The concept of security analysis in general, and fundamental analysis in particular, is based on the assumption that at least some investors are capable of identifying stocks whose intrinsic values differ from their market values.
Fundamental analysis operates on the broad premise that some securities may be mispriced in the marketplace at least some of the time.
Fundamental analysis may be a worthwhile and profitable pursuit:
- if securities are occasionally mispriced, and
- if investors can identify mispriced securities.
To many, those two premises seem reasonable.
Efficient Market Advocates
However, there are others who do not accept the assumptions of fundamental analysis.
- that the market is so efficient in processing new information that securities trade very close to or at their correct values at all times. and
- that even when securities are mispriced, it is nearly impossible for investors to determine which stocks are overvalued and which are undervalued.
Thus, they argue, it is virtually impossible to consistently outperform the market.
In its strongest form, the efficient market hypothesis asserts the following:
1. Securities are rarely, if ever, substantially mispriced in the marketplace.
2. No security analysis, however detailed, is capable of identifying mispriced securities with a frequency greater than that which might be expected by random chance alone.