Everything I’ve read about the stock markets being efficient makes sense to me. Tons of people spend lots of time, money and energy trying to make money buying and selling stocks. This would naturally lead towards the belief that arbitrage (the chance to make money through a price discrepancy) is impossible, or would only be present for very small amounts.
Efficient market hypothesis
Some people take the perspective that you can rely on this to always buy and sell at a fair price. If a stock drops 25% the day after you bought it, there’s nothing you can do, as its new price is what it’s worth. Tomorrow it could go up or down. Same if the stock went up 25%, there’s no reason to “lock in your gains” as the stock doesn’t know that you own it and it’s pretty well impossible for you to know what will happen next (before the price reflects any news or possibilities).
Financial Jungle wrote a very insightful post called “Must All Trades Be Zero-Sum” where he argues that because investors have different circumstances, how could the market efficiently price all stocks for all of us?
As a simple example, Canadian dividends are given a very generous tax consideration for Canadian citizens. As I write this, the market feels that Bank of Montreal (stock ticker symbol BMO) is worth $21.03 / share. How can it be worth the same price to me, with a juicy tax credit credit, and to an American who is going to get taxed differently on it?
For that matter, how can it be worth the same price to someone in the lowest tax bracket in Canada vs. someone in the highest tax bracket (who would obviously place more value on the credit)?
Beyond this, institutions should have their own set of considerations for what to buy.
Different investment goals should affect the price, but obviously don’t. I’m a buy-and-hold, long-term, dividend-income investor. I’m going to value a stock for different reasons than a day trader would.
I’m certain there is a way to figure out what you value, then determine where the market undervalues this.
Great food for thought Financial Jungle, thanks for your post!