[Joseph_E._Stiglitz,_Carl_E._Walsh]_Economics(Bookos.org) (1)

EFFICIENCY AND THE STOCK MARKET
Most people do not think they can wander over to the racetrack and make a fortune.
They are not so skeptical about the stock market. They believe that even if
they themselves cannot sit down with the Wall Street Journal or browse an online
broker’s site and pick out all the best stocks, someone who studies the stock market
for a living could do so. But economists startled the investment community in the early
1960s by pointing out that choosing successful stocks is no easier—and no harder—
than choosing the fastest horses.
The efficient market theory explains this discrepancy in views. When economists
speak of an efficient market, they are referring to one in which relevant information
is widely known and quickly distributed to all participants. To oversimplify
a bit, they envision a stock market where all investors have access to Barron’s and
Fortune magazines or to one of the many Internet sites devoted to providing good information
about businesses, and where government requires businesses to disclose
certain information to the public. Thus, each stock’s expected return, its risk, its
tax treatment, and so on will be fully known by all investors. Because participants
have all the relevant information, asset prices will reflect that knowledge.
But it turns out that this broad dissemination of information is not only unrealistic
but also unnecessary for the stock market to be efficient. Economists have
shown that efficient markets do not require that all participants have information.
If enough participants have information, prices will move as if the whole market had
the information. All it takes is a few people knowledgeable enough to recognize a
good deal (bad deal), and prices will quickly be bid up (or down) to levels that reflect
complete information. And if prices reflect complete information, then even uninformed
investors, purchasing at current prices, will reap the benefit; while they
cannot “beat the market,” neither do they have to worry about being “cheated” by
an overpriced security.
You cannot beat an efficient market any more than you can beat the track. You
can only get lucky in it. All the research done by the many big brokerage houses
and individual investors adds up to a market that is in some respects like a casino.
This is the irony of the view, held by most economists, that the stock market is an
efficient one. If you are trying to make money in an efficient stock market, it is not
enough to choose companies that you expect will be successful in the future. If you
expect a company to be successful and everyone else also expects it to be successful,
given the available information, then the price of the shares in that company
will already be high. The only way to make abnormally high profits on stock purchases
is to pick companies that will surprise the market by doing better than is generally
expected. There are always such companies—the problem is to identify them
before everyone else! When Microsoft shares first became available to the public
in March 1968, they sold for 19 cents. By 2000, those shares were worth $58 dollars
each. Early investors in technology stocks made enormous returns because
technology firms did better than anyone had initially expected. Because of the success
of many of these companies during the late 1990s, whenever a new one would
“go public”—sells shares to the public for the first time—the price would often
jump immediately to a very high level. The initial public offering of Google in 2004
exemplified this phenomenon. An investor buying the stock at high market prices
882 ∂ CHAPTER 39 A STUDENT’S GUIDE TO INVESTING