This
is a small case study with data from 2015. This demonstrates the failure of
efficient market hypothesis in the light of behavioral finance. EMH focuses on the
rational best interests of an investor and that the current valuation of the
company is incorporated in the public information available. It also states
that any new information which is public will be immediately incorporated in
the stock prices of the company. In the light of such theories I choose Amazon
and Berkshire Hathaway to compare the efficient market hypothesis with
behavioral finance theories.

Amazon vs Berkshire Hathaway Comparison

Amazon had surpassed Berkshire
Hathaway in market value in around July 2016 to become the largest U.S listed
company. Amazon had a market cap of $356 billion while Berkshire stood at $355
billion. The market has now determined that Amazon with a slighter edge is now
nearly equivalent to Berkshire. A small comparative analysis is shown as
follows:

Name of
Company

Amazon

Berkshire
Hathaway

Market Cap:

$356
billion

$355
billion

 Annual Profit:

 $0.59 billion
(2015), Loss of $0.24 billion (2014), $274 billion (2013), Loss of $0.03 billion
(2012), $0.63 billion (2011)

$24.08
billion (2015), $19.87 billion (2014), $19.47 billion (2013), $14.82 billion
(2012), $10.25 billion (2011)

 
Price to Earnings Ratio:

306

14.5

Consensus Earnings
Growth Rate (5 years):

49.4% per
year

Not
available

Trailing 5
years Earnings Growth Rate: –

13.15% per
year

Berkshire
Hathaway’s profits are in the billions while Amazon’s profits
were consistently less than $1 billion. Amazon has incurred losses in
two of the past five years, while Berkshire Hathaway has posted steadily rising
profits each of the last 5 years. 

The market
value is based on the future earnings of the company and not on the past prices
as securities are not mispriced in the past according to the efficient market
hypothesis. It should be no different than when we either invest in Amazon or
Berkshire.

 Let’s assume that the
profit estimates for Amazon come true for the next 5 years. Meanwhile,
Berkshire Hathaway merely matches its previous 5 years of growth.  

Amazon ends with $4.4 billion in annual profit in
2020, while Berkshire Hathaway ends up with $44.5 billion in annual profit. Let
us assume both companies end the period valued at fair value. We’ll state that
a P/E ratio of 15 is fair value in this example.

Amazon’s value in 2020 = $66 billion

Berkshire Hathaway’s value in 2020 = $667.5
billion

Investor performance

In light of these numbers, if
speculator A place $10,000 into Amazon today, while financial specialist B
place $10,000 into Berkshire Hathaway, an extensive distinction would come
about. Financial specialist A would have $1,853.93, while speculator B would
have $18,287.67. This leaves financial specialist B with right around tenfold
the amount of cash as speculator A. The efficient market hypothesis would
recommend that this result isn’t conceivable.

There are a couple of
conceivable conclusions. The first and easiest arrangement is that the
efficient market theory isn’t right. It is conceivable to outflank the market
by legitimate choice of stocks through fundamental analysis. I trust this to be
the soundest answer.

A substitute conclusion could be that Amazon will keep up
an improvement rate significantly greater than Berkshire Hathaway for longer
than 5 years. On the off chance that we by one means or another figured out how
to recognize the 49.4% improvement rate and let Amazon’s wage continue
developing at that rate, they would at last outflank Berkshire Hathaway’s
benefit. This is a possible outcome. On the off chance that this by one means
or another figured out how to happen, by then the market could be beneficially
regarding Amazon and Berkshire Hathaway. It’s reliant upon you to choose on the
off chance that you feel that is the sensible outcome.

Implications of the Efficient Market Hypothesis
for Investors

In the event that you trust the efficient market
hypothesis to be valid, at that point your best activity as a speculator is to
put exclusively in record supports that match the market. Under the effective
market hypothesis, it is difficult to outflank the market, so you will
accomplish most extreme hazard balanced returns by basically owning the whole
market. You can utilize file finances or record ETFs to accomplish this
objective.

In the event that you trust the effective market
hypothesis isn’t valid, at that point your best activity is less certain. It
can at present be sane to put resources into list reserves. Regardless of
whether the market isn’t proficient, you could at present catch normal market
returns without much exertion. This can be an extremely positive result. In any
case, on the off chance that you needed to beat the market, at that point you
could take after various esteem based procedures to build your chances of
progress. I will cover these techniques inside and out. I trust it is feasible
for a person to either beat the market or match the market with less risk than
the market all in all.

On a concluding note, the current Market capitalization of
Amazon has hugely surpassed Berkshire. The most important reason attributed to
such an event is the market sentiment relating to Amazon. The positive vibe
about ecommerce making life simpler and the readiness of people investing in
the technology perspective has hugely helped Amazon to amass nearly double the
capitalization in just 3 years. It is quintessential to observe that the market
sentiment, investor confidence and the general goodwill of the people accepting
ecommerce technology and putting their trust in it has led to huge gains for
Amazon. This case study is a classic example of the traditional finance vs
behavioral finance anomaly.