Sunday, 24 January 2010

A small chunk of Cadbury's

I'm not surprised to not find myself agreeing with Jeff Randall about Cadbury's, but I found the following para in his opinion piece interesting:
Valuing companies is a subjective business; it's what makes markets go up and down. But for those union leaders and investment managers who insist that 850p a share is a rock-bottom price, there are questions. As recently as last April, Cadbury's shares were 500p. So, why wasn't Unite's pension fund piling into the stock at that time? How many of the City's wise guys spotted all that value before Kraft turned up?
The key point I want to address is in the last sentence. The question effectively is why didn't fund managers (I assume that is who he means by City wise guys) realise Cadbury's was worth 850p earlier. There are several answers to thus. Firstly, of course, they may well have thought this. Excuse me stating the obvious but a key strategy in fund management is to try and spot companies that are trading below what the manager thinks they are worth and by their shares in order to make money when the market comes to that same valuation. You don't wait until the company hits the price you think it is worth and then buy it. So there may well be managers that bought into Cadbury when it was trading at 500p because they thought it would increase in value.

Secondly, in theory all kinds of factors could have affected how investors valued Cadbury last April compared to how they value it now. In fact presumably if you think that market prices tell us something useful, that it's signal rather than noise (which is presumably what Jeff Randall must believe to some extent to use changes in share prices to make a point), then that's exactly what we must believe. Otherwise why would the price move to such an extent?

Thirdly, in practice we obviously know that there has been a significant development that affects the valuation of Cadbury's - the Kraft bid. Some of those investors that valued Cadbury's at 500p previously and 850p now may believe that the deal will create value. Or they may simply be punting on the shares going up because of the bid. The point is that you can't isolate the current valuation and the bid. The current price wasn't there to be "spotted", as he puts it, because the deal and its implications weren't part of the story.

And finally, and most obviously, he seems to be ignoring the fact that the whole market has increased dramatically since last April (having hit bottom in March). You might as well ask why was everyone so negative about economic prospects last spring compared to now. And I suspect that if you go back to April last year the one thing you won't find are opinion pieces from Jeff Randall predicting a bull market, because that in turn would imply optimism about economic prospects.

PS. Any thoughts on what Jeff would say if union pension funds had piled into Cadbury in a big way last year and had made money out of it? I suspect he would have called them opportunists/hypocrites/capitalists or something similar.


Tim Worstall said...

"Thirdly, in practice we obviously know that there has been a significant development that affects the valuation of Cadbury's - the Kraft bid."


We have now rediscovered and proven the EMH. Markets process all available information as to what prices should be in that market. Changes in those prices come when there is new information available to be processed.

Well done that man!

Tom Powdrill said...

Hi Tim

To be honest I'm a bit ambivalent about the EMH rather than anti (I admit I have shifted ground on this since reading people who know a bit more about it).

But does the observation that markets react to information (which is basically all I have written above) actually 'prove' the EMH, even in its weak form?


Tim Worstall said...

Is consistent with rather than prove....but then rhetoric and hyperbole go so well together....

Tom Powdrill said...

I like the John Kay line that the EMH is illuminating rather than true.

Enjoy your blog a lot btw, despite not agreeing with you.