The 5-Sigma Report

A couple of months ago, I wrote an article about how the fat tail distribution of the stock market can create huge, statistically improbable moves for stocks. In a follow-up article, I went on to talk about how we should view those moves as investors. Now I'm back at it again today, in an ongoing effort to bring to light the companies making these "5-sigma" moves.

Just to briefly rehash, a 5-sigma move is when a stock has a one-day price change that's five standard deviations or more from the stock's average one-day change. Because we're looking at the price change relative to the stock's historical volatility, it's more than just a look at the same ol' jittery stocks making the biggest absolute moves. So although Constellation Brands and StemCells had some big percentage changes last week, you're not going to see them here, because of their higher average volatility.

As I showed in my original articles on 5-sigma moves, working with these stocks isn't as easy as selling every stock that makes a big move up, or buying every one that does the opposite (or vice versa). It's crucial to understand the circumstances of the move, and to figure out whether it indicates fundamental weakness in the business or just short-term trading dynamics. In some of the historical cases I studied, some stocks continued on a major upward march, even after a huge one-day move. Similarly, some stocks continued to lose ground even after a huge one-day fall.

Here are a few of the 5-sigmas from the past week:

Making a takeover a bit tougher
Shanghai-based integrated circuit (IC) manufacturer Semiconductor Manufacturing International (SMIC), the world's third-largest IC foundry, skyrocketed on the first trading day of the year on rumors that private equity buyers were circling. For SMIC's stock, which has an average daily change of 1.5%, the 22% jump represented a massive 12-sigma move.

On the continuum of high-sigma moves, SMIC's is exactly the kind that shows no fundamental improvement at the company; it's based on little more than rumor. In other words, it's exactly the kind of move aching to reverse itself. This didn't take long to get noticed, though, and two days after the stock popped, investors reversed course to the tune of 8% -- nearly another five-sigma move in the opposite direction!

The quick turnaround was partially due to the company's refutal of an imminent transaction in a filing following the jump, and partially due to a downgrade of the stock to "reduce" by UBS. In a filing requested by the Hong Kong Stock Exchange, SMIC's directors said that though they are always looking at options, "there is no certainty than any opportunity will or will not result in any transaction by or involving the Company." Meanwhile, UBS analyst William Dong realized that SMIC, a mediocre firm with a significant slug of debt and an absence of free cash flow, is probably not a particularly good takeover candidate. If nothing else, a 22% increase in the stock price makes the company an even less attractive private equity target.

Patience is a virtue
In more speculation-fueled trading, drug developer AtheroGenics soared last Friday on hopes that the company would release data from its Aggressive Reduction of Inflammation Stops Events (ARISE) study. Some investors had apparently understood the company's guidance for results to be released in early 2007 to mean that those results would be released at the very beginning of the year. In a statement issued late Monday, the company reiterated that the results would be released in early 2007, but added that it would be no sooner than late in the first quarter.

AtheroGenics' ARISE study involves the company's novel drug AGI-1067, an oral drug to combat coronary artery disease (a.k.a. atherosclerosis) that the company is developing in collaboration with AstraZeneca (NYSE:AZN). AGI-1067 is currently in phase 3 trials, but as recent blow-ups at Telik (NASDAQ:TELK) and Nuvelo (NASDAQ:NUVO) have shown, phase 3 trials can get the kibosh sometimes, too. If AGI-1067 makes it through phase 3, though, the opportunity could be huge -- the drug would compete with Lipitor, the world's top-grossing drug, which puts roughly $10 billion in Pfizer's (NYSE:PFE) pockets annually.

Following the company's press release, the stock dropped 10% on Tuesday, but popped right back up 7% yesterday after the CEO made some encouraging, if dataless, comments on the drug. While I certainly won't speculate on the outcome of AtheroGenics' trials, I can almost guarantee that this quarter will be one heck of a roller-coaster ride for shareholders.

More related Foolishness:

• The 2 Faces of Retailing
• A Tale of Two Retailers
• A Contrarian Shopping List

Pfizer is a Motley Fool Inside Value pick. Discover more top-shelf stocks trading at bargain-basement prices with a free 30-day trial subscription.

Fool contributor Matt Koppenheffer encourages reader feedback and loves to hear about sweet statistical anomalies, Penn State football, and anything with jalapenos as an ingredient. He does not own shares of any of the companies mentioned. The Fool's disclosure policy is always statistically sound.