If the efficient market hypothesis (EMH) is to be believed, then the market instantly digests all available information and regurgitates it back in the price of a stock. Therefore, it follows that this said price should also be information that is then instantly incorporated into the price of other related stocks. However, I have found two stocks that seem to explicitly defy this EMH dogma.
The first is Harbinger Group Inc. (NYSE:HRG), which is a publicly-traded holding company controlled by the hedge fund of Phil Falcone, who rose to prominence with a prescient bet against sub-prime mortgages but has had his fair share of missteps lately, including a disastrous bet on floundering wireless company Lightsquared and perhaps more troubling, a Wells Notice from the SEC. It's worth noting that all of these troubles are strictly related to his hedge fund dealings, yet HRG's reputation and value apparently has been rather unfairly impacted by Mr. Falcone's fall from grace.
HRG is the majority owner of Spectrum Brands (NYSE:SPB), holding about 28m shares worth around $950m. Considering that HRG's entire market cap is only $720m, you can begin to see the disconnect between how the market is valuing each. Coupled with several smaller stakes in other companies such as North American Energy Partners (NYSE:NOA), net cash on the balance sheet, and an insurance business purchased for a price of $350m but more recently restated as having a fair value as $500m, why would "rational" players in an "efficient" market buy SPB when they could get it at a discount through HRG and acquire all these additional assets for free?
The second case is EMC Corporation (EMC), which the all knowing market doesn't seem to realize is also still the majority owner of cloud computing darling VMware (NYSE:VMW). EMC's 80% stake in VMW is worth about $38B, nearly 65% of EMC's entire market cap, even though it only contributes less than 20% of revenues and 30% of profits. Backing out this plus the $4.5B in net cash they have on the balance sheet, EMC trades at a P/E under 10, not bad for a company with an expected growth rate of about 15%.
Even discounting the fact that some of that growth will likely come from VMW, why would any sane investor buy VMW outright when they could get it at a discount by buying the more profitable EMC? The only reason would be simply because it has gone up more, which as Warren Buffett would tell you is the worst reason to buy a stock. Then again, he doesn't believe in EMH either, so what does he know?
Disclosure: I am long HRG, EMC.