A Free Market Solution To Persistent Stock Fraud.
By Manuel P. Asensio
April 9, 1997
Even the most ardent believers of the Efficient Market Theory will acknowledge the existence of pricing inefficiencies that can cause individual stocks to become momentarily over or under valued. We believe that these "inefficiencies" are found for the most part during times when events related either specifically to an individual stock,
industry group or broader economic developments require that market forces change a stock's valuation. This does not happen instantly or precisely but rather gradually and with volatility. This price inefficiency is a natural, necessary market phenomenon. In fact, we believe that this "inefficiency" creates the incentive that compensates investors for making the expenditures and assuming the added risk that go along with acting as the market's "invisible repricing hand". In other words, the market actions of investors
who correctly trade a stock based on a firm conviction that the market price is too low or too high will reap the greatest rewards as payment for performing the function that narrows any "inefficiency".
There are occasions other than those described above when a stock can trade for prolonged periods of time at valuations that are far in excess of any economically justifiable level. Some of these stocks are what we call "grossly overvalued". For a stock to be labeled "grossly overvalued" we must be unable to find any remotely possible outcome that can provide an investor with a "non-risk" adjusted return. In other words, even ignoring risk and assuming that the best possible outcome will occur the stock's present price does not allow investors to realize positive return. When we believe an investor's return is indisputably negative we label a stock "grossly overvalued".
Our work with grossly overvalued stocks has found two main causes of overvalued stock. First is a management that is willing to withhold negative information and create a promotion based on false or factually-deficient information. The second is an investment group that knowingly or unknowingly, assists or creates a network that buys a stock or causes stock to be bought based on fraudulent, inaccurate or incomplete information. These networks have privileges such as special access to management, early notice of promotional events and sharing of investor "cold-calling" leads and scripts. These situations are usually found in the micro and small-cap segments of the stock markets. That they exist is not the issue. More important is the question of how they manage to exist in our high tech, information-rich, highly efficient capital markets....
Asensio has a strong sell recommendation on AVNT |
