Robinhoods in search of jackpot stocks
We discuss the role of retail investors investing in distressed stocks
We have done a series of posts on the returns of distress stocks. We have discussed the existence of a distress discount, and we have concluded that loading a portfolio with distress risk may not be an ideal strategy because this risk is not compensated with high returns.
We then hypothesized that there is a relation between distressed stocks and jackpot stocks, the latter being stocks that have a high probability of generating occasional returns of over 100%. Indeed, we found that distressed stocks are more likely to generate jackpot returns, even though their average expected return is low.
In this post, we investigate who invests in jackpot stocks.
The figure below is from Conrad, Kapadia and Xing (2014). It shows the average ownership by institutional investors for the stocks with median probability of default (DEATHP) versus the ownership in stocks with a high probability of default (Top DEATHP decile). While institutional ownership has been grown over time for both types of stocks, institutions tend to own much fewer distressed stocks than retail investors.
The next figure is also from the same authors. The logic is the same as in the previous figure, with the difference being that stocks are sorted in terms of jackpot probability rather than distress probability. This confirms the idea that retail investors are the main type of investor in jackpot stocks, which typically also happen to be distressed stocks.
The next figure is from the FT Alphaville. It shows the time series of the stock price (in pink) and of the number of investors (in green) in Hertz Corporation reported in Robinhood – the commission free trading app - during 2019 and 2020.
During the first few months of 2020 Hertz stock price began to suffer heavy losses. As this was happening, the number of holders of Hertz’ stock began to increase. This was driven by flocks of retail investors, that starting pouring capital into the stock.
After Hertz filed for bankruptcy on June 5, there was a huge inflow of new Robinhood investors, approximately a surge of 80.000 new investors. This coincided with a 521% return over five days!
What do we learn from this anecdote? Perhaps one of the reasons why distressed stocks have low average returns is that Robinhood investors push up prices of distressed stocks in search of jackpot returns.
References
Conrad, J., Kapadia, N. and Xing, Y., 2014. Death and jackpot: Why do individual investors hold overpriced stocks?. Journal of Financial Economics, 113(3), pp.455-475.
The zombie rally https://ftalphaville.ft.com/2020/06/09/1591692634000/The-zombie-rally/
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