Question

Many professionals regard the equity markets to be a bit like Las Vegas. That is, it's possible to win big if you take high risks, but the odds are in favor of the casinos. In the case of the equity markets, it's possible to beat the stock index funds if you take the risks, but the odds are against it.

1) Explain the concept of efficient markets. Are the equity capital markets inefficient? 2) What is the role of accounting in an efficient market? 3) Is it worth investing the time and money to beat the market? Does it help to conduct financial statement analysis? Should you time the markets?

Answer 1

Efficient market hypothesis:

The security prices already reflect all the available information.

The efficient market hypothesis says that past price movement, earnings report and volume traded doesn't affect stocks Current price and can't be used to predict the stocks future directions.

In simple words, past performance doesn't guarantee the future performance of the stock price moment. The stock price follows Brownian motion. That is stock price moment is random that's why it's also called as random walk theory.

They are 3 levels of Market efficiency:
1. Strong efficiency: Insider information, fundamental analysis and technical analysis are unless in such a market.
2. Semi- Strong: fundamental analysis and technical analysis are unless in such a market.
3. Weak: technical analysis is unless in such a market.

Thus in an efficient market: the market value would represent the true value of an asset.

In practical life: it's very difficult to obtain strong efficiency markets.

Currently, markets are not 100% efficient ( strong efficiency markets).

Most of the markets currently lie between Weak and Semi- Strong.

We can only benefit from Insider Information in Semi- Strong efficiency markets.

The role of accounting is to bridge the gap between the management and the stakeholders (mainly investors). Accounting should reflect the true and fair view of the conduct of the business.
It helps in cribbing down the insider information. Hence bringing about market efficiency.

For most of the investors (retail investors), it is worth to take time in the fundamental analysis of the company and its better to invest in the general overall market (Index funds).

For professional and institutional investors, they should take time in equity research analysis and try to beat the market.