2. But isn’t the market efficient?

The efficient-market hypothesis (EMH) argues that it is impossible to consistently beat the stock market because all stocks are always traded at their fair value and stock prices fully reflect all available information. EMH would have you believe the Warren Buffett’s (or any skilled investor’s) track record is merely luck (which he refutes).

If EMH were true, the performance of cheap stocks (low price to earnings (P/E) ratio) should match the performance of expensive stocks (high P/E) (since all available information is already reflected in the price, cheap stocks are cheap because they aren’t good stocks, not because they’re undervalued). Research has proved this wrong:

quantitative investing proof - 10 year PE ratio vs 20 year return

Also add odds with EMH are economic bubbles (or individual stock bubbles), which manifest as a result of cognitive biases such as overconfidence, overreaction, representative bias, information bias, and various other predictable human errors in reasoning and information processing, such as irrational exuberance, when underlying value is ignored and prices can dramatically rise and frantically fall.

To a quantitative investor, holes in the EMH theory — inefficiencies — are opportunities for excess returns.

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