Question

1. Suppose that Apple’s profits have always been expected to grow twice as fast as Microsoft’s. Does it necessarily make Apple stock a better investment than Microsoft stock based on the Efficient Markets Hypothesis? Briefly explain. (15 points)

Answer 1

The efficient market hypothesis basically states that it is impossible to beat the market consistently and that all information available is already priced in the stocks and hence the index.

While theoretically the rate of growth of profits does not matter, it is important to know what are the absolute values of the profits relative to the sales/revenue. Thus for both companies we would need to know the revenue numbers as well as the underlying profit numbers. Based on the profit margin and the growth rate of the profit we would be in a position to determine which company would have more EPS(Earning Per Share) growth. Based on that we would find out which stock price is likely to rise in price after discounting the said earnings of each of the companies. This would help us to determine which of Apple & Microsoft would be a better stock investment.

Based on the Efficient Market hypothesis, the information related to the profit growth and hence the EPS (earnings Per share) growth we would get to know whether there is a likelihood of stock price movement upward.