INVESTMENT ANALYSIS (SCHOOLS OF THOUGHT ABOUT STOCK MARKET PRICES)

INVESTMENT ANALYSIS

SCHOOLS OF THOUGHT ABOUT STOCK MARKET PRICES

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Schools of thought about stock market prices;

There are 3 schools of thought about the stock market prices: 

1.       Fundamentalist school of thought

2.      Technical Analyst school of thought

3.      Random walk school of thought 

FUNDAMENTALIST SCHOOL OF THOUGHT

The fundamental analysts analyzes factor such as economic influences, industry factors, and pertinent company information such as product demand, earnings, dividends, and management in order to calculate an intrinsic value for the firm’s securities.  He reaches an investment decision by comparing this value with the current market price of the security. 

TECHNICAL ANALYSIS SCHOOL OF THOUGHT

Technical analysis, in essence involves the study of historical price and volume data either for one stock and deducing the future trend from this analysis.  i.e. the  technicians endeavor to predict future price levels of a stock by examining the past data from the market itself.

RANDOM WALK SCHOOL OF THOUGHT

The random walk hypothesis of stock  market prices is concerned with the question of whether one can predict future prices from past prices.  The fundamental idea behind the random walk hypothesis are that successive prices charge in individual securities are in-depth over time and that its actual price fluctuates randomly about its intrinsic or theoretical value.

SOME PAST QUESTIONS

a.      What are the implications of Random Walk for Technical And Fundamental Analysis?

b.      How do Technicians and Random Walk advocates differ in their view of the stock market?

SOLUTION:

The random-walk theory is inconsistent with technical analysis.   Whereas random-walk states that successive price changes are independent, the technicians claim that they are dependent – that is, that the historical price behaviour of the stock will repeat itself into the future and that by studying this past behvaious the technicians can in fact predict the future.

The empirical evidence in support of the random-walk hypothesis rest primarily on statistical tests such as runs tests, correlation analysis and filter tests.  The results have been almost unanimously in support of the random walk hypothesis, the weak form of the efficient market hypothesis.  The results of semi-strong form test have been mixed. 

The Technician has done very little if anything to defend any of the technician’s theories against the onslaught of random walk. 

All technicians have done is to claim that their various systems work.  In the future, if their theories are to have widespread acceptance in the academic community, they will have to test and demonstrate that their methods can consistently outperform a simple buy-and-hold strategy.  The fundamentalist needs also to show that his efforts in analyzing securities are successful enough that does a simplified strategy to justify his expenditure of time and effort.

QUESTION:

In what ways are Nigerian securities market inefficient?

SOLUTION:

Market efficiency refers to the ability of financial asset to quickly adjust and reflect all information that is relevant to the value in its price.

Nigerian security market is inefficient in the following ways:

a.      Absence of trading over the internet

b.      Absence of free flow of information

c.       Market imperfection e.g. high transaction cost, taxes etc

d.      The Nigerian security market is not globalized.

e.      Corruption

QUESTION:

Explain briefly what you understand by the term “Beating the Market”

SOLUTION:

“Beating the Market” means doing better than the market average i.e. to outperform the market.  It happens when your investment portfolio does better than the stock market overall.  In other words, it average annual return is greater than 7-10% annual average the stock market has done over time.  The capital market will be inefficient if the investor’s trading strategy could beat the market.  “Beating the Market” does not mean that you achieved a higher return; it means that you achieved a better return per unit of risk.