Saturday 11 February 2012

Stock Exchanges and Stock Market Efficiency

Stock Exchanges and Stock Market Efficiency

Stock markets are platforms that allow companies to list and sell shares to investors. Shares are issued to raise capital for the organisations and in return, the now, ‘shareholders’ own a percentage of the corporation. Despite owning the company shareholders are secured by limited liability, this ensures that owners of shares are not held liable for debts incurred by the organisation. Once investors have purchased shares they are not responsible to contribute any more capital regardless of the firms financial situation, they risk only the cash they have chosen to invest.

Established stock exchanges now operate in over 100 different countries across the globe and in March 2010 the world stock market valuation reached highs of $49.1 trillion.

Investment markets are essential to increase cash flow in a modern economy. The capital raised by selling shares to investors is assigned to projects by the financial manager of the corporation. Ideally, these projects generate profits increasing share price and allowing the firm to produce dividends and inflate share price for its shareholders, generating wealth for investors. However, there are many factors that can contribute to the ‘efficiency’ of the market.

An efficient market can be described as one in which share price fluctuates both rationally and quickly to reflect any new information released regarding an organisation. The importance and impact of the news will determine the size of the fluctuation. However, is the theory of an efficient market hypothesis actually a reality on the stock exchange?

An example against the theory was evident on June 24th 2010 when Apple Inc launched their new product the iphone 4. The success of the iphone 3gs, selling over 1,000,000 models within three days of its release suggested the iphone 4 would have similar success. On the morning of June 24th people were queuing outside apple stores read to get their hands on the new iphone. The product launch was the company's most successful yet, selling 1.7 millions units worldwide by June 26th. Sales surpassed analysts expectations, Apple were struggling to
keep up with such relentless demand for the product, the device was ‘sold out in the majority of the apple stores in the United States the day after it went on sale’ (Carew & Madway, 2010).

Such positive news and soaring sales should be well received by investors that hold apple shares, in an efficient market, theoretically, share price should increase and yet, the opposite occurred. This trend is consistent with the launch of Apple products, the graph below displays the share price fluctuations regarding Apple product announcements:





As we can see the iPad 2 is the only product launch that appears to have had a positive effect on the company’s share price. Why then do Apple shares behave in such a manner?

There are theories that suggest reason for this trend. For example, anticipatory price movements due to information leaks. Leading to the launch of a product, share price often ‘creeps up’ anticipating the launch. This anticipation can exaggerate the value of shares leading to an overreaction of share price followed by deflation. However, Apple is renowned for maintaining secrecy of their products until the launch. An app developer was entrusted to test one of the first ipads before the products official launch. In an interview he states
Apple drilled a hole in a desk and chained the prototype to it using bicycle cables’, ‘Apple even went so far as to take pictures of the wood grain of the desk so that any leaked pictures could be traced back’ (Dhebar, 2011). He was forbidden to tell anyone about the product and had to use it in a room with no windows and new locks.

Such strict criteria suggest that very few people are aware of an Apple product prior to its launch, eliminating the possibility of anticipatory share price inflation.

It could be argued that Apple is simply unfortunate with its timing, that overall market shares drops on the day they launch their products. The circled area on the image below indicates the date at which the iphone 4 was released into stores. As we can see the Apple share price mimics that of the Nasdaq, suggesting the fall in share price may simply be due to a drop in the market.







This theory is reinforced with the image below. The circled area here indicates the day on which the iphone 4s was launched, again the Apple share price roughly mimics that of the Nasdaq:








The ‘random walk’ theory developed by Kendal could be another option to suggest why Apple shares act in such a manner. Kendal suggested that there is no link between subsequent share price movements, no consistency. Metaphorically similar to the path a drunken man may take when placed in the middle of a field. Many theorists believe this is incorrect. I believe there is some truth to Kendal’s theory when attempting to achieve short-term financial gain on the stock exchange. If share price movements are affected by news and new information arising, then each subsequent piece of news should be independent of the last, therefore shareholders never know whether the next release of information will be good or bad. In addition to this, as shown in the Apple case even if what would appear to be good news is released, share price may still fall!

I think that although there is no ‘secret formula’ for making short-term financial gains on the stock market educated guesses may be made by analysts that are well informed and experienced. These recommendations from top analysts may be correct more often than not but the volatility and inefficiency of stock exchanges means that nobody can ever be sure.








Carew, S. & Madway, G. (2010) 'Apple boasts 1.7 million iPhone 4 sales', Reuters Website, [Online]. Available at: http://www.reuters.com/article/2010/06/28/us-apple-iphone-idUSTRE65O6FE20100628

Dhebar, P. (2011) 'Developer offers brief look inside Apple's secrecy efforts', Technie-Buzz Website, [Online]. Available at:
http://techie-buzz.com/apple-2/developer-offers-look-inside-apples-secrecy-efforts.html
 

No comments:

Post a Comment