Specifically, the hypothesis suggests that excess investment returns cannot be made systematically by exploiting anomalies in the price of securities traded on liquid markets. That's because efficient markets factor all information into prices, so only the arrival of new information will move prices. Since the timing and nature of such information is unpredictable, future price changes will be equally unpredictable and, without some degree of predictability, excess returns can't be assured.
And who could have predicted the announcement that Petrofac made on 20 April, given what the company had said just eight weeks earlier when it released 2014's results? Those figures, which Petrofac had already flagged up as poor, were a cue for a penitential 'mea culpa' from the company's bosses. They confessed to trying to do too many things too quickly and straying outside their areas of competence.
In particular, they owned up to $650m (£430m) of losses and write downs, most of which stemmed from three especially costly projects. Chief among these were $230m of losses on Petrofac's $800m contract with France's Total (Fr: Euronext) to build the plant at Sullom Voe in the Shetlands that will process gas from the Laggan and Tormore fields on the edge of the north Atlantic Ocean. These fields are both totemic and significant - quite likely the last major unexploited fields in UK waters. It could hardly enhance Petrofac's reputation to louse up its part of a $3.5bn project that will eventually supply 5 per cent of the UK's gas requirements.
However, the City appreciates a heartfelt confession, especially when it comes with an assurance of lessons learnt and a promise to do better. As a result, Petrofac's share price, which - matching the oil price - had been on a downward path since mid-2012, revived strongly. From 24 February - the day before the results announcement - to 15 April the price gained 31 per cent to 1,065p as investors assumed that past news was bad enough to ensure that future news must be good.
What greeted them the following Monday - 20 April - was the efficient market hypothesis in all its indifferent brutality. Petrofac's bosses admitted that, on top of the $230m losses they had earlier identified, were another $195m of losses. So, after accounting for $50m profit earlier been credited to the contract, the $800m Laggan-Tormore project had lost Petrofac $375m; and its completion would be a year overdue. As a result, Petrofac's share price randomly walked 10 per cent lower during the day and the next day walked down another 5 per cent. It has since recouped some lost ground but, at 889p, is still 17 per cent lower than it peaked in mid April.
That so much extra loss could emerge in such a short time poses damaging questions about Petrofac's reporting systems and its ability to manage big contracts. It does not help that Laggan-Tormore is not an isolated case. Petrofac has also highlighted almost equally big losses on two other contracts - one in the North Sea, the other in Romania. Perhaps these two contain more dark secrets. Or maybe next time the bad news will emanate from somewhere completely unexpected; say, from the Middle East, where Petrofac has a strong record.
Alternatively, there may be no more bad news. What Petrofac dished up on 20 April might be, as its bosses hope, the end of the matter. It won't repeat the mistake of taking on a big lump-sum contract in unfamiliar territory, dealing with stroppy, well-organised workers. In which case, Petrofac may return to the steady generation of - for example - a return on assets of around 10 per cent, an operating profit margin of about 11 per cent and a net margin of 9 per cent. Simultaneously, the turnover of its fixed assets and its receivables, whose pace had slowed to a crawl, might liven up.
If all that comes through, then the share price should, indeed, recover. But there is no telling whether it will happen. If Petrofac's bosses knew so little about what's going on, then how can outside investors - peering through the glass darkly - know any better? Yet that's how it is with investing; and that's why the efficient market hypothesis is so powerful.
The reasonable hope is that Petrofac's performance will revert to mean. But the mean - the average - must, by definition, shift as more information comes along and Petrofac's mean could be slipping irrevocably downwards. Certainly it's a concern that the group has been inept at generating cash. In the past five years free cash flow has been negative to the sum of approaching $400m. True, Petrofac's fast growth is a factor behind that and the group's order book is worth almost $19bn (three years worth of revenue). Monetising that in the coming years, coupled with Petrofac's strong balance sheet, lies at the heart of a bull case for the shares. It is what prompted me to buy a stake for the Bearbull Income Portfolio when the flak was really flying a week ago (for more background, see Bearbull, 6 March 2015). But I'm not kidding anyone that I was making anything other than a glorified guess. In investing, that how it always is.
