Liquidity – Lower is Better

In our previous post, we talked about portfolio churn and how it can be a good indicator of the quality of an investor’s process and portfolio. Similarly, the liquidity or churn in the shares of an individual company can also be an indicator of a different type of quality.

Let’s understand this with an example. There is company A with a market capitalisation of 850 crores with free float of about 50%. And there is company B with a market capitalisation of 1700 crores and a free float of 40%. The per-share price of each company is roughly the same.

The average daily values of shares traded on the exchange for companies A and B are Rs. 20 crores and 0.5 crores respectively. If we were to convert this metric into number of days to trade the whole market cap, we could say that the entire market cap of company A is traded in 43 days and the entire market cap of company B is traded in 3400 days.

As a value investor looking for companies that are not only fundamentally good, but that also have the right entry price, you can use this metric as an indicator of the level of market hype or even just awareness about any particular scrip. All else being equal, it is better to look for long-term investment deals among the less traded securities.