Investing Blog Roundup: a Classic “Efficient Market” Example

Last week we saw a perfect real-world case of the classic hypothetical example of what an “efficient” stock market should look like. (For related reading, see: Why Stock Prices Are Still Volatile in an Efficient Market.)

The classic example is a company that’s currently involved in a court case with an uncertain outcome. If the company loses the court case, their business model will be substantially harmed. If the company wins the case, they’ll be able to continue along their currently very-profitable path. The market cannot know the outcome of the case in advance. So instead an efficient stock market would price the company’s stock in such a way that reflects that uncertainty. That is, the current price should be set between the lower share price that would be appropriate if the company lost the court case and the higher share price that would be appropriate if the company wins the case — with those two potential ultimate prices currently being weighted by what the market perceives as the probability of either outcome. And then, as soon as the court case is resolved in either direction, the share price should quickly move to either of those two other prices.

For the last couple of years, Alphabet/Google has been involved in a court case that could have potentially resulted in the company being forced to sell off its Chrome browser. Last week, the court decided not to force Google to make such a sale. The share price immediately popped upward by about 7%.

If you can predict the future, you can make a killing in the stock market. But it’s really darned hard to earn better than “total stock market” returns by acting on news that is already public. The market responds very quickly to important events. By the time you’re reading about it in an article from a major media outlet, it’s too late.