Economic BasisThe efficient market theory predicts that all known information about the probable future returns of an investment is immediately reflected in prices. An investor who purchases a stock based on future predictions should be aware that such possibilities are likely already priced into the stock.
ImpactA stock that is priced for perfection may not go up when good news such as strong earnings occur because such results were already expected. In some cases, a stock that is priced for perfection can fall dramatically on slightly negative news as the firm may have a far higher price than similar firms with a track record of mixed performance.
ExampleAt the start of a year, economists and investment pundits expect a particular economy to grow at 5%. Stocks rise dramatically early in the year to reflect this prediction. This particular economy hasn't grown at 5% for more than 30 years and this widespread prediction expects things to go very well. Mid-year it becomes clear that growth will come in closer to 3% and stocks decline significantly in response.
|Overview: Priced For Perfection|
Investments that achieve a high valuation based on optimistic expectations for future earnings.