Are the Markets Efficient?

One of the criticisms we constantly hear of Graham and Dodd's "Security Analysis" is that it's too old and it no longer applies. Information is too readily available nowadays, critics say, and therefore inefficiencies no longer exist. We disagree. As examples, we've discussed some very recent inefficiencies that offered great profits for investors, here. We have also discussed the stories of some very successful value investors, and how their secrets to success.

Graham and Dodd also discussed inefficiencies not just at the individual stock level, but also at the market level in aggregate. At times, stocks were extremely fashionable, causing companies to continually issue shares to cash in on this phenomenon. At other times, depending on the economic climate, deserving companies were not able to raise a dime. We see a table below where Graham and Dodd demonstrated back in the 20s and 30s that these gyrations in stock issues from year to year exist.

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Below, we look at a modern-day cross-section of this data. The chart below is a listing of IPO issues and their aggregate dollar amounts since 1970. In an efficient market, we would expect these to be smooth from year to year, after all, why should people be willing to pay more one year but not the next? However, we clearly see that during bear markets (e.g. 1972-1974, early 1990s, and early 2000s etc.), companies don't issue; as they don't feel they're getting enough in return for the stake they're selling in their companies. On the other hand, during bull markets we see a great number of companies trying to sell their stock for perhaps more than it is worth, as a speculator and his money are soon parted.

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Comments

[Smarty_Pants]

The chart from the 1920s and 1930s shows the easy money bubble as it happened. Cheap credit inflated stocks until the wheels came off and deflationary forces set in.

As for public offerings, a privately held business would be most likely to go public at times when the demand was high. The businesses cash flow has worth. If you can't "sell" into the public market at a price much higher than that worth, why bother? ie. If your business is worth $10 Million and you can only generate $9 Million in a stock offering after fees, why sell? Flip side, if a public offering will raise $100 Million and still let you retain enough ownership for control then it would take a very strong will to avoid going public.

2008 Oct 03 10:53 AM

[mediapro]

Efficient Market Theory is much more than simply looking at the patterns of IPO and stock offerings.

If the author would dust off his Burton Malkiel (A Random Walk Down Wall Street), he would see all of the metrics that indicate why it's not a good idea to speculate on market bets (value or otherwise). Malkiel makes an indisputable historic observation about the valuelessness of green-eye-shade technical analysis, stock gurus, actively managed mutual fund investing, and the inevitable market bubbles created by the greatest fool who is last to enter those boom periods.

The market is efficient, and those who try to predict do so at their own peril.

2008 Oct 03 08:56 PM