Black swan events are scenarios where a company encounters unpredictable experiences, such as a firm's executive getting busted for falsifying income reports, or a natural disaster obliterating a company's competition. When a black swan event occurs, investors realize their prior expectations were retroactively way off base, and a massive market correction typically ensues. Black swan events can either benefit or hinder a company.
The Black Swan Winners: Volkswagen
In one of the biggest short squeezes of all time, automaker Volkswagen became "the world's priciest firm" over the course of a single trading day. Just before this massive spike, Volkswagen was widely believed to be an independently-owned entity. The market held an overwhelmingly bearish outlook on its prospects, and the stock consequently fell victim to an unusually high number of short sellers. Then on October 28, 2008, car-maker Porsche suddenly announced it held a 74% ownership share in Volkswagen, which it had recently acquired through derivatives trading. Porsche abruptly took over Volkswagen's operations, and soon after, institutional and individual investors alike scrambled to liquidate their short positions. Consequently, some shares sold for over 1,000 euros, briefly making Volkswagen the largest company in the world, based on sheer market capitalization. At its highest point during the day, the company share price was up by more than 93%.
Investment funds such as Elliot Associates, Elliot International, The Liverpool Limited Partnership, Perry Partners, Perry Partners International, DE Shaw Valence International and York Capital Management Europe (UK) Advisors quickly moved to press charges against Porsche, claiming it intentionally hid its investment activities.
- Black Swan events can help or harm a company.
- Volkswagen was the biggest one-day winner, when Porsche suddenly announced it held a majority share of the company.
- Video maker Zynga fell $3.03 in after-hours trading, mainly due to its association with Facebook, whose share-price nosedived three months after its own IPO.
Volkswagen Stock increase
Gateway Industries was by all measures an insignificant website design firm. Trading for just a penny per share, its sole employee, CEO Jack Howard, wasn't viewed as particularly talented. Then on Feb. 11, 2011, a black swan event occurred when famed media entrepreneur Robert F.X. Sillerman announced he would be acquiring Gateway. Based solely on Sillerman's reputation, Gateway's stock immediately spiked over 20,000% to $2.97 per share. Sillerman then consolidated Gateway Industries with a handful of other firms, to create his startup firm, Viggle Inc.
And the Losers: Zynga
In Q2 of 2012, Zynga -- a tech company that develops online games, announced it had radically missed projected earnings, and subsequently fell more than 40% during after-hours trading that day. Several key factors led to this giant drop. First and foremost, Zynga works in a close partnership with Facebook, and both companies had their initial public offerings within the same year. Facebook's IPO was notoriously disastrous, with a $38 IPO price that dropped to a low of $17.55 just three months later. This reflected poorly on Zynga, whose own numbers were also disappointing.
Analysts predicted Zynga would produce an earnings per share (EPS) of six cents and revenues of $344.12 million, however the company reported an EPS of just one cent for the quarter and $332 million in revenue. Even more troubling was the company's revised full-year earnings forecast of four cents EPS, when Wall Street expected an EPS of 27.
As a result, Zynga stock fell $3.03 in after-hours trading. When a company misses earnings by as much as Zynga did, the market will rapidly correct itself and price in the new information. Once the toast of tech, Zynga found itself playing the survival game.
The Bottom Line
When stock market weaknesses are detected, the resulting short-term volatility is virtually unpredictable, thanks to new information being priced into the market. Black swan events are the most unpredictable of all new information. While we cannot know what form they will assume, we do know they will inevitably occur. Thus, properly diversifying and re-balancing a portfolio can help lower one's exposure to black swans and unsystematic risk.