Is the Efficient Market Hypothesis past its sell by date?


The Efficient Market Hypothesis (EMH) is articulated well on this site:

“Basically, the Efficient Market Hypothesis says that there can be no edge in the market, that investors are all perfectly rational, and all investors working off public information can’t profit except from inside information (and even then, maybe not), and that all stocks are equally well priced.”

The author is using that as a strawman to state the case that EMH is past its sell by date. Warren Buffet obviously believes that it is possible to beat the market consistently. He now has the law of large numbers “problem” which makes investing harder; the Buffett track record to look at is before he made his first $ billion.

It is the same in VC. Some funds (Accel, Sequoia etc) do outperform consistently.

The author’s description of his investing style matches what I have found works -

Not Buy and Hold OR Active

"I don’t consider myself a particularly active investor. Whenever I buy a stock I try to figure out valuation (what it ‘should‘ be priced) to calculate a potential upside. When a stock is close to fairly valued? That’s when I sell. This process of buy and hold isn’t quite the same as passive portfolios as it requires I keep an eye on a number of metrics, but since my holding periods are generally measured in years I don’t exactly consider myself an active investor. I don’t belong in either camp.”

He is right. Just buy and hold value investing can be the “value trap”. So you also need a clear view on what event will unlock value and bring investor attention.

That approach requires a highly concentrated portfolio as each asset requires a lot of attention

Also “value” needs to extend to pre profitable ventures that have great operating leverage. Traditional value investors won’t touch these.

I will give some examples based on my personal experience. These are examples of good investments and obviously there are bad investments as well but the point of highlighting these is to show that is possible:

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Rational Corp. This was the leading software tools company of it’s time. I bought in after the Dot Com crash for what was cash value (about $1 billion in cash, $1 billion in annual revenue, $1 billion in market cap). The Efficient Market viewed software as dead (a couple of bad quarters was evidence of that). Rational was acquired by IBM. I had no inside knowledge only the insight that software was not dead and that developers would still need tools.

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Apple. This was also after the Dot Com crash. Steve Jobs was back on board and the products were great but the stock was still trading as if the company was doomed. Insight was based on somebody giving me a Mac and an iPod and thinking “I love these products”. I made 3x and exited, would have made 30x if I I had stayed invested but the opportunity to invest at cigar butt cheap values in a genius don’t come along often.

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Lending Club. Bought in at the 3.51 in May 2016 after the CEO ouster as I thought the market had over-reacted, sold about 6 months later after it got to what I considered fair value.

Bar Bell
I do bet on some individual stocks but I also know that it is very hard to get it right. So most investments in passive low cost vehicle is right. This is the bar bell approach - most in a low cost index fund, no attempt to beat the market, just keep costs low, a few bets when I have high conviction.

Macro cycle
The Rational and Apple stories show that macro cycles matter. In deep bear markets there are amazing bargains. After a long time of loose money, central bank printing, bargains are hard to find. The Lending Club story says “hard but not totally impossible”.

Supply and Demand
The Internet changes everything. Well, not quite everything. Supply and demand is a law you can “take to the bank”. If conventional wisdom says “nobody can beat the market, just invest at low cost in baskets” then there will be less competition searching for individual stocks.

No Intermediary Business Model works for this.

If you invest on 10 deals over 10 years and make 10x, no broker or intermediary makes a profit. So the industry prefers we believe in EMH.

Bernard's post about XBRL

I do not agree the Apple example given above disproves the EMH in any way.

Yes, there has been an opportunity to make a lot of money on Apple in the past and from what you are saying you we able to make some money for yourself, too.

However, to outperform the market in the long run, you would need to:
a) invest a significant part of your total assets
b) find similar investments on the regular basis

Looking back now, it is obvious Apple was a sure winner back then, but it wasn’t looking so certain back then. Would you be willing to make such bets with relatively large amounts of money ?
If you only put 5% of your portfolio in such investment and it goes up by 300%, your overall portfolio is only up by 10%.

Secondly, not all of your bets are going to work out. You will probably lose money on some of them, if not all of them - this is what is making outperforming the market in the long run such a difficult task.

Also, brokers want you to believe that the EMH is not valid.
If you think you are better of with passive investing, you are just going to buy and hold a S&P 500 ETF - that’s just one trade.
On the other hand, if you think the markets are inefficient, you are going to be trading in and out all the time, based on what stock you believe to be undervalued at the time, when you hit your stop-loss limits, etc.