Stock Market Efficiency: Marks and Spencer - Essay Example

Stock market efficiency INTRODUCTION FINANCIAL MARKETS EFFICIENCY Efficient market efficiency proposes that the market prices of listed securities reflect all information that is available in the market. This view suggests that the market reflects both past, current and future information that is publicly available. The theory assumes that all players in the market are rational and thus all information that may affect the share price is properly reflected in the current price (Bassen 2010, p.21). . However, experts in the field of psychology argue that human beings are not always rational in making their decisions. They argue that not all players in a stock market may interpret information in the same way (Hofmann, 2007).  Proponents of the efficient market hypothesis suggest that the market has a large number of players out to maximize profits. Each of these players logically analyzes the market information available so as to make an informed investment decision. This ensures that the market quickly and fairly represents all the available market in the prices of securities. There are three types of market efficiency; allocation efficiency, operation efficiency and pricing efficiency (Kraakman, 2003, p.11). Operational efficiency refers to the transactional costs involved in the selling and buying of securities. The operation of the London stock exchange is streamlined and well aligned to ensure operational efficiency. Allocation efficiency follows the premise that there are limited financial resources and therefore the existing resources are invested in the most productive way (Cassedy, 2004, p.6). This suggests that the investors are rational and that available capital is directed to the most profitable stock. Pricing efficiency is based on the premise that the stock fairly and instantly reflects information available in the stock market. Most of the theories developed in the area of market efficiency revolve around pricing efficiency. Pricing efficiency suggests that a security’s price reflects all the available information. Market efficiency can be said to exist in three distinct levels. These are Weak-form efficiency, Semi-strong efficiency and Strong-form efficiency (Banks, 2011, p.3).  The weak-form efficiency suggests a market that reflects all the past market information. The past information is fully and instantly reflected in the price of securities. This view therefore suggests that the past market information cannot be used to predict future prices of securities. This is because listed financial securities already reflect all past market data. Semi strong efficiency; this view indicates that the market reflects all the publicly available financial information both past and current (Lo, 1997).  This view indicates that only investors with privileged inside information can out-perform the market. Pricing of securities ensures that all anomalies are detected and rectified instantly by the market. Strong market efficiency suggests that the market fully reflects all the market information both public and confidential (Powell, 2005, p.14). This stance suggests that even insider information cannot benefit an investor to beat the market. LONDON STOCK EXCHANGE The London stock exchange is one of the most important stock markets in the world. The stock market was founded in the early 1800 and it has an estimated 3000 listed companies. It is the largest in Europe and commentators place it among the top five stock markets in the world. The active London stock exchange makes London and the United Kingdom to be regarded as a major financial hub in the world (London Stock Exchange, 2010).  Investors prefer markets that are free but well protected from financial malpractices. Investors like the London stock exchange due to its information processing efficiency which ensures that the share prices are fair. This gives investors confidence that their share prices reflect the correct value and that their investment is sufficiently liquid. The London stock exchange attracts investors from all over the world with numerous foreign companies listed on the stock market. It is regarded as one of the best markets in the world as far as the information processing efficiency is concerned. All the publicly available market information is reflected instantly in the share price of the securities listed in the stock exchange. A good example is Tesco, a company listed in the London stock exchange. The company faced a severe blow to its reputation when horse meet was discovered in beef burgers. The information went to press on 16th January 2013 and immediately the share price fell to its lowest in recent times. A close observation at Tesco’s share price indicates that the share price of the company began to fall even before the information went to press. Tesco’s share price was 355.2 on 10th January 2013 and dropped to 347.1 by 16th January 2013. The share price began to drop on 11th January. This was due to the perceived impact that the reputational risk would have on the company value (Phillips, 2013). The financial market was seen to reflect the financial data fairly and instantly. The reaction of the share price before the information was made public also suggest that there were some individuals who had the information on the horse meet before the information was made public. Another example is HMV. The company was declared as not being a going concern towards the end of last year. However, even before the formal announcement that the company was going into administration, the share price had already started falling. These two cases indicate that the London stock exchange has a strong-form efficiency market. This stance has however been challenged by some commentators arguing that the market efficiency is semi-strong. They base their arguments on the fact that there are no cases of insider deal involved. In any case insider dealing is illegal in the United Kingdom and therefore insider information should not be reflected in the share price (London Stock Exchange, 2009). MARKS AND SPENCER CASE Customers flock Marks and Spencer’s stores to purchase products they perceive to be of great value. The company has over 700 stores in the United Kingdom and a workforce of almost 80,000 people. The company is one of the oldest and most consistent in the London stock exchange (Tse, 2009).  