How many analysts does it take to write a good research report? The answer: It’s almost impossible.
- Mar 28, 2006
- admin
- Investing
You can almost set your watch to it.
Every few years a certain well known blue chip company announces bad news and its stock tanks.
In 2000, the company announced earnings that dissapointed Wall Street. Within weeks the stock had tanked as investors ran for the hills. But investors who bought the stock made profits in excess of 300% within 12 months.
In 2002, the company had a bad quarter and its stock tanked. Investors who stepped in and bought the stock when it dropped this time made 100% profits within months when it bounced back.
In 2004 it happened yet again. The company announced bad news and its stock tanked. And once again, like clockwork, investors who bought the stock were rewarded profits of almost 100% within months.
Yet when I brought up all of this in conversation with a group of bright, young analysts-in-training on Sunday they looked at me as if I had four heads.
“But markets are efficient,” they argued over and over again. One of them even said making money in the market is “impossible.”
Now folks, I’m not here to pick on young, bright Ivy league educated turks who plan to conquer Wall Street as soon as they get their M.B.A. in finance this summer.
But I couldn’t help but think to myself, “Are they still teaching this stuff to kinds?”
Of course they are. And fortunately for me and investors like me it’s not likely to change for some time.
For those who don’t know, Efficient Market Theory (EMH) states that it is impossible to beat the market because prices already incorporate and reflect all relevant information.
Supporters of this model believe it is pointless to search for undervalued stocks or try to predict trends in the market through fundamental analysis or technical analysis.
This theory is taught in some of the best business schools around the country each and every day. Make no mistake about it. Wall Street, the biggest patrons of these schools, likes these kids to come out ready to gather assets (more on that another time).
The stock I mentioned at the beginning of the article is a perfect case in point. This is one of America’s best known brands. It’s been in business for many, many years and has great financials.
But for some reason, whenever the company announces bad news and the stock tanks. What’s even more bizarre is that it rises dramatically within months after its shares tank.
How does EMT theory explain this?
How is it possible for the same group of analysts and investors to get so blinded by short-term events each and every time that they forget the long-term picture?
I learned the answer on Sunday.
Let’s say 100 money managers and analysts looking at this particular stock. And these people represent the vast majority of the shareholders.
Now let’s assume that of the 100 people, 90 of them went to the same school on investing. Each one of them believed that markets were perfectly efficient.
And believing such, they sold stock in this company every time bad news was announced because, “prices already incorporate and reflect all relevant information.”
But the remaining 10 people were schooled in a different way. They were schooled to look at markets as driven by human nature and thus, by definition, inefficient.
Furthermore, they had a healthy respect for both the facts of the situation as well as financial and economic history. This knowledge allowed them to see clearly through the “fog of investment war.”
Regardless of the side you find yourself on, perhaps the best piece of advice I can give you is decide what side of the debate you’re on before you make your first investment.
If you don’t, reality may be far different from what you expect.
–By Dylan Jovine