Studying Market Anomalies
The efficient market hypothesis (EMH) says that all stocks are accurately priced, and that market anomalies returns cannot be earned by searching for mis-priced stocks. Because future stock prices reflect a random walk pattern, it cannot predict them.
However, there seems to be some market patterns that can lead to abnormal returns, thus violating the efficient market hypothesis, particularly the semi-strong EMH,
which predicates that abnormal returns cannot have earned by learning all the public information on companies and their stocks, and any other variables that may affect stock prices, such as economic factors.
Hence, the semi-strong EMH would suggest to reverse the value of fundamental analysis. (The unstable design of the EMH negates the value of technical analysis.)
Market Anomalies and Market Patterns
Market anomalies are arrangements marketplace that look to lead to abnormal returns more often than not, and since some of these patterns based on information in financial reports, market anomalies present a challenge to the semi-strong form of the EMH, showing that fundamental analysis has some value for the individual investor.
composed of small P/E stocks generally outperform portfolios composed of high P/E stocks.
Some have hypothesized, based on the capital asset pricing model and other models relating risk to returns, that the reason for this is that low P/E stocks have a greater risk, and therefore potentially greater returns.
If 2 stocks have the same return, then the one with the lower P/E ratio is riskier; otherwise they would have the same P/E ratio.
This is true, but it also expects those riskier stocks to yield higher returns to compensate investors for their risk. If 2 stocks have the same return, why would you pay the same price for the riskier stock?
Book-to-Market Anomalies Ratios
I have observed it that stocks of companies with high book-to-market ratios outperform stocks with low book-to-market ratios.
Studies have shown that this effect seems to be independent of the stock’s beta, and therefore, independent of systematic risk.
The fact could explain this effect that companies with low book-to-market ratios are companies that investors expect to explode.
However, fast growth continually decreases as companies grow larger — hence, it will reduce growth in stock prices as the P/E ratio falls as future expectations of further growth lowered. As the P/E ratio falls, the return also drops.
Stocks with high book-to-market ratios decline less in bear markets, since there is less risk when the market value of a company is close to its book value.
Earnings announcements can have alternates effects on stock prices. Sometimes stock prices go up until it tells the earnings, then decline on the news — or they may decline before the announcement if expectations are not positive.
We usually base expectations on analysts’ reports, and their forecast of future earnings. Many websites publish a consensus of earnings expectations.
If the actual reported earnings differs significantly from what they expected, then this earnings surprise can have a large effect on the subsequent stock price for an extended time.
A study by Foster, Olsen, and Shevlin has shown that the more dramatic the earnings surprise, the more effect it had on the stock price, with positive surprises causing the stock price to rise for up to 2 months after the announcement, and negative surprises causing declines — the price effect was most dramatic within the 1st several days of the announcement.
Not only does this study show that abnormal returns can earned by watching earnings announcements for surprises and responding quickly to them, but it also shows that price changes are not as fast as EMH would seem to imply.
Knowing more about Stocks
Great Post !