Intergalactic Software Company went public three months ago. You are a sophisticated investor who devotes time to fundamental analysis as a way of identifying mispriced stocks. Which of the following characteristics would you focus on in deciding whether to follow this stock?
• Market capitalization
• The average number of shares traded per day
• The bid-ask spread for the stock
• Whether the underwriter that brought the firm public is a top tier investment banking firm
• Whether the firm's audit company is a Big Four firm
• Whether there are analysts from major brokerage firms following the company
• Whether the stock is held mostly by retail or by institutional investors
Many of the characteristics mentioned in the question can be correlated with potential mispricing. The size of the market capitalization will influence the extent of interest of institutional interests. Below a certain threshold size level, it may not be economical for institutional investors to own the stock because it will be difficult for them to make a significant investment in it without owning a significant portion of the firm. The average number of trades per day and the bid-ask spread influence trading costs. The reputation of the underwriter, the quality of the firm's auditor, and the number of analysts following the stock all influence the information environment of the firm. The information environment, in turn, can influence the liquidity of the stock and the ease with which the stock can be traded. Finally, if mainly retail investors hold a stock, its potential for mispricing is greater than if it is held mostly by sophisticated institutional investors.
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