I'm reading The Successful Investor Today by Larry Swedroe. In this book, it is argued that the market is efficient. This means that all relevent news is rapidly distributed and incorporated into the price of a stock. The usually-discussed alternative is an inefficient market. Most value investing books seem to work off of this principle. I don't have specific references handy, but I'll bet on Joel Greenblatt and anyone who uses the classic analogy of "'Mr. Market." I think this comes from Ben Graham. Mr. Market is moody, and on any given day is going to change his mind about what exactly a stock is worth. In the long run, though, Mr. Market gets it right.
The Successful Investor Today describes the market as efficient based essentially on the following argument: For every buyer, there is a seller. So if someone gains, then someone loses. This is not what is usually meant by an efficient market. In fact, this describes a zero-sum market.
I would argue instead that the market is semi-efficient. On any given day that there is relevent news, that news is indeed instantly distributed and the market price of a stock more or less reflects the impact of that news. However, the daily fluctuations, and gradual drifting away from that more-or-less accurate pricing represents the inefficiency of the market. I read somewhere recently (I think it was the Piotroski paper) that 1/6 of the total change in a stock price over the course of a year occurs over the four days when the company announces quarterly earnings. Look at what happened to PLAY when their one customer, Apple, announced that it would no longer buy their product. Look at what happened to NBIX when the FDA refused to approve indiplon. PLAY lost something like 60% of its value in one day; NBIX lost 40%. That is efficient. But, the drift of any one stock, or even the market as a whole, is noise. Read Fooled by Randomness - almost everything else is noise.
So that's my conclusion. The market instantly takes into account any important news. However, it slowly seems to forget whether the news was good or bad and drifts around the price to which it revalued the stock.
I'll add one additional comment: sometimes - on rare occassions - the market doesn't seem to fully take into account particular pieces of news. I've already discussed the LPMA acquisition by PAY, when the stock was trading around $25 even though the buyout had been announced at $29. Or the other day when ASPV dropped 12% because they had missed analyst expectations. But they affirmed their yearly guidance of 20-25% growth this year! Either the market doesn't believe the company, or it doesn't take this kind of growth into account in pricing ASPV. Either way, Mr. Market is a nutbar, and cheap stocks are out there to be bought.
PS - As of yesterday, my biotech portfolio was up 1.93%, but underperforming the biotech market. On the other hand, both my MFI and HG portfolios were up 13.1%, outperforming the general market by several percent. Sweet!
PPS - I've discussed CBST a bunch. My fingers are crossed for their earnings announcement tomorrow.
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