An Efficient Millionaire in an Inefficient Market
How to become a millionaire? This is literally the million-dollar question that many have sought an answer for, but only a handful who actually is successful in the search. Stock exchanges around the world have made instant millionaires out of many Toms, Dicks and Harrys. We are now seeing Saravanans, Ah-Hocks and Rizals joining this club too.
However, with stock markets too, one can as easily turn from millionaire to a pauper. The more interesting question is whether one can avoid the risks that a potential millionaire encounters. To phrase it economically, "Are stock markets efficient?"
From the little that I gather, my guess is that stock markets are not efficient. And this means only one thing: Profits CAN be made without undertaking much risks. Like the experience of going to Chatuchak Market, you only need to spend a bit of time to research and sift out the bargains from the overpriced goods.
Rule: Under-researched companies are likely to represent better opportunities because their lack of coverage implies that the potential may not have been fully uncovered. Likewise, if a company with little news coverage faces problems, the market may also be slow to react and this in itself, represents another opportunity (e.g., by selling the stock).
Example: GrandBanks Yachts Ltd. This company's share price plunged 22.6% in a single day, apparently with no good reason. On the surface, the company has very strong cashflows and even if businesses may not be good, it does not warrant a reduction in market value by more than one-fifth. The problem, however, was that on 6th Sept 2007, it announced that earnings for the first half FY will be materially lower than both the first and second FY of prior year. As the diagram clearly shows, this FACT was not taken into account at all until almost 2 months after the announcement. Conclusion? Under-researched companies represent opportunities because inefficiencies exist.
And this is but one common source of inefficiency found in the markets today. So if anyone tries to convince you again that the stock market is efficient, you know what to say.
However, with stock markets too, one can as easily turn from millionaire to a pauper. The more interesting question is whether one can avoid the risks that a potential millionaire encounters. To phrase it economically, "Are stock markets efficient?"
From the little that I gather, my guess is that stock markets are not efficient. And this means only one thing: Profits CAN be made without undertaking much risks. Like the experience of going to Chatuchak Market, you only need to spend a bit of time to research and sift out the bargains from the overpriced goods.
Rule: Under-researched companies are likely to represent better opportunities because their lack of coverage implies that the potential may not have been fully uncovered. Likewise, if a company with little news coverage faces problems, the market may also be slow to react and this in itself, represents another opportunity (e.g., by selling the stock).
Example: GrandBanks Yachts Ltd. This company's share price plunged 22.6% in a single day, apparently with no good reason. On the surface, the company has very strong cashflows and even if businesses may not be good, it does not warrant a reduction in market value by more than one-fifth. The problem, however, was that on 6th Sept 2007, it announced that earnings for the first half FY will be materially lower than both the first and second FY of prior year. As the diagram clearly shows, this FACT was not taken into account at all until almost 2 months after the announcement. Conclusion? Under-researched companies represent opportunities because inefficiencies exist.
And this is but one common source of inefficiency found in the markets today. So if anyone tries to convince you again that the stock market is efficient, you know what to say.
posted by Jeremy at 10:34 AM
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