Efficient Market. What is a share really worth?

From www.investorhome.com:

"An issue that is the subject of intense debate among academics and financial professionals is the Efficient Market Hypothesis (EMH). The Efficient Market Hypothesis states that at any given time, security prices fully reflect all available information. The implications of the efficient market hypothesis are truly profound. Most individuals that buy and sell securities (stocks in particular), do so under the assumption that the securities they are buying are worth more than the price that they are paying, while securities that they are selling are worth less than the selling price. But if markets are efficient and current prices fully reflect all information, then buying and selling securities in an attempt to outperform the market will effectively be a game of chance rather than skill."



This got me thinking a little bit. Not a bad thing....

When we look at the current price of a share, who believes in the Efficient Market Hypothesis or at least some variation of it?

I guess some would say that, for example, if the current price of BHP is $20.00 then by and large that's probably it's 'true value' based on all the valuation estimates carried out by the various large institutions from the best available information and they would respond fairly quickly.

Alternatively, others would say that this price may exclude some 'human sentiments' such as fear and greed which may also have a big impact on current price. For example, the EMH price may be one thing but then add to that a bit of 'fear and greed' and we'll get the plus and minus variations around the EMH value over time.

So what is the 'true value' of a share? (yes......yes......it's what someone is willing to pay for it but I'm looking at this from a slightly different angle).

If we assume that human sentiment may distort the 'true value' regularly in the short term, would it be likely that maybe the long term average of the EMH value would actually give us a pretty good estimate of a share's true value? If so, over what period may be another good question.

Any thoughts?

 

Hey, I might be challenging Kenneth for most 'last' posts at one time - but I doubt it.
I reckon a lot of todays share prices is to do with speculation with what a share might return in the near future. I have some Biota shares and obviously a lot of focus is on them in the media at the moment. Yeah, lucky me although some were bought at a price double what it is now when they were muted as the next great thing re a flu/cold cure. It's easy to see the immediate correlation of 'oil' and 'gold' shares against the respective oil and gold prices as they are announced. It's all rather artificial I reckon. But when the recession hits, make sure you got brewery and/or gambling shares (probably funeral parlours too...). You know, the basics of life...(and death...) ...hope I'm not being too morbid.

 

The market is definitely inefficient. How can a share in a solid business be worth $10 one day and $11 the next with no change in the underlying business. Not quite as inefficient as the property market but definitely inefficient. And therein lies the opportunity

It's all about perception.

 

" When we look at the current price of a share, who believes in the Efficient Market Hypothesis or at least some variation of it? "

Alan,
Maybe Enron saga can give some answers...

As you know ENRON collapsed some time ago...
Its auditor Arthur Anderson had approved the use of accounting tricks that resulted in financial statements that were misleading and incomplete and possibly fraudulent.
Enron started out in 1985 as a natural gas pipline company, but tried to transform itself into a global trading company. It borrowed heavily to finance an aggressive expansion, but didn't want a big depth to reduce its credit rating or depress the share value.So instead of listing debt on the balance sheet, Enron formed hundreds of off-the-books partnerships.
Enron's chief financial officer ran some of the partnerships , with obvious conflict of interest, but this was approved by Enron board.
The partnership called " Special Purpose Entities " ( in accounting jargon ), allowed the company to take in capital from outside investors or lenders, ( pension funds, insurance company ) to finance its many ventures.
Accounting rules allowed Enron to keep a partnership off its books as long as the equity od SPE couldn't borrow more than 97 % of its capital and Enron as the sponsoring company did not contribute any of that equity. Because of strong business lobbying, The Financial Accounting Standards Board was unable to reach a consensus on a new standard.
So - the SPEs let Enron manipulate its account by increase earnings and hidding losses, especially on overseas acquisitions and investments in tech. companies. The SPEs also helped Enron keep investors in the dark on total debt level, artificially improve its credit rating, and pay well several top managers who participated in the partnerships.
When the ' partnerships ' asset values fell, ( or they were unable to make a loan payment ), Enron had to fork its own shares.
Enron's " empire " collapsed with the stock market's decline. For 2001 ( 3 quater ) Enron had to report a $ 618 million loss because of the partnership losses. Few weeks later Enron restated net income back to 1997 by cutting ( trimming ) it by $ 586 million and later on, it announced that it had to repay $ 690 million in partnership debt.
All this caused Enron stock to plummete from a high of $ 90 in the fall of 2000 to under $ 1 in Dec. 2001.
The company filed for bankruptcy on Dec. 2.

Before this happened Enron shareholders thought they were $ 1 billion richer than they really were. Arthur Andersen forced Enron to comply with SEC rules that prohibit a company from counting as equity in its balance sheet, any issues of stock that have not been paid for ( one example involves Enron's issuance of $ 1 billion of its own stock to the Raptor SPEs in returne Enron accepted IOUs worth $ 1 billion - but never received any cash for them ).
Enron's finances ( especially its many off-balance sheet partnerships ) were incomprehesible even to the smartes anaysts on Wall Street, who recomended Enron's stock because it delivered results : revenues in 2000 came to $ 101 billion and it's stock market value topped $ 75 billion.

The biggest blow resulted from Enron's use of accounting tricks, which auditors at Artur Andersen and the board of directors should have known about and stopped. At that time the board of directors appear not to have asked the right questions and accepted Enron's financial statement without really understand it.
One of the Enron's biggest sharholders was Californian Pension Fund ( CalPERS ) whose $ 146 billion in assets - now includes 3.5 million nearly worthless Enron shares.
Special investigative of the Enron board said that the entire board, despite its financial sophistication, had failed in its oversight duties.

The above brief story makes you wonder how sophisticated the board of directors of many big companies in Australia might be, and what is the real value of the stock they represent.

 

Hi Sim.

You expressed it much better than I..........but that is exactly where I was coming from.

Personally I think sentiment plays a large part in the short term. Just look at all the talk and articles in the recent week about 'Margin Calls'.

But over an 'extended period'(whatever that may be), the institutional analysis combined with the plus and minus of sentiment cancelling each other out, may well give a fairly acceptable figure? So indeed the Market may be efficient over the longer term.

I don't know whether it has to be over 'long term and looking at the entire market' though. Maybe this is still acceptable for most individual shares if an extended period is used?

I guess this is all prefaced by a couple of assumptions though for valuation. For example, we seem to think an average longterm average Price to Earnings Ratio of 15 or so is ok. Why? What if an economic shift now made a PER of 5 or 10 now the rule.

It's interesting anyway.......

 

So over the l o n g term there should be reversion to mean?

 

Yes......fair enough Tropo.

I guess how well the Institutional Analysts etc can value a company still depends on the reliability of the provided figures etc.

 

Alan,

That is what I think ....