📈 Equity Investments

Efficient Market Hypothesis (EMH) — Weak, Semi-Strong & Strong Forms

Efficient Market Hypothesis explained. Three forms of market efficiency — weak, semi-strong, and strong — with evidence, anomalies, and implications.

Key Concepts

Efficient Market Hypothesis (EMH)

Security prices fully reflect all available information. Prices adjust rapidly to new information.

Weak Form

Prices reflect all past market data. Technical analysis cannot earn excess returns.

Semi-Strong Form

Prices reflect all publicly available info. Neither technical nor fundamental analysis earns excess returns.

Strong Form

Prices reflect ALL info including private/insider info. Even insiders cannot earn excess returns (not supported empirically).

Market Anomalies

January effect, size effect, value effect, momentum, post-earnings announcement drift. May be real or data-mining artifacts.

Behavioral Finance

Loss aversion, overconfidence, herding, information cascades. Investor psychology can create mispricings.

Formulas

Master Formula Sheet -- Equity Investments

DDM (Gordon Growth)

V₀ = D₁ / (r - g)

Constant growth dividend model

Required Return (DDM)

r = (D₁/P₀) + g

Dividend yield + growth rate

Price-to-Earnings

P/E = Price / EPS

Leading P/E uses forecasted EPS

Justified P/E (Leading)

P/E = (1-b) / (r-g)

b = retention ratio, g = b × ROE

Sustainable Growth

g = ROE × b

b = retention ratio = 1 - payout

PEG Ratio

PEG = (P/E) / g

P/E relative to growth rate

Price-to-Book

P/B = Price / Book Value per Share

P/B < 1 may signal undervaluation

Enterprise Value

EV = Market Cap + Debt - Cash

Total value of the firm

EV/EBITDA

EV / EBITDA

Cross-capital structure comparison

Decision Frameworks

Implications for investment strategy?

Use when:

  • Weak efficient: fundamental analysis can work, but not technical
  • Semi-strong: only insider info gives edge; use passive strategies
  • Strong efficient: no analysis adds value; index everything

Avoid when:

  • Assuming perfect efficiency — real markets have frictions

Test Your Understanding

Under the semi-strong form of EMH:

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