are only covered by one analyst) which may imply a decreased efficiency of the market price equaling the “true value” of the shares.
  3. Relatively low institutional ownership.
  4. Has a high beta. Beta is the sensitivity of a stock's returns to the returns on some market index (e.g., S&P 500). For more on beta look here:

Stock price reaction to news about companies with a low float, little analyst or professional trader coverage, low institutional ownership and a high beta is often exaggerated. All of the factors listed above can increase volatility. On bad news such stocks will tend to take a short term drop more dramatic than fundamentally warranted. On good news they tend to rise in the short run more than they should. Supply/demand issues will exaggerate these gains or losses when there is a low supply (GRVY has a low float) or when trading volume is much higher than normal (such as today).

The GRVY news this morning was clearly bad:

GRVY’s previous revenue and earnings estimates “will be difficult to meet”. Please compare this to GRVY’s 1st quarter earnings announcement from May:

“We currently expect that several issues, however, including increasing competition in Korea, will continue to impact our results in the second quarter and for the full year 2005. As a result, we now expect our full-year 2005 revenue will be approximately US$75.1 million, with a pre-tax profit target of US$33.2 million”.

This news was very similar to the news today, the main difference being last time they gave the new target and this time they did not (increasing the uncertainty). If you look at the three month chart for GRVY you will see that the stock price dropped severely and quickly after the news in May, from over 9 to below 6. The losses were magnified because of the 4 factors I named above. I was not watching GRVY that day in May so I was not able to buy any shares when it was at its low. As you can see in May the stock recovered from $5.30 to well over $7 in a matter of days once people had time to realize fundamentally the sell off was too extreme and GRVY was undervalued. For a great fundamental analysis of GRVY I highly recommend reading this blog:

Today I was prepared to act on the news and purchased GRVY. When a stock is in a freefall it is dangerous to buy (like catching a falling knife). For that reason I watched the ticker tape and waited for a confirmed uptick before buying. Today’s low was $6.01. After an uptick, I put in a buy order and was lucky to get an execution at $6.05. I expected that GRVY would recover in the next few days like it did back in May, but I did not expect it to recover so fast!

The recovery to the $7.30 range happened pretty quickly. Perhaps people looked at the chart and saw the similar pattern from May on nearly identical news. What is more difficult to explain is the spike at the end of the day bringing the price up to $8.60. One of my co-workers offered the following explanation:
“Many people track the daily losers list for values, perhaps people saw the GRVY drop today, did some fundamental analysis and decided to buy”.

While I agree with CoolHeadInvester that GRVY is a great fundamental value, I dismiss my co-workers argument for the following reason. If people realized the fundamental value of GRVY today it would have led to a more gradually increasing price from the lows, not relatively flat trading near $7.30 for a few hours followed by a sudden spike to $8.60 in only the last few minutes of trading (look at the one day price chart of GRVY).

My explanation is this:
Many day traders may have tried to sell GRVY short today following the news. Due to the uptick rule (from the Securities Exchange Act of 1934, allowing short selling only if the price of the last sale was higher than the preceding sale, also known as an uptick) many short sales may not have gone through until $6.05 or so (where I purchased shares) since it was largely a freefall before that with little chance to take advantage of an uptick. These short selling day traders quickly lost over $1 per share as the stock rose to well above $7 later this morning.

There is significant risk in holding an overnight short position (you never know if there will be a buyout offer, or other major positive news to drive the stock up) so most day traders try to avoid it. By the end of the day therefore many of these traders had accepted they would lose $1 or more per share and decided to buy GRVY (to close out there short position) and cut there losses instead of holding overnight. A mad rush of buy orders then followed in the last few minutes of the day and this combined with the low float led to a massive run up to $8.60 or so.

I still feel GRVY is a good long term value. However today I made a large purchase to take advantage of the market inefficiency discussed above. I have profited handsomely. Unfortunately, GRVY now takes up a large percentage of my portfolio, so I will likely sell most of my shares in the next few days (but keep some shares to hold long term) purely for diversification and asset allocation reasons.

Disclosure: I am long GRVY


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