The Daily Workshop Report
by Randy Befumo (TMF Templr)

WILLIAMSBURG, VA. (June 11, 1997)

How efficient or inefficient is the market? Whether or not you realize it, this is the question that anyone who follows a mechanical approach to buying and selling stocks has to answer. Whether you as an investor use the Dow Dividend Approach or one of the more experimental variations that live in the Workshop, this is a very important question to explore before you begin to deploy your hard-won savings into the world's greatest wealth creation engine, the stock market. For the next few days while regular Workshop writer Robert Sheard is off gallivanting about the countryside, I wanted to take the time to explore this issue both as it relates to the Dow Dividend Approach and to the Foolish Workshop.

What does the word "efficient" mean in relation to stock prices? A stock has been "efficiently" valued by investors if the current market price accounts for all of the public information that can be known about the security. Although one can quibble over whether stocks are priced based on the actual information or on the perception of what that information could mean, given the massive amounts of capital constantly churning in the market, the majority of stocks are priced efficiently relative to the expectations of investors based on what is "known," or at least what everyone believes. To think otherwise would be to postulate an "inefficient" market theory, where the reaction to relevant information about stocks is almost random -- hardly a situation that any rational investor would want to participate in.

Even if we assume stock prices are kept efficient for the most part by the billions of dollars of capital looking to squeeze out a few percentage points of excess returns, can we conceive of any systematic inefficiencies that might exist? Momentum investors like Gary Pilgrim of the PBHG fund group have maintained for years that one of the key inefficiencies that has existed are companies where analysts are inadvertently misleading the consensus opinion, resulting in mispriced securities due to earnings expectations that are lower than what earnings will actually be. Pilgrim also maintains that when earnings growth is high enough, investors tend to underestimate the ultimate compounding power of those earnings over longer periods of time. Although you can certainly disagree with his thesis, the fact that Pilgrim has focused on systematic market inefficiencies rather than simply "doing what works" has resulted in a robust investment approach that allows for evolution.

Each of the stock screens in the Foolish Workshop has an equal burden to not just work, but to work for a reason that can be clearly identified and articulated. Otherwise, they are simply quantitative screens that leave the most important element of buying a stock out of the equation -- the actual business that is being purchased. I believe that investors use simple, quantitative approaches to automatically invest their money take the same risk as someone who chooses to drive while looking out his rearview mirror. Given the mass of money that is constantly searching around for the best possible return, two or three step quantitative approaches are among the first that most analytically inclined institutions would adopt, quickly causing the prices of the stocks involved to become more efficient. What kinds of inefficiencies exist that individual investors can take advantage of? Are these inefficiencies so straightforward that a few simple screens will create the magic money machine? More on this tomorrow.

Monthly Growth Screens
(Jan. 3 to present)
27.63% Relative Strength
16.24% S&P 500 Index
15.14% Low Price/Sales
 -4.02% YPEG Potential
 -3.80% Investing for Growth
 -5.21% Unemotional Growth
-11.07% EPS Plus RS
-21.41% Formula 90

Annual Value Screens
(Jan. 1 to present)
17.00% Dogs of the Dow
17.49% Dow Jones Ind Avg
11.43% Beating the S&P
 9.42%  Unemotional Value
 9.42%  Beating the Dow
 9.09%  Dow Combo
 1.94%  Foolish Four