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The Google Earnings Debacle: The Piranhas Attack

At Index Funds Advisors, Inc, we often talk about the Efficient Markets Hypothesis which states that current prices incorporate all publicly available information.

At Index Funds Advisors, Inc, we often talk about the Efficient Markets Hypothesis which states that current prices incorporate all publicly available information. When new information appears, traders act on it like a school of piranhas devouring a fresh piece of meat. Mark Hebner, IFA's founder and president, commissioned the painting below to drive home the concept.

Devouring The News

On October 18th, Google's stock price took a nosedive when its quarterly earnings were accidentally released prematurely by R.R. Donnelley & Sons. Normally, the earnings would have been released shortly after the market close, but in this case, they were accidentally posted to the Security and Exchange Commission's EDGAR Website about 3.5 hours before the close. The earnings were significantly lower than the analyst's expectations, so Google's stock price took a 9% hit, and trading had to be halted. The aspect of this story that I find so remarkable is the speed with which the market incorporated the earnings surprise that showed up when nobody was expecting it. As the chart below shows, it was over in a matter of a few minutes.

Google Stock Price on 10/18/2012

It amazes me that a piece of news that was initially known to only a few traders (those who were monitoring the EDGAR database) became fully incorporated into the price in such a short period of time. An hour later, when Google issued a press release blaming R.R. Donnelley for the mishap, a similar drop occurred with R.R. Donnelley's share price, as shown below.

 

R.R. Donnelley & Sons Stock Price on 10/18/2012

 

R.R. Donnelly accepted responsibility for the blunder and blamed it on human error, although no heads have rolled as of yet.

In both of these cases, the few traders who were first to the trade would have made a nice profit, partly at the expense of people who had buy orders sitting out there before the news hit. As soon as these lucky few acted on the opportunity, it vanished, perhaps with some help from the high-frequency trading programs that dominate the market today.  Retail investors (or the "home-gamers" as Jim Cramer would call them) who hope to score by acting on the news are playing a loser's game.

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