Semistrong Form

The semistrong form of the efficient market hypothesis states that stock prices adjust quickly to publicly available information that is relevant to the valuation of the stocks. Public information includes all published reports (financial statements); analysts’ reports; analysts’ and brokerage firms’ recommendations; press, radio, and television reports; and historical information. When a company announces new information, it is reflected quickly into its stock price. Therefore, analysis of this information may not produce superior returns because stock prices will have already incorporated the information. For example, when a company announces that it will exceed the estimates of analysts for a quarter, its stock price generally does not rise after the news announcement. The reason is that the stock price probably rose in anticipation of the news of the earnings expectations. Thus, when you read that Intel, for example, has released a new, faster chip, it is too late to earn superior returns from buying Intel stock. This information is already reflected in the price of the stock.

The semistrong theory asserts that investors can achieve superior returns through an analysis of this information, but over time this technique does not consistently produce superior returns when transaction costs are taken into account. This conclusion may be quite rational when you consider that analysts and investors are exposed to the same public information. In their competition with each other over changes in information, analysts and investors make the pricing of stocks much more efficient. If a perceived change occurs in a stock’s value, investors buy it, thereby moving the price up to its equilibrium value.

Many studies support the validity of the semistrong form of the efficient market hypothesis, which asserts that stock prices change quite rapidly to reflect new public information and in many cases anticipate the announcements of information to the public. One study questioned whether investors could earn higher profits from buying stocks that were about to split (Fama et al., 1969, pp. 1–21). The authors found that even though stocks went up in the weeks before the split, when the split was announced, the stocks did not increase any more. To profit from a split, investors would have to buy the stock months before the stock split was announced. This theory implies that investors can earn superior returns by anticipating any new information before it becomes public and is reflected in the stock price. This strategy may be a clairvoyant’s dream!

If any institution could outperform the market averages, it would seem to be the brokerage firms, which usually have many analysts on their payrolls. Dorfman (1993, p. C1) reported that only 6 of the 16 major brokerage firms outperformed the 38 percent earned by the S&P 500 Index in 1995.

However, research done on the semistrong form shows that some anomalies occur, which suggests that some inefficiency in the market can produce superior returns.

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