No such thing as an 'efficient market'

Some people believe stock markets are efficient and share prices reflect all that is known about a particular company as well as the state of the economy as a whole.

The academics who believe in the so-called efficient market theory argue that, nowadays, analysts receive all the information necessary to value a company and ensure its shares are correctly priced. They go on to say that investors who regularly beat the market are lucky and are the kind of statistical exception that proves the rule.

I prefer Elmer Letterman's view that 'luck is what happens when preparation meets opportunity' and Gary Player's remark that 'the harder I work the luckier I get'.

I believe that the efficient market theory is absolute nonsense. The most amusing and complete refutation of it was argued by Warren Buffett in 1984 in Appendix 1 of the classic investment book The Intelligent Investor.

Mr Buffett asks you to imagine that 225 million Americans engage in a coin-flipping competition of 20 flips starting at a dollar and doubling up each time. This would result in 215 people winning every flip and, as a result, making over dollars 1m each.


Mr Buffett anticipates that the 215 winners would become a bit cocky and soon begin telling everyone the secrets of efficient and successful coin-flipping. They would say to the sceptical academics: 'If it can't be done, why are there 215 of us?'

The academics might reply that the same competition with 225 million orang-utans would have produced 215 victorious orang-utans.

Mr Buffett then goes on to point out that if 40 of the 215 victors had come from a particular zoo, you would begin to wonder if you were on to something. You might question the zoo-keeper and ask if he had been feeding the 40 orang-utans something special, or exercising them in a special way, or what books they read.

At this point, Mr Buffett draws attention to the remarkable investment records year by year (flip by flip) of the main value investors (the 40 winning orang-utans) who followed the teachings of Graham and Dodd. The nine investors in question, including Mr Buffett himself, were all close and early disciples of Ben Graham and subsequently became managers of very substantial funds. Their detailed track records make it clear that they consistently beat the market by a wide margin and over a very long period. Mr Buffett's key point is that they all had the same intellectual origin. They all followed the teachings of Graham and Dodd and were among the very few big fund managers who did so. They all had a similar approach, method and discipline and that, not luck, helped them all to achieve such exceptional results.


A successful investor needs a discipline - a method to focus on and temper, refine and improve by constant practice. All systems of investment really come down to one basic idea - trying to seek out shares that offer value for money. This means buying a share at a discount to its real value. The share price is there for all to see, but establishing the real value and making sure that the share is a bargain is where the difficulty arises.

Graham and Dodd had several different approaches, but are best known for buying assets at a discount. Mr Buffett expanded this concept with a wider interpretation of asset values by including competitive advantage in the form of business franchises and brand names.

Another simple method is to buy growth stocks with low PEGs (price-earnings growth factors) - prospective price-earnings ratios that are low in relation to their estimated future earnings growth rates. This is equivalent to buying growth at a discount.

A further well-known approach is to buy high-yielding shares - which I like to think of as yield at a discount. This is a simple and reliable method that beats the market regularly by a sufficient margin to refute, on its own, the efficient market theory.

Next week, I will write about how and why the high yield approach works so well.

John Travolta is a qualified airline captain and employed the pilot with his company, Alto
people'That was the lowest I’d ever felt'
Life and Style
healthIt isn’t greasy. It doesn’t smell. And moreover, it costs nothing

Other places that have held independence referendums
Arts and Entertainment
Pharrell dismissed the controversy surrounding
musicThe singer said 'the last thing I want to do is degrade'

footballThe latest scores and Twitter updates from tonight’s games, featuring Bayern Munich vs Man City and Chelsea vs Schalke
A male driver reverses his Vauxhall Astra from a tow truck
newsThe 'extremely dangerous' attempt to avoid being impounded has been heavily criticised
peopleThe Times of India said actress should treat it as a 'compliment'
Arts and Entertainment
Jack Huston is the new Ben-Hur

It scooped up an unprecedented 11 Academy Awards when it was first remade in 1959


