Catching up on my weekend reading in Barron’s, BusinessWeek, RealMoney, and hundreds of posts from my favorite bloggers, I was struck by the sheer consensus that today’s markets are not efficient. Whether they call it forced selling, capitulation, panic, broken markets, or something else, nobody is convinced that the current prices convey an accurate picture of economic prospects.
Efficient market hypothesis [EMH] posits that liquid markets will quickly price in all known information. The knock on EMH in this environment is that the prices are so different from six months or a year ago. Most companies will have a worse year in 2008 than 2007, but for the majority the performance difference will not be as great as the decline in stock prices.
But it's a leap of logic to assume that current prices are inefficient. Maybe last year’s peak was inefficient, and current markets are spot on. How many times have you heard pundits in recent days complaint that xxx is priced as if it is going out of business? Well, what if that is exactly what happens…what if the market is accurately foreshadowing a massive wave of corporate bankruptcies?
Gun to head, I don’t believe that will occur in the near term. In fact, I think we are likely to see a sharp rally beginning sometime in the next 10 trading days.
However, it is possible that the today’s dismal prices are telling us precisely what is around the corner.
If that’s the case, one stock that may be a big winner is Epiq Systems (NASDAQ:EPIQ). Epiq provides software and back office support to bankruptcy trustees. Business is booming. In August, Epiq announced record retention levels for large corporate bankruptcies. And that was before it got the Lehman bankruptcy business.
Analysts following EPIQ predict that it will earn $.60/share in 2008 and $.74/share in 2009. The $420 million company has over $40 million in net debt, so it is not cheap. However, if you believe that large bankruptcies are about to skyrocket, EPIQ could be a huge beneficiary.