If past price movements don’t predict future ones, every chart is useless. Fine. But what about studying the company itself — its earnings, its growth, its competitive position? Efficient markets have a challenge for that approach too, and it’s one every serious investor needs to understand.
In Part 2, we saw why technical analysis fails. If all information about past prices is already reflected in the current price, then chart patterns and trend lines are just noise. There’s nothing in the price history that gives you a consistent edge.
The obvious comeback is: fine. Forget the charts. Study the company.
Instead of looking at price movements, look at what actually drives prices over the long run — earnings, revenue growth, profit margins, competitive position, management quality. Estimate what the business is truly worth. Buy when the market is pricing it below that value. Wait for the gap to close.
This approach is called fundamental analysis — the practice of studying a company’s financial statements and business fundamentals to determine whether its stock is fairly priced. It’s the foundation of value investing, the approach championed by Warren Buffett, Charlie Munger, and Benjamin Graham.
The efficient market hypothesis has a challenge for this approach too. It’s a serious one. And understanding it is essential before you conclude that any fundamental analysis is giving you a real edge.
What Fundamental Analysis Claims to Do
A fundamental analyst starts with a simple premise: a company has an intrinsic value — its true economic worth, based on the cash flows it will generate over its lifetime, discounted back to what they are worth in today’s dollars.
The market price of a stock is not always the same as intrinsic value. Markets overshoot. They undershoot. Investors get optimistic and drive prices above what the business is worth. They get pessimistic and drive prices below it. These gaps between price and value — mispricing — are the target.
A fundamental analyst is trying to do two things:
1. Estimate what a business is worth more accurately than the market
2. Buy it when the market is underestimating that worth
The gap between what you paid and what you believe the company is actually worth is called the margin of safety — a cushion that protects you if your estimate turns out to be a little wrong.
This sounds rigorous. And it can be. But the efficient market hypothesis raises a pointed question: if the market is full of analysts doing the same work you’re doing, all studying the same public information, why would your estimate be more accurate than theirs?
The Semi-Strong Form — When Public Information Is Already Priced In
In Part 1, we introduced Eugene Fama’s three forms of the Efficient Market Hypothesis. In Part 2, we looked at the Weak Form — which holds that all information in past prices is already priced in. That’s what kills technical analysis.
The Semi-Strong Form goes further: it holds that all publicly available information is already reflected in the current price — not just price history, but everything. Earnings reports. Revenue growth. Industry trends. Analyst research. News coverage. Management commentary in quarterly calls. All of it.
If the Semi-Strong Form is correct, the bar for fundamental analysis is extremely high.
Think about what it means. By the time you sit down to read a company’s 10-K annual report, hundreds of professional analysts — some at firms with billions of dollars under management, with proprietary databases and direct access to management teams — have already read it. They have already modeled the earnings. They have already updated their price targets. Their trading has already moved the stock to reflect what the report implies.
This doesn’t mean you can’t still do fundamental analysis. It means the information in the public filing is already in the price by the time you see it. To get ahead of the market, you’d need to extract insight from that same public information that the market hasn’t already priced in — or to know something material that isn’t public, which is illegal.
The question the Semi-Strong Form forces you to ask is not “Is this a good company?” It’s “Do I see something here that the market has missed?”
What the Research Shows: Active Fund Managers
The most direct test of the Semi-Strong Form is the performance record of professional investors — people who are paid to analyze companies and select stocks. If fundamental analysis consistently generates an edge, it should show up in their results.
The research is sobering.
Studies going back decades, covering thousands of actively managed mutual funds across multiple countries, consistently find the same thing: most actively managed funds underperform a simple index fund over the long run, after accounting for fees.
An index fund is a fund that simply owns all the stocks in a market index — say, the S&P 500, which includes the 500 largest U.S. companies. It doesn’t try to pick winners or avoid losers. It owns everything. Its management fee is tiny because no analysis is required.
The S&P Indices Versus Active (SPIVA) scorecard — which compiles these comparisons — has found, year after year, that the majority of active fund managers underperform their benchmark index over a 10-year period. Not all of them. But most. And the minority that do outperform in one decade don’t do it consistently in the next.
This is strong evidence for the Semi-Strong Form. If professional analysts — with massive research budgets, sophisticated models, and access to management — can’t consistently extract edge from public information, what does that say about the rest of us?
There are two explanations for why active managers underperform:
First: fees. An actively managed fund typically charges 0.5% to 1.5% per year in management fees. An index fund charges 0.03% to 0.10%. In a world where markets price information efficiently, the active manager has to beat the market by at least their fee just to break even for the investor. That’s a high hurdle to clear year after year.
