Thursday, May 13, 2010

On Wikipedia and Markets

I was reading this book "The World Is Flat" and this small little story on Wikipedia caught my attention. Btw this is quite an old book and one can so obviously deduce I am so behind in my reading... I think the author has written like three updates and published at least a sequel. There wasn't much of truly good insights but lots of small interesting stories which makes it an entertaining read and perhaps that's why it's selling million copies.

Anyways the story on Wikipedia was that even though it was a free encyclopedia,  contrary to popular belief that Wikipedia has a lot of crap, things posted can actually be quite accurate. The rationale was that for every topic, there will always be those that are Pro and Against. So the Pros will write their story, but whatever is overboard gets deleted by the Against. This goes on until what is written on it presents the most valid view and nobody edits the page any further.

Of course this only works when there are many people editing the pages. At the end of the section, the author did state an example where a senator was accused of involved in killing JFK on Wikipedia, and since a lot of sites simply take what is on wiki, he was shocked to find newspapers calling him asking  whether he killed JFK. Similarly you can go and write a wiki page full of rubbish to spite your idol's rival and if not enough fans edit the pages, you achieve your aim.

Now the link here is that markets work in the same way too. Someone who thinks the stock is too cheap buys it, someone who thinks otherwise sells it. Until equilibrium is reached. Now this equilibrium is based on every market participants judgement on the stock at that point in time. So the current stock price should reflect the most efficient price to most of the participants at that time. This is the basis for the efficient market hypothesis.

Needless to say, if the stock is very thinly traded, ie not too many people have an opinion on it, the stock can be mispriced and stay mispriced for a long time. Value investors buy stocks that are  mispriced by being very cheap and wait for the market to find its true value. Or in the Singapore context, these stocks get taken out private at a cheap price. Of course, the way the human mind works, a lot of people actually don't mind overpaying for garbage, like companies with no earnings, LV bags and Mickey mouse apartments at $1000psf. So stocks can stay mispriced on the upside for a couple of years too.

Now you might be asking if the market is efficient, how does value investing fit in? If the stock is always at the right price, there is no gap between price and intrinsic value, how can value investors benefit then?

The answer is Patience. Most of the time, price trade very close to value. There won't be 50% upside. But there will always be times when things go out of whack. In the big way, it would be like 2007 financial turmoil, where great companies get whack down to very cheap levels even though nothing much has changed in their businesses. Think Coke or P&G, do people stop drinking and stop shampooing in a financial crisis? In the minor ways, some stocks trade down on temporary, one-off issues. Most market players then get emotional and judge the stock only in one direction (ie down) in the span of that few days or weeks.

E.g. bcos of bad weather, less people go out shopping, fashion clothing stocks get sold down. We all know that girls need to change their wardrobe every month, so when chances like these come by, just go buy Gap or Victoria's Secrets or Zara. (disclaimer: I have never researched these co.s, just arbitrary naming fashion stocks) Sooner or later, they go back up to their true value.

In a sense, this is how value investors can beat the market. But this is still easier said than done. Well at least now we know Wikipedia may be more accurate than your beloved local press reporting, so for those who thinks Wikipedia is unreliable, give it more credit!
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