What Is Market Efficiency?

No one knows what intrinsic value really is. That is what makes a market. Myriad investors with different amounts of money, different levels of sophistication and different motives place their bets and the current market price is where that supply and demand meet.

I believe there is such a thing as intrinsic value. However, intrinsic value is in the eye of the beholder (different investors use different discount rates, different growth and profitability assumptions, different multiples) and is better looked at as something within a band or range of values (as compared to a singular point estimate). At a micro level that band is narrower for individual companies than it is for the market as a whole. As you add companies to the investment universe, the number of factors, level of uncertainty and multitude of different individual value ranges expands the general market's intrinsic value range.

So, for example, a company's intrinsic value may range between $18-$22 given all currently available information. This might translate to a multiple of 14x-16x based on an historic average multiple of 15x. This does not mean a company's stock will be priced within its intrinsic value range. Conversely, the general market's intrinsic value may range between $16-$24 based on cumulative individual valuations with a multiple ranging from 12x-18x based on a historic average multiple of 15x.

When the market price (and a company's price) is within its intrinsic value range you should go with the trend (momentum). When the market price goes outside its intrinsic value range that is when you should adopt a contrarian or mean reversion position.

80% of the time, the market trades within its intrinsic value range. But there are times when "animal spirits" (whether fear or greed) commandeer the zeitgeist and lead to exploitable inefficiencies (playing defense when things are overcooked and offense when things are falling apart).