IFB08: Debunking Flawed Efficient Market Hypothesis Assumptions

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The efficient market hypothesis is one of the hottest debated topics in the investing world. In today’s session, we are going to discuss some of the many ways this theory is flawed. We will talk about many of the efficient market hypothesis assumptions and how they may or many not have gotten it wrong. Pricing is one of the main hot buttons in this theory and we will show why the efficient market hypothesis assumptions are incorrect.
 

* The efficient market hypothesis states the market can’t be beat
* All stock prices have all relevant information included in them
* Only way to beat the market is with passive investing
* Warren Buffet debunks this with his famous speech
* Value investing has beaten the market over the last thirty years
* The efficient market hypothesis is based on people being rational, which we all know we are not.
* The market can be beaten and there are lots of tools to help.
* If you don’t want to be an individual investor than index funds are the way to go.

 
Andrew: Well, two weeks ago we took out our weapons and fired them into the financial services industry and probably pissed off a few people.
Today we are going direct it against some other group. Probably make some people mad. Basically talking about the academic types in their ivory tower. There is a theory called the efficient market hypothesis, really based off a lot of the professors at the University of Chicago.
If you pursue an education in relation to investing or the stock market, economics you will get exposed to the efficient market hypothesis.
It is something that there has been a lot of studies on. Ph.D. thesis was done on it. It is also a very hotly debated theory among investors, particularly value investors.
You have the value investor side. Guys who have made billions like Warren Buffett, Seth Klarman, Peter Lynch, Joel Greenblatt, Monish Pabrai, and on, and on.
It’s kind of like them through their performance that has proved the efficient market hypothesis hasn’t held true for them. So, there’s that camp. And there’s the other camp that says the other investors should not try to beat the market because the markets are efficient.
So that’s something we kind of want to address and give our own takes on it to see.
Our audience is a lot of beginners and if there are academic studies saying we shouldn’t try to beat the market. Or is it something we should try to follow, or is it something we should look further into and see if there is a way to mitigate that.
That’s what I hope to do with this episode.
Dave: Why don’t you tell us a little bit about the efficient market hypothesis. Where it originated and who started it, and what your thoughts are on it.
Andrew: It’s been around for a while. Most recently is has been popularized by Jack Bogle and author Burton Malkiel, who wrote a Random Walk Down Wall Street. Where he brought his own inputs into it and gave some conclusions about why the markets are really efficient.
So the whole premise behind it is that there is this idea that every stock available in the stock market is fairly priced based on the information that is available currently.
There is all this financial data, these stocks trade on how they release earnings, what balance sheets look like. So, the whole premise of the efficient market hypothesis is that all this information is freely available. You’ve got millions, perhaps billions who are sifting through this.
Industry professionals, fund managers, individual investors like you and I are all dissecting this data as it comes out and investors react. For examples,