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Lets say I am using the dividend-discount model (DDM) to figure out the share price of a company and I also believe that markets are efficient, what does the long term/perpetual growth rate produced under this assumption means?

EMH tells me that securities will be fairly priced since all information are available to investors. What does this tell me about the long term rate? So given all the information available to the public, the long term growth is x. What does x means?

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The EMH cannot tell you the future growth rate of a company. There is no way to accurately predict the future growth rate even from private information. The EMH claims that stocks are fairly prices if all investors have access to all public information. It does NOT say that stocks are correctly priced. Market conditions change, companies make bad (or good but risky) decisions, etc. All of that affects the future value of stocks.

Anyone that comes up with a future growth rate must use assumptions about the future. Now, those assumptions may come from publicly-available forecasts from the company or other public data, but that does not mean that everyone uses these forecasts or the same data. Some may feel that the company is being overly optimistic (which is common), or that market conditions will change that makes the forecasts inaccurate.

So there really is no connection between analysts' growth rate assumptions and the EMH.

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  • What is the difference between fairly priced and correctly priced?
    – CountDOOKU
    Oct 11 at 14:11
  • @CountDOOKU The correct price can only be known after the fact?
    – user12515
    Nov 10 at 16:12
  • @CountDOOKU Estimates may be off in any direction and by any amount, therefore they are certainly not correctly priced. But in an efficient market there is no realiable way to tell by how much any estimate is off or even in which direction.
    – Manziel
    Nov 11 at 9:24
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EMH tells me that securities will be fairly priced since all information are available to investors.

No, it doesn't. It says all publicly available information is priced into the stock. The Efficient Market Hypothesis says there is no way to accurately predict the future value of a stock.

You can use DDM, but that goes against the Efficient Market Hypothesis. Think of it this way - DDM is Googleable. Everyone knows or can very quickly learn it. All public information, which is used to calculated DDM, is already priced into the stock.

I highlighted the word public because the "best" way to make money on individual stocks is with insider information. If you know a company is embezzling, you can short it. Good luck talking with the SEC.

If you want to invest based on the Efficient Market Hypothesis buy index funds, and throw any equation trying to predict future value out the window.

EDIT to address comments

If you're interested in a pretty detailed and exhaustive explanation, from theory to implementation, read A Random Wall down Wall Street - it's written by the person who "invented" (or at least popularized) the Efficient Market Hypothesis.

given all information that is available to investors

Like I said, all public information. If an investor has private information, that is insider trading.

The answer to your original question is still the same though. Any predicted value based on DDM is already priced into the stock when you buy it. You get a fair price because any predicted future value is already priced into the stock.

Going the other way, if DDM gave you an advantage, the stock price wouldn't be fair - in finance terms, that's called arbitrage. Investors would see an undervalued asset and start buying, driving up the cost. Eventually, investors would not be able to make money at the new higher price and stop buying.

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  • Hi thanks for commenting. But I don't think this answers the question? I am not asking about investing in real life under EMH, I am doing a "thought experiment", just a scenario and what it means under those scenario. You mentioned nothing about growth?
    – CountDOOKU
    Oct 10 at 6:44
  • Also, "EMH - It implies that securities will be fairly priced, based on their future cash flows, given all information that is available to investors" berk, J., and DeMarzo, P., (2019) Corporate Finance, Global Edition, 5th Edition, Pearson. Direct quote from a textbook
    – CountDOOKU
    Oct 10 at 6:45
  • @CountDOOKU - see edits Oct 10 at 14:43
  • Hi sevensevens, thanks for updating your answer. I appreciate it.
    – CountDOOKU
    Oct 11 at 13:55
  • Under the strong version of the EMH (which maybe nobody really believes), even insider information is priced in.
    – user12515
    Nov 10 at 16:11

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