Implications Of Efficient Market Hypothesis

Challenges to Stock Analysis

Discuss about the Implications of Efficient Market Hypothesis.

It is crucial for an analyst or investor to select the shares for making an investment as various skills and knowledge is required by the analyst to investigate over the risk and return of the company. Usually, two methods are taken into consideration by the analyst to conduct this study which is technical and fundamental analysis. In technical analysis, share prices are analyzed and according to that and other factors, future movement is the share pricing is depicted whereas in fundamental analysis, financial performance of the company is evaluated and macro economic data is also investigated to analyze the future movements in share prices of the company. In technical analysis and fundamental analysis, various tools are used. However the most famous tools which have been used in this paper are moving average and line chart (technical) and PE Multiple and dividend discount model (fundamental). In this report paper, two portfolios have been prepared which includes 10 stocks each. Out of these portfolios, one portfolio has been prepared according to the technical analysis and other one has been prepared according to the fundamental analysis.

The stock analysis for making an investment starts by evaluating the company’s financial performance and position. Further, historical prices trends of the stock are analyzed to make a better decision about the investment in the stock. Thus, two methods are taken into consideration by the analyst to conduct this study which is technical and fundamental analysis (Schlichting, 2013). These methods are quite crucial to analyze the stock. However, it has been observed that various challenges are there which has been paused by efficient market theories and behavioral finance theories in which the analysis of stock and selection stocks is done. The efficient market hypothesis theory and behavioral finance theory provide an observation about the market (Schlichting, 2013). Even the stock selection by delivering out a complete analysis of fundamental aspects and technical aspects could not be avoided by the possibility of beating when behavioral finance influences persist.   

The theories of finance and fundamental concepts like Harry Markowitz’s modern portfolio theory and Sharpe’s capital asset pricing model have offered a strong basis to investigate over the selection of the stocks and performance of the stock (Elton, et al., 2009). The above fundamental theories are based on a belief that entire investors act realistically. Further, fundamental theories also assume that the stock market is efficient and always remain similar all the times due to the reason that the entire required information is accessible by all the participants in the market all the times (Elton, et al., 2009). Though, the behavioral finance theory opposes the observation that entire investors are sensible. Further, efficient market hypothesis theory depict that the view of capital markets are always efficient. It must be kept in brain that the models and techniques which has been used in fundamental analysis and technical analyzes are always based on an assumption that the investors are sensible and capital markets are resourceful (Schlichting, 2013).

Fundamental Theories vs Behavioral Finance Theory

Thus, the conflicts are always existed among the fundamental results and technical results and the behavioral finance results and efficient market theories results. The investors struggle to hit the market by investigating over the stocks which are methodically covering the fundamental and technical aspects, but the EMH states that it is not easy to beat the market (Ackert and Deaves, 2009). Additionally, the behavioral finance concepts states that investors could not always be sensible which depicts that the decisions made by them for buying and selling the stocks could not always be validated on the fundamental analysis and technical analysis. The choice of investors to buy and sale the shares are sometimes affected by behavioral power (Ackert and Deaves, 2009). Such as in the year of 2008 when the global financial crisis has taken place in USA and affected  the economy of USA as well as other countries like United Kingdom (UK), China and Australia.

The fundamental concepts depicts that the financial crisis of USA in 2008 must have affected the US only, but it left an impression over the entire world. The worldwide capital markets went into gloominess when the global financial crisis has been encountered in the US (Baker and Nofsinger, 2010). The main reason behind this gloominess in all the capital markets and economy was the behavioral influences. It has been observed that when the United States stocks had fell down, the other company’s investors such as the UK, Australia and China had also begun to lose their faith and they have started selling their hold stock. And thus the huge selling made the company weak and it directly made an impact over the share price of the company (Baker and Nofsinger, 2010).                              

The behavioral finance mainly affects over the understanding of capital markets, the EMH also offers sight of another side of the capital market. The behavioral finance principle states that investor could not be sensible and the EMH depicts that the capital market could not be unproductive (Kurth, 2013). The EMH theory is based on an idea that the securities prices incorporate entire required information, and thus, it become impossible for investors to take benefit of the information gap and with the help of it, make excessive gains. In other words, the EMH depicts that the investors could not find the securities undervalued or overvalued to make chances to earn more profits. though, the financial fundamental concepts has been established in the CAPM and Gordon’s growth rate model which provides an idea that the securities could be overvalued or undervalued in the market. Financial fundamental principles depicts that the securities which are trading in the market could not always be traded in their faire value (Kurth, 2013).

Rational and Methodology

The methodology includes entire framework which helps in selecting the data and analytical equipments to draw a conclusion from the selected information. It is crucial to adopt a suitable methodology for completing the research work in a very effective and efficient manner. In this report the capital market has been taken into consideration, in which the stock has been analyzed, and it has found out that whether the selected stocks would be able to beat the market or not (Phillips and Stawarski, 2016). The selected methodology for this report comprises stock selection’s two primary methods which are fundamental and technical methods. The fundamental analysis and technical analysis offers different concept which are based on diverse parameters of selecting the stocks (Palicka, 2011). Since, as both methods are based on diverse principles and concepts so, none no method is superior on other.    

In fact, it could be said that both the methods such as technical and fundamental could be known as each other’s complementary method. The fundamental analysis outcomes in stocks selection which are quite strong in context of financial performance at the same time the technical analysis focuses over the growth in the prices along with the financial performance of the company which offers them the best basis to choose a good stock (Palicka, 2011). For this report, it has been found that the stock of Keppel Corporation which is financial strong as the return of the company is quite strong (Yahoo finance, 2017). Further, according to the fundamental analysis it has been comprised that the stock named by Courts Asia Limited is quite strong as the return of the equity is 8.83% (Yahoo finance, 2017). Hence, the fundamental analysis over the selection of the stocks would be good in context of the financial performance. At the same time the stocks which have been selected according to the technical analysis would also offer a good return to the shareholders (Palicka, 2011).