There was a rumor that Qataris were planning to take over Marks and Spencer. Though the information available was unofficial and unverified, it impacted on the company’s share price. It was believed that investors from Qatar were preparing to take over the company in an £8 billion swoop. It was believed that investors from Qatar were seeking serious and potential equity investors so as to seal the takeover deal. This information was taken positively by the market and the company’s share price rose dramatically. On the 14th of March 2013, 11 million Marks and Spencer’s shares were traded. This is almost triple the normal volumes traded in the company shares per day. The share price changed to reflect this new information. This was despite the fact that the financial information was not yet officially released. In this case, it can be argued that the market showed strong market efficiency (Kimpton, 2013).  The share price of Marks and Spencer is quite sensitive to any new information. Like other stocks in the London stock exchange the information is reflected instantly in the company’s share price. In the past one week the share price fell by 3 %. This was following information that the retailer had ran out of stock of some products. The company’s management admitted having run out of stock of some bestselling women wear products. This information may appear insignificant but it was interpreted differently by the market. Some rational investors may have argued that the company would lose out on some profits due to lack of stock. It may be argued that the anticipated profits that were lost had been included in the current share valuation. Therefore the value of the stock had to be readjusted downwards to allow the lost profits to be eliminated from the current share value. Others may have interpreted it as a matter of inefficiency in the company’s operations management. This could also have a negative impact on the share price as operational failures may affect profits which in turn affect potential dividends and capital growth (Powell, 2005).  There were negative impacts on most businesses following the euro zone crisis and the earlier global economic crises. These led to a decrease in disposable income among many citizens (Sawyer, 2012). . Most investors also lost confidence in retail businesses as several had gone under during the hard times. Most of the citizens had to adjust their spending patterns to cope with the harsh economic conditions at the time. The information on the financial crises was fully and instantly reflected in the share price of companies listed in efficient stock markets. This led to a net decline in Marks and Spencer’s share price. SHARE PRICE EVOLUTION Looking at the share price trend over time can give a good insight about market efficiency. A company that pays a constantly increasing dividend over time is seen as an ideal investment by market players. This in turn translates to a rise in the share price of that stock. Marks and Spencer is on e of the companies that issue dividends consistently and therefore one could expect a rise in the market price of its ordinary equity shares (Worth, 2007, p.43). However the share price remained relatively unchanged in the 10 years between 2002 and 2012. However, it is worth noting that the share price fluctuated greatly in the 10 year period. The company recorded the highest price in 2007 following an increased profitability in the period. The increase in the company’s profitability was reflected efficiently in the stocks pricing. Performance of Marks and Spencer Stock (In Cents per Share) 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Revenue 287.0 348.2 363.9 393.6 468.0 505.5 569.2 574.6 603.2 614.9 Earnings 16.2 21.9 24.6 21.7 31.1 39.8 43.2 28.0 32.7 34.4 dividends 9.5 10.5 11.5 12.1 14.0 18.3 22.5 17.8 15.0 17.0 (London Stock Exchange, 2012). The revenue per share more than doubled in between 2002 and 2012. However, as described above the share price was relatively the same in the two years. The company’s earnings and revenue per share recorded consistent growth over the period. Following the efficient market hypothesis one would expect the stock to have also doubled in value(Fuller, 2006). However in this particular case the stock does not seem to follow this expected trend. From the table above it can be seen that the company had a strong performance in 2007 and 2008. As discussed earlier the company’s stock performed commendably well in the year 2007 in relation to the years reviewed. This may create basis for the argument that the share price was reflecting the current information available in 2007 as well as future performances (i.e. 2008). Therefore the share prices in the year 2007 rose to reflect past, current and future information. CONCLUSION The above discussions suggest that the London stock exchange is an efficient market. It can be seen that the market displays characteristics of strong-level market efficiency. However, as discussed earlier players in the London stock exchange do not utilize insider information while trading. It can therefore be suggested that the market portrays semi-strong market efficiency (Bassen, 2010, p.29). The market seems to have pricing and operational efficiency. It is evident that the market responds quickly and accurately to new market information. The London stock exchange allows the investors to deal in stocks without operational friction. This allows the easy movement of capital and ensures liquidity for investors and listed companies (Banks, 2011).  Investors in a stock market are concerned with the level of market efficiency so that they are confident that their securities are fairly and accurately valued. The London stock exchange is a perfect market where securities reflect available information instantly in their share price. This ensures that investors are protected from making bad investments in securities that take a long time before they reflect negative information (London Stock Exchange, 2011). As seen from the above analysis of Marks and Spencer; the market is quick to pick information and reflect the impact instantly on the market price of the company’s shares. The stock market has a mechanism of ensuring that information is relayed in a timely manner through appropriate channels. For example, the directors of Marks and Spencer disclosed several matters to the investors such as when they ran out stock in womanswear. These disclosures ensure that investors are in a position to make informed financial decisions. References BANKS, E. (2011). Finance. New York, Routledge. BASSEN, A. (2010). Information dissemination, market efficiency and the joint test issue. Norderstedt, Books on Demand CASSEDY, P. (2004). Finance. San Diego, Califonia, Lucent Books. FULLER, D. (2006). The stock market. Minneapolis, MN, Lerner Publications. HOFMANN, P. (2007). Psychology of decision making in economics, business and finance. New York, Nova Science Publishers KIMPTON, H. (2013). The stock market: theories and evidence. Homewood, Ill, R.D. Irwin. KRAAKMAN, R. (2003). The mechanisms of market efficiency. 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