Myth: Everything Is Priced Into The Stock

Daniel Solin wrote an article in October that has gotten a lot of attention, and you can read it here: “Investors: Researching Stocks Is A Total Waste Of Your Time.” While each peg is probably deserving of its own response, there is one thing in particular I want to discuss—Solin’s argument that “everything is priced into the stock.”

Solin writes: It’s not difficult to understand the reason for this underperformance. We live in a world where information is disseminated almost instantaneously. All the news that could possibly affect the price of publicly traded securities is already known to the millions of traders engaged in buying and selling stocks. And it is immediately incorporated into the price of stocks. The possibility of an individual uncovering something these traders have missed is infinitesimally small.

Even if you concluded, based on your research, that a stock is underpriced, there must be someone on the other side of the trade willing to sell that stock to you. That person or institution has reached the opposite conclusion. Why would you assume you are right and they are wrong?

Let’s work those arguments in reverse order. First, let’s talk about the person that is selling you a particular stock when you place a buy order. There are many reasons why someone may sell a stock. Oftentimes, people invest with a particular goal in mind—a house, a charitable fund, university donation, retirement funds to live off, an education to fund, and so on. Someone’s decision to sell a stock could merely be the arrival of a certain goal, the time to turn a dream into reality. After all, the point of investing isn’t to amass money aimlessly (though I agree there are people out there who get misguided and do become this way), but to turn accumulated capital into a particular purpose. Also, sometimes you just need the money. You lose your job, have an unexpected expense, or whatever, and you withdraw from your stock holdings to pay the bill. There’s all sorts of reasons investments get sold that have nothing to do with commentary on the investment itself.

Also, if someone is selling a stock deliberately for company specific reasons, it doesn’t mean that the investment is bad. What if someone sells Procter & Gamble to buy Visa, believing Visa will compound at 14% while Procter & Gamble will compound at 8%? It’s not that they think P&G is crap; they’ve merely found a better opportunity. If Procter & Gamble is the kind of company that is within your wheelhouse of skills to evaluate, and you are satisfied with a safe 8% long-term return, why would you be upset that someone is getting richer faster as long as you are still marching towards your goals?

I remember a few years ago when I was buying Johnson & Johnson in the $60s. It was literally at the time Warren Buffett was selling. Talk about a heck of a situation—being on the exact opposite side of a trade from my childhood investing hero while I was in the process of making Johnson & Johnson my largest personal investment. Since then, J&J has gone from $60 to over $100, and played a growing dividend along the way. Maybe Buffett used those proceeds to fund the Heinz purchase, and he’ll compound the money at a higher rate. Also, companies that Buffett has discarded through the years have gone along to do quite well—McDonald’s and Disney come to mind—so the fact that Buffett is selling something isn’t proof the company is going to hell. And if Warren Buffett selling a stock isn’t proof that it is bad, why the heck should I worry about Joe Smith hawking shares of Chevron to me at $110?

To address the first part of Solin’s—that information technology has reached a point where all stocks are appropriately priced—ignores the fact that we are all operating on different time horizons. It has reached the point where operating on Wall Street or running a mutual fund has become a twelve to twenty-four month game. Very few people are interested in 5-10 year time horizons anymore, because people read investment news every day and can’t stand the thought of underperforming for a year or more. BP and IBM have underperformed for the entire history of me owning the companies, and I don’t care one iota, because I know BP will experience significant capital appreciation when the lawsuit clears way and I can see IBM’s earnings per share growth rate increase before my very eyes. I care about where those shares will be in the 2020s, and as far as I’m concerned, lower prices in 2014 and 2015 only provide reinvestment opportunity to enhance my compounding rate.

Almost every analyst I’ve ever talked to has agreed with me that BP is a great 5+ year investment. What they don’t know is how the stock will do in the next year or two, as low oil prices and adverse court rulings could make the stock a bad performer from a price perspective in the short-term (though, with the dividend this high, it provides the opportunity to “snack on the hors d’eouvres as John Neff would say, or add to my “bear protector” and “total return accelerator” as Professor Siegel would say). Being able to truly make decisions for the long term—not merely pay lip service to the term, but to actually make decisions with ten-year measuring periods in mind—is the individual investor’s greatest advantage which is rarely discussed. It flies in the face of everything being priced into the stock the heavy traders are usually reacting to short-term movements in the pursuit of making a buck. If you have confidence in your business judgment and the ability to make decisions in 2014 with 2024 in mind, you can move beyond all this pseudo-intellectual flummery and build a badass collection of ownership interests instead.

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8 thoughts on “Myth: Everything Is Priced Into The Stock

  1. What a great, well articulated perspective on this Tim! I’m completely with you all the way here – of course we’re not trying to compete in thinking we have more knowledge about the business or a better grasp on what it will do in the next 12 months. What we are trying to do is take advantage of those with a much shorter term outlook. 

    Cheers,

    Jason

  2. says:

    Tim,

    How do you account for the dismal, historical failure of stock pickers, both amateur and professional.  Did this article have any impact on your views?  http://thereformedbroker.com/2014/11/28/the-worst-year-for-active-stockpickers-in-three-decades/

    Dan Solin

  3. says:

    dansolin Why do professionals mess up? They are forced to adopt a short-term time horizon. If you underperform for a few years, you’re gone. You get fired. A mutual fund manager gets about as much time to adjust to his craft as an NFL football coach. People want results now, and so the game becomes about guessing where prices will be in the next 12-24 months rather than actually making decisions with 10+ year time horizons. Check out the portfolio turnover rate among most mutual funds–you’ll see something in the 33% to 50% range. That implies a holding period of 2 to 3.3 years. 

    As for amateur investors? I think they sell at lows. Imagine someone who bought BP this summer for $48. I could easily see such a person getting spooked and selling at $39, or selling if the price fell to $30 or something. People say they can handle volatility, but cannot. Keep in mind that people who invest in index funds make the same mistake of selling low (see the Dalbar studies) because, frankly, not a lot of people can see $800,000 in paper wealth turn into $500,000 and sit through it doing nothing even if that is the wise course of action. 

    I think there is a huge discrepancy between how much volatility people think they can handle and how much they actually do handle, and I think long-term investing is often paid lip service and not actually practiced–people want steady 10% gains, year after year, but the stock market doesn’t work like that.

  4. says:

    The track record of professionals over the long term is significantly worse than over the short term.  There is little evidence that professional have stock picking expertise.  Some get lucky.  See:

    The track record of index based investors in capturing market returns is superior to those invested in actively managed funds.  See:

    The views of analysts about a stock over the short or long term have not been shown to have any more accuracy than the flip of a coin.

    The issue comes down to this:  Even if you think markets are inefficient, it is exceedingly difficult to identify and exploit those inefficiencies prospectively, especially after considering fees and costs.  It is basically a zero sum game.  Why play it?

  5. Jonnydee83 says:

    I like the security and consistency of owning super stable value companies. In 2008/2009 I was able to tell myself that if coke, Exxon and proctor gamble go belly up then the whole world economy is going too. That helped me avoid selling.
    That being said, I read Jason Zweig’s column in the wsj regularly and he makes a great case for indexing. I don’t think you can go wrong investing your money in broad market index funds. “There’s more than one way to skin a cat”

  6. scchan_2009 says:

    The fear of under-performance transcends regular investors. It is a huge problem for pension and mutual fund managers – giving rise to huge portfolio turnovers or closet indexing, so the manager can keep their job.

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