Does an efficient stock market exist?

In my first blog post I touched briefly on stock market efficiency, this blog will compare the effects of a profit announcement on two company’s share prices; Balfour Beatty in 2015 and Moneysupermarket.com in 2013.

Pricing efficiency in stock markets has divided opinions among academics and investors, this concept dictates that all security prices fully and fairly reflects all information regarding both past and future events in the marketplace, therefore they are fairly priced (Watson and Head, 2013).  Fama (1970) identified three forms of market efficiency

Weak form effeciency: share price fully reflects information in historical prices
Semi strong effeciency: share price fully reflects all information that is publicly available
Strong form effeciency: share price fully reflects all information that is publicly and privately available

 

On March 25^th 2015 construction company Balfour Beatty reported a pre-tax loss of  £304m, the total shrank to £59m once profits from discounted operations including the sale of its US business Parsons Brinckerhoff were included (The Telegraph, 2015).  Balfour Beatty also announced that due to the financial difficulties they were facing they would not be paying shareholders an annual dividend (BBC News, 2015).  We can see from Graph 1 below that Balfour Beatty’s share price dropped significantly on the day of the announcement.   This I believe demonstrates a semi strong form of efficiency, as the share price reflects all publicly held information and not just historical price movements (Fama, 1970).  The fall in share price could reflect shareholders discontent at the news that dividends will be axed! (wouldn’t you be annoyed if you were a shareholder in Balfour Beatty?!)

Graph 1: Share price of Balfour Beatty from 25^th March until the 30^th March

Source: London Stock Exchange

The chief executive of Balfour Beatty, Leo Quinn announced the company were facing a variety of legal challenges in a number of construction projects and stated they were facing ‘major short term problems (BBC News, 2015).  This announcement was publicly available to the market and may have encouraged investors to sell their shares in the company as the short term future of Balfour Beatty doesn’t look positive, suggesting they will not be reinstating a dividend policy anytime soon!

A contrasting story to Balfour Beatty is that of moneysupermarket.com, who on the 31^st of July 2013 announced half year profits were up 70% from £11.6m to £19.8m (BBC News, 2013).  In the six months previous to the announcement EBITDA had risen 29% to £39.9m and revenue grew 10% to £112.3m (BBC News, 2013).  You would have thought if you were a shareholder in moneysupermarket.com you would be delighted (or laughing all the way to the bank as they say).. well your wrong! Despite the announcement of an increase in profit share price fell 15%!

Graph 2: Share price of moneysupermarket.com on 31^st July 2013

Source: London Stock Exchange

In an efficient market you would assume that the market would react positively to news of improved performance, thus impacting the share price of moneysupermarket.com, which we can see in the graph above didn’t happen.  This in my opinion shows a lack of efficiency in a market place, as this reflects share price of historical information and not positive publicly held information.

Does this mean that share prices are entirely random? Well that was what Kendall (1953) proposed in a theory of random walks, highlighting that share prices change in a random manner arguing there was no link between share prices.   However Kendall (1953) did acknowledge that share prices were random because they only changed when new information entered a market place, which in itself can be entirely random.  The fall in share price of Balfour Beatty would support this theory, as shareholders did respond to information that entered into the market place at a random time, however it doesn’t explain the fall in moneysupermarket.com’s shares.  Could it be because Balfour Beatty’s announcement was concerned with dividend payments and moneysupermarkets was only an increase in profit?

Even though Kendall (1953) proposes that the stock market is entirely random, how do investors make so much money from it? Is it simply luck? Or maybe insider information that isn’t publicly available.   If the latter were true it would suggest that different people are investing in different markets in theory, an investor with insider information would be investing in a market which by Fama’s (1970) definition is a strong market.  

In my overall opinion I don’t believe you can predict the stock market (no matter how much I wish I could), because I think share prices are subjective to any news which is released publicly.  I don’t think anyone can predict the future and no one can tell what is going to happen tomorrow, therefore how could someone predict what news will be announced and the effect this will have on share prices.   It should also be noted that as demonstrated by the dip in moneysupermarket.coms share prices that not all information is relevant to shareholders, it seems information which will directly affect investors such as dividend policy causes more of a market reaction than other pieces of news.

I think it is vital that stock markets are efficient, if they were not then it would be hard for directors and managers to know what strategies and steps to take to create shareholder wealth wouldn’t it? I can’t imagine the look on moneysupermarket.com manager’s faces when share prices dipped as they announced an increase in profit!  Managers will rely on an efficient market in order to ensure they make wealth creating financial decisions (Arnold, 2013).

References:

Arnold, G. (2013). Corporate Financial Management. (5^th ed.), Harlow: Pearson.

BBC News. (2013, July 31). Moneysupermarket.com share price drops despite 70% profit rise - BBC News. Retrieved from http://www.bbc.co.uk/news/uk-wales-north-east-wales-23517365

BBC News. (2015, March 25). Balfour Beatty reports £59m loss and axes dividend - BBC News. Retrieved from http://www.bbc.co.uk/news/business-32046614

Financial times. (2013, July 31). Moneysupermarket hit by change to Google algorithm. Retrieved from http://www.ft.com/cms/s/0/aedcccfc-f9c7-11e2-98e0-00144feabdc0.html#axzz3Vy4TuXbb

London Stock Exchange. (2013, July 30). MONY MONEYSUPERMARKET.COM GROUP PLC ORD 0.02P. Retrieved from www.londonstockexchange.com/exchange/prices-and-markets/stocks/summary/company-summary-chart.html?fourWayKey=GB00B1ZBKY84GBGBXSTMM

London Stock Exchange. (2015, March 25). BBY BALFOUR BEATTY PLC ORD 50P. Retrieved from www.londonstockexchange.com/exchange/prices-and-markets/stocks/summary/company-summary-chart.html?fourWayKey=GB0000961622GBGBXSTMM

The Telegraph. (2015, March 25). Balfour Beatty scraps its dividend for a year after falling into the red - Telegraph. Retrieved from http://www.telegraph.co.uk/finance/newsbysector/constructionandproperty/11493591/Balfour-Beatty-scraps-its-dividend-for-a-year-after-falling-into-the-red.html

Watson, D. & Head, A. (2013). Corporate Finance: Principles and Practice. (6^TH ed.), Harlow: Pearson