What is the implication of the efficient market hypothesis on stock selection?

The efficient market hypothesis (EMH) suggests that stock prices reflect all available information at any point in time. As a result, it implies that stocks are priced accurately and that any new information is quickly absorbed and reflected in the stock’s price. This leads to the conclusion that achieving consistent outperformance of the market is unlikely because any potential mispricings that could be exploited for above-average returns are quickly corrected by the actions of informed investors.

In the context of stock selection, if the market is efficient, it becomes very difficult for individual investors or even professional fund managers to find undervalued stocks consistently. Since prices already incorporate all known information, the odds of consistently identifying stocks that will outperform the market diminish significantly, making it more challenging to achieve significant and repeatable investment success through selection alone. This foundational principle of EMH is key for understanding many strategies in finance and investing, as it suggests that passive management might be a more effective approach than active management for most investors.