Watch this commuter wage a one-man war against the Circle Line
ebooksAn unforgettable anthology of contemporary reportage
Home body: Badger stays safe indoors
lifeShould we feel guilty about keeping cats inside?
Life and Style

Olympic diver has made his modelling debut for Adidas

Arts and Entertainment
Toby Jones (left) and Mackenzie Crook in BBC4’s new comedy The Detectorists
tvMackenzie Crook's 'Detectorists' makes the hobby look 'dysfunctional', they say
Arts and Entertainment
Maxine Peake plays Hamlet at Manchester's Royal Exchange
theatreReview: Maxine Peake brings emotional ferocity to Shakespeare's starring part
10 best table lamps
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
Independent Dating

By clicking 'Search' you
are agreeing to our
Terms of Use.

iJobs Job Widget
iJobs Money & Business

Trainee Recruitment Consultant Birmingham

£18000 - £23000 per annum + Comission: SThree: The SThree group is a world lea...

Trainee Recruitment Consultant - Birmingham - Real Staffing

£18000 - £23000 per annum + Commission: SThree: Real Staffing are currently lo...

Recruitment Consultant - Soho - IT, Pharma, Public Sector

£20000 - £25000 per annum + OTE £35,000 first year: SThree: The SThree group i...

Sales Executive

£20 - 24k (Uncapped Commission - £35k Year 1 OTE): Guru Careers: We are seekin...

Day In a Page

Mystery of the Ground Zero wedding photo

A shot in the dark

Mystery of the wedding photo from Ground Zero
His life, the universe and everything

His life, the universe and everything

New biography sheds light on comic genius of Douglas Adams
Save us from small screen superheroes

Save us from small screen superheroes

Shows like Agents of S.H.I.E.L.D are little more than marketing tools
Reach for the skies

Reach for the skies

From pools to football pitches, rooftop living is looking up
These are the 12 best hotel spas in the UK

12 best hotel spas in the UK

Some hotels go all out on facilities; others stand out for the sheer quality of treatments
These Iranian-controlled Shia militias used to specialise in killing American soldiers. Now they are fighting Isis, backed up by US airstrikes

Widespread fear of Isis is producing strange bedfellows

Iranian-controlled Shia militias that used to kill American soldiers are now fighting Isis, helped by US airstrikes
Topshop goes part Athena poster, part last spring Prada

Topshop goes part Athena poster, part last spring Prada

Shoppers don't come to Topshop for the unique
How to make a Lego masterpiece

How to make a Lego masterpiece

Toy breaks out of the nursery and heads for the gallery
Meet the ‘Endies’ – city dwellers who are too poor to have fun

Meet the ‘Endies’ – city dwellers who are too poor to have fun

Urbanites are cursed with an acronym pointing to Employed but No Disposable Income or Savings
Paisley’s decision to make peace with IRA enemies might remind the Arabs of Sadat

Ian Paisley’s decision to make peace with his IRA enemies

His Save Ulster from Sodomy campaign would surely have been supported by many a Sunni imam
'She was a singer, a superstar, an addict, but to me, her mother, she is simply Amy'

'She was a singer, a superstar, an addict, but to me, her mother, she is simply Amy'

Exclusive extract from Janis Winehouse's poignant new memoir
Is this the role to win Cumberbatch an Oscar?

Is this the role to win Cumberbatch an Oscar?

The Imitation Game, film review
England and Roy Hodgson take a joint step towards redemption in Basel

England and Hodgson take a joint step towards redemption

Welbeck double puts England on the road to Euro 2016
Relatives fight over Vivian Maier’s rare photos

Relatives fight over Vivian Maier’s rare photos

Pictures removed from public view as courts decide ownership
‘Fashion has to be fun. It’s a big business, not a cure for cancer’

‘Fashion has to be fun. It’s a big business, not a cure for cancer’

Donatella Versace at New York Fashion Week