Second: competition. The market is not competing against amateurs. It’s competing against thousands of professional analysts all looking at the same information. In that environment, extracting a consistent edge requires seeing something that all those other professionals have missed. Occasionally, someone does. Doing it consistently is a different claim.
Why This Doesn’t Mean Fundamental Analysis Is Useless
Here is where we need to be precise — because the evidence argues for humility, not surrender.
Fundamental analysis serves two important functions even in a highly efficient market:
First, it is the mechanism that makes markets efficient. Markets are efficient because analysts study companies, build models, argue about valuations, and trade on their conclusions. If everyone stopped doing fundamental analysis and just bought index funds, prices would stop reflecting available information. Mispricing would grow, and disciplined analysts would once again be able to profit from it. The efficiency of markets is sustained by the participation of skilled analysts. The question is whether any individual analyst can be among the ones who consistently extract more signal than the average.
Second, fundamental analysis is the floor of investment discipline. Even if you cannot consistently extract an edge from public information, doing the analytical work helps you avoid the most common and costly mistakes: buying overvalued companies in popular sectors, holding poor businesses through deteriorating fundamentals, or selling sound companies during temporary panic. A disciplined framework is valuable even if it doesn’t reliably produce returns above the index.
The honest takeaway is not “fundamental analysis is pointless.” It is: “the bar for fundamental analysis to produce a genuine, sustainable edge over the market is much higher than most investors assume.”
Where Edges Might Still Exist
The efficient market hypothesis is not a blanket statement that no one ever outperforms. It says that outperforming consistently, on risk-adjusted terms, is extremely difficult using publicly available information. But researchers have documented some areas where disciplined analysts may still find a foothold.
Less-covered companies. The Semi-Strong Form is most powerful in large-cap stocks — heavily covered companies where dozens of analysts produce regular reports. For small companies with no analyst coverage, the information advantage of doing your own research is potentially larger. The price may not fully reflect all available information if almost no one is looking.
Longer time horizons. Most professional money managers are evaluated against their benchmark quarterly or annually. This creates pressure to perform over short periods — which often means following the crowd into popular ideas and avoiding the patience that long-term investing requires. A patient investor with a five- or ten-year horizon can sometimes exploit the short-term thinking that dominates institutional trading. The market may be efficient at pricing next quarter’s earnings. It may be less efficient at pricing a business’s competitive position in ten years.
Qualitative judgment. Financial models are built on numbers. But numbers don’t fully capture management quality, brand strength, customer loyalty, or the durability of a competitive advantage — what Warren Buffett calls an economic moat. Investors who can evaluate these qualitative factors more accurately than the consensus may have an edge that doesn’t show up neatly in the same spreadsheet everyone else is building.
None of these potential edges are guaranteed. And the honest investor has to ask whether they actually possess them — or whether they are just telling themselves a flattering story. But they point to why serious fundamental analysis is not a waste of time. It’s just a harder game than most people entering it expect.
A Note to Luca and Lili
You’ve now read about two challenges the efficient market hypothesis poses to common investing strategies: it undermines chart reading, and it raises serious questions about stock-picking.
I want to be honest with you about where I stand.
I believe the Semi-Strong Form is mostly correct for large, heavily followed companies. When I analyze a company like Apple or Google, I assume the market has already processed most of what I can find in public filings. My job is not to outthink thousands of professionals on the most-studied businesses in the world.
But I also believe the efficient market hypothesis is not the final word. Markets misprice things — not as often as investors hope, and not as obviously as they imagine, but genuinely. The edges are real. They are smaller than advertised. And they require a level of patience, discipline, and analytical rigor that most investors are not willing to sustain.
The system I’ve built — the growth screen, the intrinsic value model, the PEGY scoring — is not an attempt to outsmart the market on every trade. It is an attempt to maintain discipline, buy with a margin of safety, and avoid the behavioral mistakes that cost most investors dearly. Whether it produces above-market returns over the long run, only time will tell. But I believe it is the right process.
The evidence about market efficiency is not a reason to give up on careful analysis. It is a reason to take that analysis seriously — to do it honestly, to test your conclusions against the data, and to remain humble about what any one investor can know.
— Papa
The One-Sentence Summary
The Semi-Strong Form of the Efficient Market Hypothesis holds that all publicly available information is already reflected in stock prices — which means fundamental analysis, while not useless, must clear a high bar before it produces a consistent, exploitable edge over a well-diversified market index.
Next: Efficient Markets, Part 4 — The Efficient Market Hypothesis, All Three Forms. We’ve touched on the Weak Form and the Semi-Strong Form throughout this series. In Part 4, we lay out all three forms together — Weak, Semi-Strong, and Strong — examine the evidence for and against each, and consider what the research as a whole tells us about how efficient markets actually are.
— Jim