An investment theory that states it is impossible to "beat the market" because stock market efficiency causes existing share prices to always incorporate and reflect all relevant information. According to the efficient market hypothesis (EMH), stocks always trade at their fair value on stock exchanges, making it impossible for investors to either purchase undervalued stocks or sell stocks for inflated prices. As such, it should be impossible to outperform the overall market through expert stock selection or market timing, and that the only way an investor can possibly obtain higher returns is by purchasing riskier investments. This implies that there is no further need for analysis involving a search for mispriced securities.
However, if all investors adopted this attitude, no equity analysis would be conducted, mispricing would go uncorrected, and markets would no longer be efficient. Markets may be inefficient under some circumstances:
1) relative to investors, managers have superior information on their firms' business strategies and operation; 2) Managers’ incentives are not perfectly aligned with all shareholders' interests; and 3) Accounting rules and auditing are imperfect.
When these conditions are met in reality, John could get profit by using trading strategies designed to exploit any systematic ways in which the publicly available data are ignored or discounted in the price-setting process.
Three types of potential errors in financial reporting include:
1) Error introduced by rigidity in accounting rules;
2) Random forecast errors; and
3) Systematic reporting choices made by corporate managers to achieve specific objectives.
Business Analysis Valuation (BAV) also help corporate managers in several ways:
1) Assess whether the firm is properly valued by the investors. If not properly valued, corporate managers can help investors to understand the firm’s business strategy, accounting policies, and expected future...
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