Geoffrey Henley, a professor of finance, states: "The capital market is efficient. I don't know why anyone would bother devoting their time to following individual stocks and doing fundamental analysis. The best approach is to buy and hold a well-diversified portfolio of stocks.". Do you agree? Why or why not?

Answer 1

Professor Henley's strategy is consistent with much of the literature in modern finance. If the stock market is efficient, diversification permits investors to generate a risk-return relation that strictly dominates that of investing in just a few stocks.
However, if the stock market is not completely efficient, it may be possible to use fundamental analysis to predict future stock prices. In this sense, an informed investor can generate an even higher risk-return profile than holding a diversified portfolio by investing in stocks where he/she has an information advantage. Of course, one could think of the superior returns from this strategy as a return on the investment of time and money required to acquire and evaluate information about the financial and strategic performance of a firm.
Thus, Professor Henley's recommendation is probably very sound advice to most investors, who do not invest in following a few stocks very closely. However, it may not be the best advice for a professional investor who has invested in developing industry or firm-specific knowledge from detailed fundamental analysis.