---

Efficient Market Hypothesis and NEN WLL

09/15/2004

Change of the newsletter

As you already know, the Blast Investor Real-time Plus newsletter will change into commercial operation after September 17, 2004 so that this issue is the last free public issue.  After Friday, the newsletter will turn into closed non-public Yahoo group and will require new sign up. Please pay attention to our web site in this weekend for details of signup, fee schedule, free trial period, etc.

Efficient Market Hypothesis (EMH)

Efficient Market Hypothesis (EMH) is very popular in academic world and in Wall Street too. The core idea of EMH is that market (NASDAQ or New York Stock Exchange)  tend to, and do, achieve instantaneous efficiency. What EMH preaches is that whatever the market quotes the stock price is whatever the stock is worth.  Therefore, whoever (a value investor) claims that XYZ stock is under-valued is at odds with EMH. In EMH world,  the latest stock price already reflects all the information and it is already a fair value and whoever beats the market is pure out of luck, just like a billion people tossing coin, there will always be some winner out of billion who beat market and make money.  EMH believers even quote the poor performance of majority of mutual fund as proof for their theory.

Well, I am not one of those mutual fund managers. For BlastInvest,  EMH  is pure nonsense even though EMH is championed by substantial majority of financial academics. Here is my view:

• Some markets tend toward instantaneous efficiency, just as EMH professors are predicting.
  
• Some markets tend toward efficiency, but slowly.
• Some market are inherently inefficient.

Whether a stock is efficient or not depend on lots of factors, how liquid is the stock (small cap, low float or not), who the controlling insiders are and how well they are financed? Where is company is (foreign vs US ) ?  Arbitrage opportunity such as merger acquisition, etc. It is not an easy answer.

Blast Investor portfolio tend to take advantage of the market inefficiency by buying inefficient cheap stock and selling efficient expensive stock.  I will take NEN as example for this strategy.

NEN - a gem in real estate

NEN, New England Realty Associate used to have ticker NEWRZ years ago.  It is up a lot year-to-date. Since I first invested into it in my personal account less than 3 years ago at $28 a share, it is up 2.8 times or more than 44% per year plus 4% - 6% cash payout or close to 50% per year total return. When I first discovered it 3 years ago, it was trading at half of its real estate value and its true earning yield was nearly 20%( earning yield is past year earning divided by its stock price). It was so irrationally inefficiently cheap simply because the market did not like it for being a  low float small cap stock, or because it had unfavorable corporate structure of limited partnership, or because it was somewhat difficult to understand its business and accounting books.

The inefficient market price of NEN and NEWRZ gave me opportunity and made me huge profit over past 3 years.  As we know now, Real Estate market has been red hot, especially in Boston and New England area. The rise or potential rise of interest rate also provides a favorable business environment for NEN. The NEN insiders have purchased a lot of NEN shares over past 3 years. From insider point of view, NEN stock price offered better investment than  real-life apartments. Hypothetically, they could buy up all the outside shares and resale NEN at higher price with merger to a public REIT or to take NEN to private and liquidated it if they want cash.  Therefore, as long as NEN is trading significantly below true real estate price, insiders will continue to buy up all the shares and NEN stock price will continue to rise. That was exactly what happened over past 3 years.  The fact that current NEN price is at $77.70 compared to $28 three years ago,  proves how inefficient market was when NEWRZ (NEN former tick) was trading at $28 3 years ago.

From my point of view, making 50% yearly profit return on NEN over past 3 years is not by chance at all. It is perfect example to show how powerful the long term value investment theory is.

When NEN price goes higher and higher and gradually approaches its efficient market price, you all should expect more selling from me on this stock.

WLL - a gem in oil & gas industry.

Since put an alert on WLL for 2nd purchase, WLL has been up a lot. This is no surprising to me in that WLL was so under-priced just like NEN did 3 years ago. What I found the inefficiency in Real Estate stock NEN 3 years ago, I found this year in gas and oil stock on WLL.  Oil and natural gas stock is still in early stage of bull market and I expect more to come in CHK or WLL.

Best wishes  to all subscribers

The Blast Investor Model Portfolio has beaten market significantly year-to-date. According to EMH, this is pure chance. But I would say no. Although I can not guarantee my future performance to my subscribers,  I will continue to do my best to find out more gems like WLL or NEN for all of you. Let's make money together in the coming days ahead.

Blast Investor Model Portfolio Update

Model Portfolio - Performance