What is the efficient market hypothesis, and what is its relationship to stock valuation?

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The Efficient Market Hypothesis (EMH) proposes that stock prices reflect all available, publicly-known information at any given time. This implies that stocks always trade at fair value and are not mispriced. The EMH states that active trading strategies, such as attempting to buy or sell undervalued or overvalued stocks in the hopes of profiting off the difference between the purchase price and future sale price, do not lead to superior returns. In other words, it is impossible for investors to consistently outperform the market by picking individual stocks.

Historically, proponents of EMH considered financial markets as efficient systems and argued that share prices responded quickly and accurately to new information about a company’s prospects and risks. According to this view, it is impossible for an investor to beat the market since all known information is already factored into the current share price—any attempt by an investor to exploit discrepancies between actual values and perceived ones would be futile. Thus, they argued that stock valuation should rely on an analysis of available information rather than speculation or guesswork.

In practice, however, research suggests that certain conditions must exist for efficient markets—namely perfect competition among traders with equal access to information—which may not always be present in reality. As such, some experts believe it’s possible for experienced investors with a deep understanding of particular sectors or industries can find opportunities for outperformance in markets deemed ‘inefficient’. Investors should also monitor macroeconomic factors when valuing securities since these can have a significant impact on their performance regardless of how well informed they are about individual companies