In some capital markets, such as the United States, there is a vast amount of free factual information about stocks and bonds available on the Internet.

According to the Efficient Market Hypothesis, this flood of free information should result in an “efficient market” in which prices reflect the “intrinsic value” of securities.

However, the Crash of 2008 demonstrated that although much information was indeed “free”, the market was far from “efficient”.

The dominant aspect of the market in Q4 2008 was that no one seemed to know what securities were really worth — despite all this “free information”.

See: 2008 Never Again!

Free information has a cost, if not a price

In order to investigate the world of free information, I engaged in an experiment. I chose the stock NRO (Neuberger Berman Real Estate Income Fund, Inc.) to do some research based on “free information”.

	Is Neuberger Berman's NRO a "reasonable investment"?

This stock is listed on the American Stock Exchange and has free commercial information posted on various sites:

• Yahoo Finance
• ETF Connect (Nuveen Investments)
• Closed end fund association (Lipper-Reuters)
• Bloomberg

The stock was thinly traded and usually had no analyst reports available.

On March 9, 2009, the stock was trading at $0.84 and had an indicated cash yield of 54.7%.

The stock had been issued in 2003 at $15. It was an closed-end fund investing in REITs and managed by Neuberger Berman, an investment management firm that had been involved in the Lehman Brothers bankruptcy.

	The NRO research

Questions to be answered

The questions I wanted to answer about NRO were as follows:

• Could the current yield be maintained?
• Was the investment manager acting prudently?
• What had caused the drastic loss of value? Had past errors been corrected?
• Was the stock a reasonable investment?

I won’t say what my conclusions were, but the facts that I was able to find from free sources on the Internet are posted on Capital Market Wiki.

Most of the required information was found in SEC files, the company website, legal sites, and miscellaneous sites found through Google.

It took me about 75 hours to research the facts indicated above, between February 27 and March 6, 2009.

You can compare these facts with the base information that was immediately available on Yahoo and the other sources indicated and judge for yourself the value of this research.

Between March 9, 2009 and April 20, 2009, the price of NRO increased and the stock returned (including two cash dividends), about 96%.

The cost of the “free” information, for me, in this case, was about 75 hours of work.

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The Efficient Market Hypothesis continues to impede understanding of how capital markets work.

The front-page article in the WSJ of June 12, 2006, announcing record levels of stock buybacks, continued to promote a common misperception that stock repurchases enhance equity prices by the following mechanism:

1. By reducing the number of shares outstanding through buybacks, earnings per share increase;

2. Investors, noting this increase in earnings per share, are willing to pay higher prices;

3. Therefore, buybacks. by increasing earnings per share, cause prices to rise.

This, of course, is in line with the Efficient Market Hypothesis, and depends upon the assumption that increasing earnings per share improves intrinsic value and that a crowd of rational, competing, profit-maximizers will therefore force prices upwards.

Ignoring the Evidence

The popular line of reasoning of the WSJ ignored Federal Reserve flow of funds accounts that showed that something far removed from the Efficient Market Hypothesis was driving the market in Q1 2006:

1. Corporations were spending vast sums (more than $146.7 billion) to take stocks off the market with the intent of directly manipulating prices upwards;
2. Individual, sophisticated investors, dealing in specific stocks, were not bidding up prices because of enhanced earnings-per-share, but rather were selling out on a grand scale ($216.6 billion) — cashing in their stock options;
3. Unsophisticated investors (according to surveys by the Investment Company Institute) were naively buying ’stocks for the long run’ through automatic payroll deductions channeled to tax-deferred mutual funds, with no perception, whatsoever, of changes in earnings-per-share of individual securities.

The WSJ interpretation of the record level of buybacks, supported by the Efficient Market Hypothesis, puts a spin on events that is far kinder to corporate executives, stock brokers, and option exercisers, than the unvarnished truth that prices were supported not by improved earnings per share and crowds of rational investors seeking ‘intrinsic value’, but rather by the brute force of $146.7 billion in corporate cash being applied to take stocks off the market from option holders, many of whom were the same executives ordering the buybacks.

Furthermore, what was going on in Q1 2006 was not some random event — mere noise in the market — but rather the continuation of a long-standing pattern of behavior involving corporations, option-holders, and mutual fund investors that has been going on for many, many years.

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The Federal Reserve national flow of funds accounts for Q4 2005 confirm a remarkable and disturbing new trend in corporate behavior that seriously undermines the intrinsic value of the U.S. stock market.

Over the last five quarters, the annual rate of dividends paid by U.S. non-financial corporations has fallen by two-thirds, from $462.2 billion to $160.5 billion.

(See flow of funds table F213.)

The apparent reason for this negative trend is the intent of corporate management to radically increase stock buybacks in order to boost the value of executive options.

The discounted cash flow basis for stock valuation, which has been accepted by serious analysts since the 1930s, defines the intrinsic value of equities as a function of the projected rate of growth of cash dividends.

Now we have a situation in which the rate of growth of dividends is negative, and this is not a fluke occurrence in a single quarter, but a real trend that seems likely to continue.

Furthermore, the reduction in dividends has not been to reinvest in the company in the immediate term, with the objective of increasing future dividends.

Rather, the purpose has been solely to divert corporate profits into the pockets of executive managers by manipulating prices upwards in spot markets to give value to stock options.

(See: Essays on Stock Buybacks.)

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