What is the efficient markets hypothesis?

The efficient markets theory assumes that all knowable information concerning a company is distributed, read, and understood by all investors at the same instant. Therefore, at any given point in time, the common share’s market price is an accurate reflection of the share’s true value. In other words, the stock market is perfectly efficient in adjusting a common share’s market price to equal the share’s true value.

Investment research by its very nature believes that markets are inefficient and thus, investors can make money by searching for market pricing inefficiencies. Investment analyists do not believe in the efficient markets theory.

Today’s accepted valuation methods are the analysts’ attempts to uncover the market’s mispricing of share values.

Author Eugene F. Fama, Random Walks in Stock Market Prices Financial Analysts Journal, September/October 1965 (reprinted January-February 1995) provides the definition for the efficient market:

“An ‘efficient’ market is defined as a market where there are large numbers of rational, profit-maximizers actively competing, with each trying to predict future market values of individual securities, and where important current information is almost freely available to all participants. In an efficient market, competition among the many intelligent participants leads to a situation where, at any point in time, actual prices of individual securities already reflect the effects of information based both on events that have already occurred and on events which, as of now, the market expects to take place in the future. In other words, in an efficient market at any point in time the actual price of a security will be a good estimate of its intrinsic value.”

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