Translation: Illiquidity Discount = Illiquidity Discount

The illiquidity discount (Illiquidity Discount) is the price difference or reduction that investors apply to an asset’s value when selling and trading it is slow or limited to a narrow segment. The disappearance of this discount (as when moving from parallel markets to primary markets) increases the asset’s market value and improves its liquidity. However, it should always be remembered that this discount reflects trading conditions and does not necessarily reflect weak financial or operational performance by the company.

Simplified definition: It is the “cost of reduced liquidity” deducted from an asset’s value to compensate the investor for the risk of capital being tied up. In other words, an asset that can be converted into cash immediately with the press of a button (such as shares listed on the primary market) is sold at its fair value, whereas an asset that requires time to exit in a market with limited liquidity (such as private companies or the parallel market) is sold at a lower price.

Calculation method: The effective price of an illiquid asset is calculated by multiplying its fair (original) price by the complement of the discount rate (1 minus the discount rate) required by the buyer.

Note: The discount rate is determined based on the nature of the market and the trading restrictions imposed (such as limiting trading to “qualified investors” with narrow daily volumes).

Example: Suppose there is a sports company (Company B) listed on a market with limited liquidity that earns the same profits as another company (Company A) listed on the primary market, with a fair valuation of SAR 100 per share. Because of the limited liquidity in Company B’s market, the buyer demands a 20% discount.

Result: The share will be sold for only SAR 80. The difference (SAR 20) is not a loss in the company’s operational performance; rather, it compensates the buyer and disappears as soon as the company is listed or moves to a liquid market (as happened with “Armah Sports” when it moved to the primary market, “Tadawul”). = Original price × (1 - discount rate)

What does this mean for you?

  • Reducing the cost of capital: Moving to primary markets eliminates the liquidity discount, increasing the company’s market value and making it easier for the company to raise capital or borrow on better terms.
  • Improving portfolio valuations: Investors who entered during the early stages (such as the Nomu market) benefit from the stock being revalued at its fair price without liquidity discounts immediately upon moving to Tadawul.
  • Trading appeal: Eliminating the discount gives institutions and investment funds greater flexibility to enter and exit the stock freely without causing sharp fluctuations in its price.

Frequently asked question: Does the illiquidity discount reflect a company’s poor financial condition?

Answer: No, not at all! The illiquidity discount reflects the nature of the market and the method of trading, not the company’s financial solvency. The experience of “Armah Sports” is a prime example: it achieved the same operational performance in the “Nomu” market, but its valuation was freed from the liquidity discount and reflected its true value as soon as it entered a broader trading environment for investors on “Tadawul.”