It has been observed that it is a good choice for the analyst and investors to analyze the stock according to both the methods as due to it, the result would be sensible and it would help the investor to make a better investment. According to the current research, 2 portfolios have been prepared which includes 20 stocks which have been selected according to the fundamental and technical analysis.  

Fundamental portfolio has been prepared according to the two main tools of fundamental methods which are Dividend discount model and PE multiple methods. In this report, the stock which has been named by great Eastern limited has been taken into consideration for PE multiple model and dividend discount model.

The intrinsic value of Great Eastern limited has been applied over the PE multiple models according to the following details:  

The intrinsic value of the stock has been depicted in the above given table is SGD 3.29 which is quite higher than the share price of the stock and thus the share price of the company is undervalued.

Dividend discount model is a tool of fundamental analysis which has been taken into consideration to analyze the intrinsic value of the stock. The intrinsic value of Great Eastern limited has been calculated as below:

It has been observed through this model that the intrinsic value of the stock is SGD 3.34 which is depicting that the stock is overvalued as the current market price of the company is quite lower than the intrinsic value of the company.

Technical analysis is most common used model. Technical portfolio has been prepared according to the two main tools of technical methods which are line chart and moving average. In this report, the stock which has been named by Frasers Centre point limited has been taken into consideration for Line chart model and moving average model.

It has been observed through the above line chart that the trend line which has been shown in the chart depicting that various ups and downs have been faced by the company in context of fluctuations in the share price. Currently the share price of the company is growing up. Thus by relying over the current scenario, it could be said that the investment in this company would be worthy.

The moving average analysis has been done over the Frasers Centre point limited and it has been found that the average of the stock price is SGD 1.94. The moving average could be taken as a cut off level which depicts that the price of the stock is according to the level and thus there are quite more chances for the stock price to be enhanced. Thus by relying over the current scenario, it could be said that the investment in this company would be worthy.

Two activities have been performed in preparing the fundamental portfolio. Under the first activity, 500 shares of Jardine Cycle and Carriage Limited have been bought at the rate of S$41.34 per share on June 25, 2017. The decision to buy 500 shares of Jardine Cycle and Carriage Limited has been taken to manage the profits to sell those shares in the peak season. Further, under the second activity, 5000 shares of Wilmar international Limited has been purchased on August 5, 2017 at the rate of S$3.6201 (Appendix-2). The amount which has been received on selling the 300 shares of Jardine Cycle and Carriage Limited has been used in buying the shares of Wilmar international Limited. Looking at the fundamentals of Wilmar international Limited, it has been estimated that the stock would grow in near future therefore the decision to enhance the holdings more in the company has been made.  

Two activities have been performed in preparing the technical portfolio also. Under the first activity, 1000 shares of Frasers Centre point Limited had bought on August 5, 2017 at the rate of S$ 2.201 (Appendix-2). It has been observed that the stock price has been decreased; as a result, the decision of buying more shares have been taken as it would offer more profit to the company. Under the second activity, the funds which have been released from Frasers Centre point Limited has been deployed in buying the shares of Tiong Seng Holdings limited on August 20, 2017. The preliminary analysis of Frasers Centre point Limited showed probable in the stock; accordingly, it has been considered the finest option to organize the released amounts.  

Through the above analysis it has been found that both the portfolios would be offer more profits of the investors as the portfolios have been set after considering and analyzing every single aspect of the stock and various tools have been used for this report.  

Conclusion:

Thus through this report, it could be concluded that both the portfolios are quite impressive and would offer he profit to the investor as the portfolios have been set after considering and analyzing every single aspect of the stock and various tools have been used for this report.

References:

Ackert, L. and Deaves, R. 2009. Behavioral Finance: Psychology, Decision-Making, and Markets. Cengage Learning.

Baker, H.K. and Nofsinger, J.R. 2010. Behavioral Finance: Investors, Corporations, and Markets. John Wiley & Sons.

Elton, E.J., Gruber, M.J., Brown, S.J., and Goetzmann, W.N. 2009. Modern Portfolio Theory and Investment Analysis. John Wiley & Sons.

Kinsky, R. 2011. Charting Made Simple: A Beginner's Guide to Technical Analysis. John Wiley & Sons.

Krantz, M. 2016. Fundamental Analysis for Dummies. John Wiley & Sons.

Kurth, S. 2013. Critical Review about Implications of the Efficient Market Hypothesis. GRIN Verlag.

Madura, J. 2014. Financial Markets and Institutions. Cengage Learning.

Palicka, V.J. 2011. Fusion Analysis: Merging Fundamental and Technical Analysis for Risk-Adjusted Excess Returns. McGraw Hill Professional.

Phillips, P.P. and Stawarski, C.A. 2016. Data Collection: Planning for and Collecting All Types of Data. John Wiley & Sons.

Schlichting, T. 2013. Fundamental Analysis, Behavioral Finance and Technical Analysis on the Stock Market. GRIN Verlag.

Yahoo finance. 2017. Frasers centre point limited. [Online]. Available at: https://in.finance.yahoo.com/q/ks?s=C31.SI [Accessed on: 4 September 2017].

Yahoo finance. 2017. Jardine Cycle and carriage limited. [Online]. Available at: https://sg.finance.yahoo.com/quote/RE2.SI/key-statistics?p=RE2.SI [Accessed on: 04 Sept 2017].