Free information and the Efficient Market Hypothesis

In some capital markets, such as the United States, there is a vast amount of free factual information about stocks and bonds available on the Internet.

According to the Efficient Market Hypothesis, this flood of free information should result in an “efficient market” in which prices reflect the “intrinsic value” of securities.

However, the Crash of 2008 demonstrated that although much information was indeed “free”, the market was far from “efficient”.

The dominant aspect of the market in Q4 2008 was that no one seemed to know what securities were really worth — despite all this “free information”.

See: 2008 Never Again!

Free information has a cost, if not a price

In order to investigate the world of free information, I engaged in an experiment. I chose the stock NRO (Neuberger Berman Real Estate Income Fund, Inc.) to do some research based on “free information”.

Is Neuberger Berman's NRO a "reasonable investment"?

This stock is listed on the American Stock Exchange and has free commercial information posted on various sites:

The stock was thinly traded and usually had no analyst reports available.

On March 9, 2020, the stock was trading at $0.84 and had an indicated cash yield of 54.7%.

The stock had been issued in 2003 at $15. It was an closed-end fund investing in REITs and managed by Neuberger Berman, an investment management firm that had been involved in the Lehman Brothers bankruptcy.

The NRO research

Questions to be answered

The questions I wanted to answer about NRO were as follows:

  • Could the current yield be maintained?
  • Was the investment manager acting prudently?
  • What had caused the drastic loss of value? Had past errors been corrected?
  • Was the stock a reasonable investment?

I won’t say what my conclusions were, but the facts that I was able to find from free sources on the Internet are posted on Capital Market Wiki.

Most of the required information was found in SEC files, the company website, legal sites, and miscellaneous sites found through Google.

It took me about 75 hours to research the facts indicated above, between February 27 and March 6, 2020.

You can compare these facts with the base information that was immediately available on Yahoo and the other sources indicated and judge for yourself the value of this research.

Between March 9, 2020 and April 20, 2020, the price of NRO increased and the stock returned (including two cash dividends), about 96%.

The cost of the “free” information, for me, in this case, was about 75 hours of work.

The law of diminishing returns

I   stopped my research not because there was no more information available or that I had no more questions to answer.

In fact, since NRO is a closed-end fund, I would like to have had time to research in depth each of the 85 positions it held in portfolio. I would also have liked to have researched the various real estate market segments in which NRO held positions.

Free information is not free and there are diminishing returns

However, I estimate that it would have taken at least 7,500 hours to research all the relevant “free” information that was available.

In other words, it would have taken about three and a half years to mine the free information just on this relatively simple closed-end fund!

Obviously, with “free” information there is a law of diminishing returns — some point at which there is no practical economic advantage to continue to dig out facts.

There is also the problem of the timeliness. Spending over three years digging out information would mean missing out the chance to invest in a profitable opportunity.

Finally, there is the fact that I simply don’t have three and one-half years of time available to research just one company.

Other problems with free information

To conduct research properly, you must be ready to walk away from an opportunity when you run across a negative fact that makes the investment no longer desirable.

You may run across this “toxic fact” in your first hour of research — or only after several weeks of hard study. The longer you spend on your research, the more you have “invested” in the outcome, which might bias your decision to “walk away”.

Obviously, before starting a research project, you try to screen out cases that are not likely to pan out.

But this is easier said than done.

For example, in the case of NRO, above, it is a cliché that stocks with extremely high yields usually have a fatal flaw — so it might have seemed reasonable to eliminate NRO without doing any research at all.

Another problem is that you might go through a number of research projects, spending months, and still not come up with an investment opportunity.

Finally, and most importantly, you’ve got a life to live. Your family, your job, your children … you can’t forget everything and spend months locked up in a room doing securities research.

Free information is not free after all.

The cost of “free” information is different for everyone

It took me 75 hours to research NRO because I wasn’t an expert in REITs or closed-end funds.

Sure, I knew something about these instruments, but to be really certain I had to do some legal research, which took time. An expert in these areas could have skipped this step.

On the other hand, I do have years of experience in securities analysis.

Someone without this experience could have researched NRO, but would probably have taken longer to get the same result.

Technology can dramatically reduce the cost of “free” research

Fortunately, modern methods make it possible to get at this free research, getting competitive advantage in the investment market, while still living a normal life.

This technology includes crowd-sourcing, wikis, semantic databases, capital market taxonomy, and structured cooperative research.

I’ll go into this more in a future article.

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One comment on the article “Free information and the Efficient Market Hypothesis
  1. Very good analysis. Awaiting eagerly your next blog entry related to crowd-sourcing, wikis, semantic databases, capital market taxonomy, and structured cooperative research.
    Fascinating information on capital flows and I recently stumbled onto to your site. Will be spending time to slowly digest the details. Again, thank you for sharing.
    I know you talked about how bad the stock buys been to retail investors. Would be interested to know about the latest Goldman Sachs earnings and their desire to do more stock buybacks.
    Where you think this financial companies are headed in next couple of years.


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