gular expense, as normal companies do, AOL spread them over two years. This let AOL report annual profits based on revenue figures derived from denying actual expenses (as cited in Newsweek, November 11 edition).By deferring those costs, AOL over the years reported profits $385 million greater than they would otherwise have been. The company then used these non-existent profits to promote itself as a money-making opportunity for both stockholders and potential investors, artificially increasing its stock prices. This accounting practice is perfectly legal, but the information was kept private for over two years. The company has recently announced that, effective immediately, promotion expenses will be charged to earnings as the expenses are incurred, the way a normal company does. AOL will also take a one-time special charge of $385 million for the "deferred" promotion costs. This effectively negated all profits reported by the company over the years and put them in a negative net cash flow situation. As a result, AOL's stock is currently listed at 35 1/4, down from a high of 71 in May. This example clearly outlines a major flaw in Efficient Market Theory: If EMT relies heavily on information as the basis for determining market value, what happens if the information is manipulated? As a counterpoint, the clear assertion in the Newsweek article is that most normal companies do not use such accounting practices, however legal, to falsely report superior performance. EMT states:Fundamental analysis cannot produce investment recommendations that will enable an investor consistently to outperform a buy-and-hold strategy in managing a portfolio (Malkiel, 1990).The corollary of the theory must also then be true. An investor cannot be hurt by the market because the stock value of a poor or overvalued performer already reflects that fact in its price. The available information would indicate to investors that certain stocks are overvalued and su...
