Does a company’s share price reflect its fair value? The answer, say advocates of the efficient-market hypothesis, is yes. In their view of investing, the price of any asset is essentially a reflection of all that is known about it, and the markets in which it trades.
Yet not all forms of information can be correctly or even adequately priced. Legal matters are a case in point. For example, once we learn a company has a contractual dispute, what value or risk do we attach to it? What about the reputational damage that could come from an executive’s criminal charge? Is it ever even possible to know what is happening in patent litigation? And how might we factor a long-running fraud investigation into our assumptions about a company’s future value?
Eventually, most long-term investors will encounter some type of litigious information asymmetry. Unfortunately, even companies find it hard to quantify the accompanying risk, as much as a chief executive might press his or her general counsel or law firm for a definitive, cold number. Even if you view legal risk as a necessary part of doing business – alongside currency swings, the occasional asset impairment and insurance – there may come a time when investing means making a mini-judgement of your own.
Then again, it is possible to profit from special situations where legal disputes are involved. For proof, one only need look at a share price chart for Burford Capital (BUR), one of the London Stock Exchange’s true success stories of recent years.
For those who haven’t been briefed, Burford is the largest provider of investment capital to lawyers and clients engaged in major litigation and arbitration. In particular, Burford offers funding for companies with a civil litigation case they might be unable to pursue for either financial reasons or due to time constraints, in return for a cut of the amount awarded by the courts in the event of a successful legal outcome. Some of Burford’s cases are enormous. Following the acquisition of Gerchen Keller Capital last year, the group has been bankrolling a £14bn claim against Mastercard on behalf of British payment cardholders. Its stake in the Petersen Group’s $3bn (£2.2bn) lawsuit against Argentina has already generated more than $100m in cash profits, following its disposal of 25 per cent of its entitlement in the case to date.