Liquidity, Scrutiny, and Market Inefficiency

I am a big fan of Michael Burry, and just re-discovered one of his overlooked investing philosophies.  It can be summed up with these three statements:

1. I prefer to look at specific investments within the inefficient parts of the market.

2. The bulk of opportunities remain in undervalued, smaller, more illiquid situations that often represent average or slightly above-average businesses

3. It is likely, however, that the investors in the habit of overturning the most stones will find the most success.

Found here http://michaelburryblog.blogspot.com/2012/06/michael-burry-quotes.html

He makes a really good point about inefficient markets and liquidity.  The more a stock is scrutinized, the smaller chance there will be that the stock price is far away from the stock's intrinsic value.  If you have hedge funds, analysts, and everyone in between analyzing the profit potential of Apple, or Google, it is possible that you can make fantastic profits if you have good timing, but it is more likely that you will perform about even with the market.  That is not to say you can never profit in these stocks - Warren Buffett has done very well buying "brand name" stocks such as Coca Cola, American Express, and IBM.  But there is more incongruity - and therefore profit potential - in overlooked, small cap, illiquid stocks.  Of course there is more risk there, but if you do your research you can minimize your risk.

I am going to try to focus some attention on review of smaller stocks to see if I can improve portfolio performance.  Here is one example:  IGO, Inc. (IGOI) makes chargers for cell phones and laptops.  The company is unprofitable, and I would ordinarily not consider it a good investment.  I have followed it for about four years.  Recently, a company stated that it will issue a tender offer with Board approval for 44% of IGO shares at $3.95.  Before the announcement, the stock was at about $2.70, but it soon jumped to about $3.35.  Still 60 cents short of the tender price.  Why the difference?  First, I think that people are concerned that the tender will be oversubscribed, and investors will only get to cash in a portion of their shares.  But more importantly, I think that large-scale investors are scared that the stock is too illiquid (only market cap of $10 million).  No one is bothering to buy a lot because they are afraid they won't be able to get out.  I recently bought some at $3.45, and I am hoping that the stock will rise to at least $3.85 before the tender takes place (about 12% gain over a month).  If it does, I will sell the shares.  If it does not, I will tender.  This seems to be an example of a more illiquid stock with some profit potential.  We will see if it plays out that way or if I am mistaken.

Three-year review

I think enough time has lapsed for a portfolio review.

Neutral news:
Over the last three-and-a-half years, my stock picks have been about average with the market.

Good news:
Over the last year-and-a-half, I have outperformed the market.  I think a portion of that is luck, but it is encouraging.


Lessons:
The market is NOT efficient.  In 2009, believing the efficient market hypothesis I learned in college, I picked a variety of small-cap stocks with minimal research.  Those stocks did not perform as well as the market.  Starting in mid-2011, I became more careful with the stocks I invested in, and performance has increased. 

The real test will be the next market downturn.  It's relatively easy to perform well in a good market by simply buying stocks that are more volatile and getting lucky.  If you can make money in a good market and weather a downturn with minimal losses, that will show that there's a good chance you have some skill.

Conclusion:
Some room for optimism, but must get better.