I have always been split 50/50 on the Market Efficiency Theory. What this theory suggests, is that all information is already baked into the share price. This is the premise behind technical analysis.
If a stock is trading at $100 per share, market efficiency tells us that the share price is absolute (more or less) and has already factored in all available information. The theory suggests that the share price is reflecting company financials, company direction, company head-winds, and any other company info that might be important to know. No work is needed on your part, says the market efficiency guru.
So, I did a little study to see how accurate consensus estimates are. After all, if market efficiency is true, then you would think estimates would be somewhat accurate. Wouldn’t you? If a share price is absolute, and “is what it is,” then the market makers who set these prices have to base them off of something. Company financials are certainly a big part of the theory.
First, here were the rules for my study:
- I couldn’t pick the companies. I asked my Facebook group to pick random companies. Those companies had to be legit, and could not be garbage OTC companies. However, I did have to switch 4 companies on my own, as the previous 4 did not have enough financial data on the website I used. The companies I picked were ROKU, AMZN, AMD, and Macy’s. I used 10 random companies total.
- I used the same financial website for all data. I used Markets Insider. I also used the same 3 quarters of information for all companies.
- I used earnings per share (EPS) and revenue (Rev), as those two are the “big” ones that are looked at closely.
- I simply took the difference between estimate and actual, and then found the percentage in which it was off from the actual. From there, I subtracted the percentage it was off from 100%, and used that as my study’s accuracy level.
So what did I find out? Let’s see…
The first 5 companies: Disney, Tesla, Apple, Shopify and Amazon.
The second set of 5: Goldman Sachs, Kinder Morgan, Advanced Micro Devices, Macy’s and Roku.
The overall accuracy for EPS was 73.36%, and the overall accuracy for revenue was 95.87%. That’s pretty impressive if you ask me. The only companies that brought the overall accuracy down were the “wild card” companies: Tesla, Shopify, and Roku. I call them wild cards because they’re technology based. Except Tesla. Tesla is a wild card because it’s a new space in the auto sector, and their CEO is a little bit of a loose cannon.
You can take what you want from this little study of mine. But for me, it brings me a little bit closer to believing the efficiency theory. Am I all in on it? Nope. But I’m closer than I was before.
However, there is still the unforeseen to contend with… Elon Musk tweeting that he may de-list his company and go private, for instance. Or the sex scandal at CBS, or shady accounting practices at Enron. The list goes on. There is much in the market that makes things not efficient.
As I always say, there is absolutely no way to predict the market with 100% accuracy. There never has been, and there never will be. But, I’d take 73.36% or, even better, 95.87% accuracy ANY day of the week!