clarkkent, page-125

"Do you believe in EMH Clark?"

dbk,

We have both read the same books, and you know that the EMH argument can become circular.

Let's set the scene first. EMH does *not* imply that all stocks are correctly priced at all times (this is clearly not the case, go back 10 years and look at the then prevailing stock prices .. some stocks have succeeded spectacularly, some have plodded along - keeping pace with the market average - and others have died eg HIH, ION, Sons of Gwalia etc). Obviously, not all stocks were priced correctly. Similarly, 10 years from know, stock returns will vary wildly relative to each other.

What EMH *does* imply is that this mispricing cannot be harvested systematically, it is random. Studies like Fama/French would tend to suggest that if you buy stocks which display certain characteristics such as low PB or low PE you will outperform. I don't buy that. As I said earlier, the outperformance of those companies can be explained by higher risk, ie an investor would demand higher returns from CNP than BHP.

Therefore, what can be said of EMH is that the market can be temporarily inefficient (for many reason including at times irrational investor behaviour) but *becomes* efficient in the long-run.

Buffett believes that the market is inefficient enough to make trying to beat it worthwhile. I fall in that camp. This is why I don't simply invest in an index type fund. I make choices. This includes the positive choice for owning the 30-odd stocks which I own and the negative choice of the 1730 stocks which I choose to pass up.

Anyway, Philip Fisher (the man who Buffett acknowledges as his inspiration) wrote this 50 years ago in his classic 'Common Stocks and Uncommon Profits' :

"Efficient market theory grew out of the academic School of Random Walkers. These people found that it was difficult to identify technical trading strategies that worked well enough after transaction costs to provide an attractive profit relative to the risks taken. I dont disagree with that. Perahps the market is efficient in this narrow sense of the word"


He went on to say :


"I do not believe that that prices are efficient for the diligent long-term investor. Most of us are or should be investors, not traders. If the market was as efficient as it has become fashionable to believe, and if important opportunities to buy or significant reasons to sell were not constantly occuring, stock returns should not subsequently have the huge variations that they do. By variation, I am not referring to changes in prices for the market as a whole, but the dispersion of relative price changes of one stock against another. If the market is efficient in prospect, then the nexus of analysis that leads to this efficiency must be collectively poor"





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