Quagmire No 2. - Corporate Actions

My advice on Quagmire No.1 (Consistent Accounting) was not to go there.

It would be nice if that was the case with Database Quagmire No.2 - Corporate Actions....

...But I am afraid this pothole is not one which you can avoid entirely...

... The best I can say is forewarned is forearmed...

....And the best advice that I can give is to avoid as many sinkholes in this particular quagmire as you can, and with this to guide you, hopefully you will.

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The fact is that 'Corporate Actions', 'stock splits', discounted rights issues, convertibles, stock dividends, etc. etc. are actually fiendish traps DESIGNED by corporate financiers EXPLICITLY to confuse and confound investors, and in the process muck up databases.

And muck them up they do. Not least because the corporate action adjustment factors are cumulative, eg. if a company had a 1 for 10 split every year we need to keep adjusting prior years earnings numbers etc.. Add in convertibles, warrants and goodness knows what you have a stinking rats nest to untangle.

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Tip-Toeing through the Tulips

So to counter this fiendishness we first of all need to keep our hand about us and REMEMBER FIRST PRINCIPLES.

For example:

We normally thing of PE as being :    Share Price/Earnings per Share

So when the Corporate Finance Goblins change the no. of shares by stock split/ discounted rights issue we could get into a real spin.

Unless we remember our 'O' Level (sorry 'GCSE' level in modern parlance) algebra, that is.

Because

EPS=Earnings per share= Total Earnings (however defined)/Total Shares

Similarly

Market Cap=Share Price x Total Shares

Therefore PE also equals

Market Cap/Total Earnings


Because      

Share Price x Total Shares =     Share Price
     Total Earnings                      Earnings/Total Shares


OK, your purist analyst will say, what about dilution for convertibles, do we use average or weighted average number of shares....yada...yada...yada...

IT WILL DEPEND ON WHAT YOU ARE TRYING TO GET OUT OF THE DATABASE WHETHER THIS IS RELEVANT OR NOT.

If, for example, you were trying to build a simple database for historic valuation [which I'll discuss in a separate blog posting] based on high/low/year-end figures for share prices, it might not be necessary to do individual corporate action adjustments at all, or if you do you might be able to get them from your data source (eg. Datastream or whoever) by the simple expedient of downloading BOTH adjusted and unadjusted data for your High/Lows and YE prices.

You could find that get what you want by just working off group net profit/earnings (or whatever), year-end number of shares and unadjusted year end share price. So no need for corporate action adjustments.

Or if you are working your data a different way, getting a whole database of corporate action adjustment factors might be as simple as multiplying/dividing your downloaded unadjusted/adjusted price data and VOILA - a whole corporate actions database done for you using just a small Excel workbook of three spreadsheets!!!!

(And think smart - there around 250 trading days in a year, so if you are working off daily data your database will hold data equal to

Total Data = No. of Companies   X  Years in the Database    X   250

But do you need this level of info. for what you are doing. Because there are only 12 months in a year, so then your database will hold data equal to:

Total Data = No. of  Companies  X Years in the Database   X   12

It can be quite quick to knock up that sort of database).

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Obviously 'Corporate Actions' is a much more technical subject than I can deal with in a one-page blog entry, but if an analyst comes into your room in response to a simple request for some data for a simple database, spouting about definitions of weighted average, fully-diluted, cashflow adjusted...nonsense...

1. Put Wax in your ears!
2. Remember these simple lists of do's and don'ts for handling corporate actions

DON'T         Be afraid of just chucking your old Database out and starting again. It's often easier.
                     Just make sure you keep the 'Data', or know where to get it next time.
DO               Keep all the 'Unadjusted', 'Original' Data that you can
DON'T         Do more than you have to initially. 'Mission Creep' kills these projects.
DO               Keep all the spreadsheets etc. with your workings. It can be a lot easier to 'tweak your data,
                     when you have it and want to get something different out of it.
DO               Remember FIRST PRINCIPLES of whatever it is you are trying to do.