SpaceX, Mega-IPOs, and Efficient Markets

A reader writes, asking

“With Spacex’s recent IPO and other upcoming IPOs and the changes that the index fund providers are making, would it be more advantageous right now (until at least things calm down a bit) to mix my own choice of domestic/international funds versus going with a ‘pre-mixed’ blend fund like VT, target date, or something like AOA?”

It’s always the case that if you have a prediction that you think is better than the market’s collective prediction — and you turn out to be right — then doing something other than a boring market-weighted index fund would have given you better results. The challenge of course is somehow managing, on your own, to know better than the market’s collective knowledge.

My prior article, “Why Stock Prices Are Still Volatile in an Efficient Market,” is applicable here. Here’s the relevant part, edited for brevity:

The idea of an efficient stock market isn’t that the stock market can predict the future. Nobody knows what is ultimately going to happen with any given stock.

That is, the market price for a stock doesn’t mean that this is where the price will stay; it’s simply the consensus best estimate, given the information that is currently available.

By way of analogy, imagine that I’m hosting a raffle, in which the winner gets $100. I’m going to sell exactly 100 tickets to the raffle. How much is each ticket worth?

Each ticket is worth $1, because each ticket has a 1% chance of winning $100.

Of course, the reality is that, of the 100 tickets, 99 of them will turn out to be completely worthless, and one lucky ticket will turn out to be worth $100. But we don’t know in advance which ticket will be the lucky one, so until the raffle actually happens, each ticket is worth $1.

The point of the efficient market concept isn’t that an efficient market would successfully predict which raffle ticket will be the winning ticket. Rather, the point is that an efficient market would successfully price each ticket at $1 prior to the raffle.

With regard to SpaceX’s market price, it’s a similar concept. Everybody knows that the current price is not the ultimate “right” price. But the challenge is that there’s a pretty good chance the company will turn out to never be profitable and thus the shares will ultimately be worthless or nearly so. And then there’s also a small chance that it will someday be wildly profitable, possibly even the most profitable company in the world. So the current market price is the market’s attempt to probability-weight those two potential outcomes (as well as potential outcomes in between).

And of course nobody really knows the percentage probabilities of any of those outcomes, nor does anybody have a good way of calculating how profitable the company would be in the best scenarios. So there’s a lot of guesswork going on here. But:

1. “A lot of guesswork going on here” is something that is true for a lot of stocks, a lot of the time, and
2. It is, at least, the collective guesswork of the market, which is probably better than my own guesswork anyway.