If the prices are wrong, you should be rich

I bought a Peloton exercise bike in the early days of the pandemic.

It’s convenient and the technology is pretty neat.¹

But I would never have bought shares in the company. I have a rule of thumb that anything new related to fitness is a fad. Over the years, we’ve seen far too many fad diets and fancy exercise equipment or videos.

John Foley, former CEO of Peloton, didn’t see it that way. As he watched the company’s market cap explode from $7 billion before the pandemic to nearly $50 billion a little more than a year later, Foley told his board that Peloton would be $1 trillion in 15 years.

They replied, “Stop saying that. It makes you look like an idiot.”

The board was right.

Peloton stock crashed once things got back to normal and all the demand was made being pulled forward.

The stock is 97% off its all-time highs.

Foley was once worth a billion dollars (on paper), but basically lost it all. The New York Post recently profiled Foley’s rise and fall. Even though he’s gone from the company, Foley is still optimistic about Peloton’s value:

But he has no interest in taking a company public again. “(Peloton shares) went from $170 to $2 … with that kind of delta, I don’t trust the public markets to get the prices right … (Peloton is) a $40 or $50 company, from my perspective today,” he said. (The current price is around $4.50) “The public markets contract to get an appraisal right is broken.”

Peloton is a stock under $5. Foley thinks it’s a “$40 or $50 company,” which is a huge discrepancy. He blames the public markets.

To be fair, Peloton was caught up in the speculative mania of the pandemic days, but this is ridiculous. If he really believes that Peloton is so undervalued, he should raise as much capital as possible to buy stock or take the company private.

Foley’s outrageous thoughts on market pricing dovetail nicely with Eugene Fama’s recent interview in the Financial Times.

Fama created the efficient market hypothesis.

No one believes markets are perfectly efficient, not even Fama:

Fama is surprisingly phlegmatic when it comes to defending his life’s work, echoing the famous British statistician George Box’s observation that all models are wrong, but some are useful. The efficient market hypothesis is just “a model,” Fama points out. “It has to be wrong to some extent.”

“The question is whether it is effective for your purpose. And for almost every investor I know, the answer to that is yes. They won’t be able to beat the market, so they might as well act like the prices are fair,” he argues, his chicken wrap now efficiently devoured. Some of the backlash against the efficient market hypothesis may simply be due to hang-ups around the word “efficient,” which Fama admits he can understand. “I couldn’t think of a better word. Basically, it means the prices are right.”

Markets are not completely efficient, but most investors should behave as they are. I agree with this sentiment.

This quote from Fama is the one John Foley needs to hear: “If the prices are obviously wrong, then you should be rich.”

Stock prices are rarely “right,” but they are right more often than most investors think. And if they were so clearly wrong all along, it wouldn’t be that hard to beat the market.

But it’s hard to beat the market!

Just look at the numbers:

Professional money managers find it almost impossible to beat the markets 10, 15 and 20 years out.

In the same interview, there was a quote from AQR’s Cliff Asness about how the markets actually became Less time efficient:

“I think (markets) are probably less efficient than we thought 25 years ago,” Clifford Asness, a hedge fund manager and former research assistant at Fama, admitted in an interview with the FT last year. “And they’ve probably become less effective over the course of my career.

This doesn’t seem to add up. If markets are becoming less efficient, why are they also becoming harder to beat?

Fortunately, Asness has just published a new paper in the Journal of Portfolio Management that lays out his thesis in more detail. It’s a long piece. I read everything (not to brag).

Here’s the main summary:

I think markets have become less efficient in the 34 years since my dissertation data ended. I think it probably happened for a number of reasons, but technology, 24/7 gamified trading on your phone, and especially social media are the biggest culprits.

I agree with this sentiment. The speed of market movements has made things more macro-inefficient, even though security prices are still relatively micro-efficient. So there is more volatility, but it is still very difficult to pick winners.

Asness says this will make it more profitable for investors who can stick with proven strategies for the long term, but it’s also harder to stick with those strategies in the short term.

Thinking and acting long-term remains the highest probability of success in the markets.

Unfortunately, it’s harder than ever to think long term.

Michael and I talked about efficient markets and more in this week’s Animal Spirits video:



Subscribe to The Compound so you don’t miss an episode.

Further reading:
Flash locks are getting faster

Now here’s what I’ve been reading lately:

Books:

¹I only use it now in the winter because then I can’t jog in the cold Michigan weather.