Expert: Paul Henneman - 4/24/2009

Question
 I'm currently a college student majoring in finance and I invest in a mix of ETF's and pick some of my own stocks.  Today my economics prof. told us that nobody can pick stocks, it makes a lot of sense because everything that is currently known is already factored into the price and information moves too fast unless its inside information.  Is he correct in saying this?  How do you explain the very few people who do beat the market consistently such as Buffet, Soros, and some others who've done it for a long time?  Luck?  I argued that in times like this all the information cant be accurately priced into a stock because investors and funds might not be able to get into a stock even if they wanted to.

Answer
Bill,
   Thank you for your question!
Your professor appears to be presenting to you the efficient market theory. This dictates exactly what you describe, that the market already factors in all available data, so it is impossible to really make any money. Any gains would be offset by losses as they average out.
   However, this is just a theory, and if this is the only one that is being presented by your professor, he is doing you a great disservice. I do hope that he moves on to the other side of the argument, the one that has gained much more strength over the past 15 years, that of inefficient markets. Overall, I believe that it is much more established that the markets are inefficient in the short term, so it is possible to find undervalued stocks that will produce positive returns.  There is so much data available, that it is not factored in by every investor, at all times, as they try to determine if a stock is over or undervalued. Also, the efficient market theory does not take into account investor emotion. Most, if not all, investors are tied emotionally to their investments. For many it is their retirement nest egg, and for others it is their primary source of income. Think of an investor over the past year, watching the value of their investments fall by 50% or more. Are they making investment decisions based on all of the data available for each of the investments they are holding? Emotions are the worst enemy of the investor, and this includes both small scale individuals as well as large scale institutional money managers. Fear of losses, and over confidence after gains, means that the market is continually mispriced. Sometimes over priced, sometimes under, and by different levels. Times like this are actually a huge opportunity for investors that are able to buck the trend, and examine the market data rationally.
  To sum up, what your professor is presenting was a decade or two ago the leading theory in financial research. However, the trend in this area is to recognize that the markets are not perfectly priced at all times and do have inefficiencies.

Here is a link to a fairly quick and concise summary of what I describe above:
http://www.investopedia.com/terms/i/inefficientmarket.asp

Also, if you go to www.amazon.com and do a search for "Efficient Markets", you will see numerous books and studies that are written in argument, and favor the inefficiency of markets instead.

I hope that this helps, please do not hesitate to follow up with me if I can be of any additional service,

Sincerely,
Paul Henneman
President
ValuEngine Inc
www.ValuEngine.com