Republic Airways Rallies 14.4%
What a start to the trading week! Yesterday we saw stocks jump out of the gate, and while volume was light in many instances, most stocks finished the day with nice gains. The Russell 2000 small-cap index gained 2.2% to close at 642, the highest level we've seen since January 19th. The next level of resistance I'm targeting is 660 on the index, and judging by the gains we saw in overseas markets last night, I think the Russell will charge higher today.
Remember Republic Airways (NASDAQ: RJET), the beaten down airline stock we reviewed last week? Last Monday I featured this stock that one of our readers, Patricio, requested I take a closer look at. In that issue of Small Cap Investor DailyI wrote, "The bottom line here is that Republic Airways is cheap, really cheap. Its stock has fallen apart because of industry pressures and a tough economy. But if any positive developments occur, the stock could move higher. I think speculative investors who are comfortable using a bottom-feeder strategy and picking up shares in hopes of a dead cat bounce could profit from Republic Airways."
Well last Thursday Republic Airways announced that it booked a big one-time gain as a result of the bargain priced acquisition of Frontier Airlines. The company stated that revenue in the fourth quarter rose 88%, bringing full year revenue up to $1.64 billion, an increase of 10.8% over last year. The news sent the stock soaring, and by the closing bell on Friday shares rose 14.5%.
I hope some of you were able to pick up shares on my recommendation ahead of this move. If you did, let me know. My address is: editorial@smallcapinvestor.com.
Now, this development doesn't mean there are no longer any risks to holding shares of Republic Airways, there still are. But we were able to find this company at a low point and I believe shares will continue to move higher in the coming months.
***The movement in Republic Airway's stock reminded me of a subject I've wanted to discuss here in Small Cap Investor Daily for some time. And that is the efficiency of markets. I wrote about this subject in my book, The Small Cap Investor, and it is one of the phenomenons that makes small-cap investing particularly attractive.
The efficient market theory states that financial markets react efficiently to the release of information. The theory is preferred among academic market experts because it makes market reactions nice and tidy and easy to predict, even though in the real world far more chaos prevails. The efficient market theory states that all information available publicly is already factored into the price of stock. But what is wrong with this idea? In reality, chaos dominates the market.
Stock price movement tends to consist of many overreactions in the short term, so that a single day's price movement is going to be corrected the following day (or the following hour). Buyers overreact when the news is good, scooping up shares at inflated prices; sellers overreact on the other side, dumping bargain-priced shares to avoid further losses. At the top of the price trend, greed dominates; at the bottom, the predominant emotion is panic.
Among the hundreds of maxims about the market, the one that most accurately dispels the myth of the efficient market theory is this: "Bulls can make money, and bears can make money. But pigs and chickens get slaughtered." The constant struggle between buyers and sellers, with trades made in the middle of a vast array of information, news, and rumor, demonstrates that in the short-term the market really operates on the inefficient market theory.
Under this more realistic idea, the current price of a stock is the culmination of all known information, true and false, and the overall mood has exaggerated the latest price movement (too far up on good news and too far down on bad news).
The efficient market theory raises many questions, and properly so. Most people can spot a weakness in a theory right away because common sense tells them it cannot be so simple. The efficient approach is no exception.
Consider these questions:
- Do all investors access the Internet at the same moment?
- Does everyone refer to the same websites for information?
- Do all investors talk to their family, friends, and people in the investment community in absolute lockstep?
- Is it not more likely that two people buying or selling the same stock are naturally going to make those decisions based on differing reasons?
- Can anyone reasonably argue that, if you both decide to buy a particular small-cap stock, you came to that choice based on an identical path of reasoning and information?
Remember, the efficient market theory doesn't claim to be instantly accurate 24/7. Rather it says that investors have to allow sufficient time for the parity that the hypothesis embraces to level out.
That's reasonable, but some stocks that have tumbled take years to recover while others bounce back within a quarter, if not sooner. This means that in many cases, the markets are extremely inefficient in the short-term.
And these inefficiencies create buying opportunities for investors. I firmly believe that the advantage here is even greater for small-cap investors. Why? Because these stocks are followed less than their large-cap brethren, they move in bigger swings, and they are more sensitive to economic data. All these reasons give astute small-cap investors an advantage.
This is what we've seen with Republic Airways. And I see it every day with many small-cap stocks. In my Small Cap Investor PRO portfolio we seek to take advantage of these buying opportunities when they appear. We don't always nail it like we did here with Republic Airways, but we do have a solid track record of success.
