By Wayne H. Wagner and Mark Edwards
A recent magazine article states in the subtitle that "Blue chips now cost more to trade on the Big Board than small caps do," noting this runs counter to the conventional wisdom that "large, actively traded stocks have lower transaction costs than smaller, less liquid ones."
The author provides a table that shows "microcap" stocks (less than $250 million capitalization) costing 0.5 cents per share on the NYSE, while "giant cap" stocks (capitalizations in excess of $25 billion) cost 1.9 cents per share.
The article attributes this phenomenon in part to pennying; "... NYSE specialists' and floor brokers' putative practice of bidding a stock up or down by 1 cent and trading for their own accounts ahead of investors."
That finding is false. And it is dangerous: It might lead to misidentification of the magnitude, source and relevance of transaction costs and thus contribute to inferior performance.
We will develop three important points:
-- Using pennies-per-share as the metric ignores the fact that small-cap stocks trade at lower prices than large-cap stocks. When expressed in economic terms as percentage of principal, this key finding is simply false: liquid, large-cap stocks trade at no higher impact cost than smaller stocks.
-- The actual costs of implementing investment ideas is in fact significantly higher than the figures quoted in the article. True implementation costs are egregious and much larger than can be seen through the narrow perspective of the volume-weighted average price, or VWAP, comparison.
-- The damning of specialists and floor brokers on the basis of this evidence is faulty logic based on faulty measurement.