'The market is always right!' That's a favourite saying of followers of an investment theory called the efficient market hypothesis (EMH) which was popularised by Professors Eugene Fama and Paul Samuelson in the 1960s.
In a nutshell, the crux of the thinking behind the EMH is that investors can't beat the market because at any point in time, stock prices are "perfectly efficient" and reflect all relevant information about a company. In effect the EMH means we should all just put our money in an index fund and head to the beach!
Ever since the EMH theory was suggested it has been very controversial, mainly due to investors such as Warren Buffett, who have proven for decades that they can profit from the market's inefficiencies. According to the EMH, Buffett can't do what Buffett does!
No doubt millions of hours and words have been spent debating the EMH and I won't add to the count here except to highlight one practical way that investors can benefit from applying a "weak" form of the EMH. By assuming that more often than not stocks are close to fairly priced (in other words the market generally gets it roughly right), investors can get a mindset whereby they need a strong conviction in a stock before declaring they are right and the market wrong.
It is worth keeping in mind that whenever you buy or sell a stock there is someone – most likely with an opposing view – on the other side of the trade.
Three stocks which in recent times have come under selling pressure are Metcash Limited (ASX: MTS), Reject Shop Ltd (ASX: TRS) and Worleyparsons Limited (ASX: WOR). These beaten-up stocks naturally attract bargain hunting investors checking whether a stock may have become mispriced during the fallout.
In the case of Metcash, the sell-off would appear justified given it is likely to be a slow and somewhat painful turnaround for the wholesaler as it implements a massive spending program to position the company for future growth.
Reject Shop has been dumped by the market after disappointing investors with results below expectations. I would argue that the dramatic de-rating has possibly been overdone, making the stock appealing despite the weaker outlook for profit growth.
Worley Parsons is a leader in its field but like many companies exposed to the mining sector it is facing headwinds. The company has operations around the globe which insulate it from the tough domestic outlook, however it would appear too early to upgrade this stock from a hold.
Foolish takeaway
Once again it would appear that the market has these stocks roughly, rightly priced. The sell-off in Metcash's share price appears justified following its earnings update. The uncertainty over the store roll-out program of Reject Shop has investors rightly sceptical, although there is arguably some value at current levels. While the market's view that companies exposed to the resource sector will continue to struggle to grow their earnings appears accurate and is fairly reflected in Worley Parsons share price.
