Question

Discuss the efficient market hypothesis. Explain why financial statement analysis can or cannot be performed in a way that provides significant advantage to an investor

Answer 1

And:-
* Efficient Market Hypothesis:-The efficient market hypothesis is an investment theory that states it is impossible to "beat the market" because stock market efficiency causes existing share prices to always incorporate and reflect all relevant information.
According to the EMH, stocks always trade at their fair value on stock exchanges, making it impossible for investors to either purchase undervalued stocks or sell stocks for inflated prices. As such, it should be impossible to outperform the overall market through expert stock selection or market timing, and the only way an investor can possibly obtain higher returns is by purchasing riskier investments.

* Significance of Financial Statement analysis:-The financial analysis determines a company's health and stability. The data gives you an intuitive understanding of how the company conducts business. Stockholders can find out how management employs resources and whether they use them properly.
Governments and regulatory authorities use financial statements to determine the legality of a company's fiscal decisions and whether the firm is following correct accounting procedures. Finally, government agencies, such as the Internal Revenue Service, use financial statement analysis to decide the correct taxation for the company.

* Advantages of Financial Statement analysis:

1) Profitability: Profitability ratios reveal a firm's success at generating profits. “The profit margin of a company determines its ability to withstand competition and adverse conditions,” reports Credit Guru. Return on assets, reveals the profits earned for each dollar of assets and measures the company's efficiency at creating profit returns on assets. Net worth focuses on financial returns generated by the owner's invested capital.

2) Liquidity: The balance sheet provides liquidity ratios that show how much monetary worth the company has on a given day, which helps determine if the firms' financial reliability. The current ratio shows “the 'working capital' relationship of current assets available to meet the company's current obligations,” reports Credit Guru. The quick ratio is similar, calculating those assets easily convertible into cash, determining the immediate working capital relationship. The debt to equity ratio establishes who owns more of the company, creditors or shareholders.

3) Limits:It is important to know that financial statement analysis has limits; simply manipulating numbers hides the actual state of the company. Different accounting methods will look different on paper, and the method a particular firm uses can change the visible health and profit levels for either better or worse. Quantitative financial analysis is an art, and different analysts may get slightly different results from the same information, or may return different data about the same business

4) Efficiency: Efficiency ratios measure how efficiently the company turns inventory into revenue. The day sales outstanding ratio focuses on the time required to turn inventory into cash and the age of your accounts receivable. The inventory turnover ratio “indicated the rapidity with which the company is able to move its merchandise,” reports Credit Guru. Accounts payable to sales shows the percentage of sales funded with supplier's money.