Question

What is the connection between the Efficient Market Hypothesis and Value Based Management?

Answer 1

Answer of the above question is given below.

The efficient market hypothesis (EMH), alternatively known as the efficient market theory, is a hypothesis that states that share prices reflect all information and consistent alpha generation is impossible. According to the EMH, stocks always trade at their fair value on exchanges, making it impossible for investors to purchase undervalued stocks or sell stocks for inflated prices. Therefore, it should be impossible to outperform the overall market through expert stock selection or market timing, and the only way an investor can obtain higher returns is by purchasing riskier investments.

Although it is a cornerstone of modern financial theory, the EMH is highly controversial and often disputed. Believers argue it is pointless to search for undervalued stocks or to try to predict trends in the market through either fundamental or technical analysis.

Theoretically, neither technical nor fundamental analysis can produce risk-adjusted excess returns (alpha) consistently, and only inside information can result in outsized risk-adjusted returns.

$342,850

The January 10, 2020 share price of the most expensive stock in the world: Berkshire Hathaway Inc. Class A (BRK.A).

While academics point to a large body of evidence in support of EMH, an equal amount of dissension also exists. For example, investors such as Warren Buffett have consistently beaten the market over long periods, which by definition is impossible according to the EMH. Detractors of the EMH also point to events such as the 1987 stock market crash, when the Dow Jones Industrial Average (DJIA) fell by over 20 percent in a single day, as evidence that stock prices can seriously deviate from their fair values.

Value Based Management (VBM) is the management philosophy and approach that enables and supports maximum value creation in organizations, typically the maximization of shareholder value. VBM encompasses the processes for creating, managing, and measuring value.

The value creation process requires an understanding of the attractiveness of the market or industry where one competes, coupled with one’s competitive position relative to other players. Once this understanding is established and is linked with key value chain drivers for cash flow and profitability, competitive strategy can be established or modified to maximize future returns.

Lucintel assists clients in understanding the dynamics and underlying forces in the materials and manufacturing industries, including specific product, application or geographic markets, as well as their company’s strengths and weaknesses compared to others.