Is the Market Smoking Weed?

By September 23, 2018 Blog

            It only takes one counter example to disprove a mathematical theorem.  The same is true in finance.  This makes counter examples particularly useful for investors.  In previous posts, I discussed Bitcoin as a possible counter example to the efficient market hypothesis view that the market price always reflects fundamental valuation.  My argument was the Bitcoin had essentially no fundamental value and yet traded as high $20,000 per coin.  For stock investors, a more direct example is the recent behavior of Tilray, the Canadian marijuana company.  The problem is not that Tilray has no fundamental value – it clearly does.  The problem is that the market cannot seem to decide what that fundamental value is, even minute to minute.
            To illustrate the point, Exhibit 1 plots the minute by minute price of Tilray (in terms of Eastern time) during trading on September 19, 2018.  The close on September 18 is included as the first observation.  The points where the line plunges down and jumps back up are trading halts.  As the exhibit shows, there were five trading halts during the day.
            As shown, Tilray closed at 154.98 on September 18.  Within 10 minutes of trading on September 19, it had jumped more the 25% to about 215.  After that, it rose in a herky-jerky fashion up to nearly 300, almost double the previous day’s close.  At the high, the market capitalization was nearly $30 billion.  At about three Eastern time, the price started to drop, although the drop was interrupted by five trading halts.  Finally, the stock closed at 196.04, down over 30% from the day’s high, but still up almost 25% from the previous day’s close.  The volume for the day was 31.7 million shares – compared to shares outstanding of 76.5 million and a public float of 17.8 million.  While all this action was going on, there was no release of any fundamental information
            Of course, Tilray is an extreme example, but its existence suggests that significant mispricing is always lurking out there.  The stock could not have been fairly valued at $150 and $300 on the same day without the release of fundamental information.  The hard part is identifying and exploiting mispricing.  For example, in the case of Tilray was it too cheap at $150 or too expensive at $300?  Or maybe it was overpriced in both cases?  The only way to decide is with a fundamental valuation model.