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A Random Walk Down Wall Street

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Summary of “A random walk down Wall Street”
Written by Burton G. Malkiel

 Chapter 1: Firm Foundations and Castles in the air
A random walk means that future steps or directions cannot be predicted on the basis of past history. In the stock market, this concept means short-term changes of stock prices are unpredictable. Burton, writer of the book, distinguishes between “investing” and “speculating” and I agree this conceptual difference. Investing is purchasing assets to acquire profit in the form of reasonably predictable income such as dividend, interest, rentals over the long term. On the other hand, speculator buys stocks hoping for a short-term gain over the next days or weeks.
Traditionally, investment experts have used one of two approaches for asset valuation. One is “the firm-foundation theory”, and the other is “the castle-in-the-air theory”. The interesting point is, two theories appear to be mutually exclusive.
The firm-foundation theory insists that each investment instrument has a firm anchor of something called “intrinsic value”, which can be determined by careful analysis of present conditions and future prospects. Williams, writer of “The Theory of Investment Value”, went on to argue that the intrinsic value of stock was equal to the present value of its entire future dividend. The theory is reasonable, because the greater present dividends and increasing rate, the greater the value of the stock.
The castle-in-the-air-theory focuses on psychic values, professional investors analyze how the crowd of investors is likely to behave in the future and how during periods of optimism they tend to build their hopes into castles in the air. In other words, the value of stock would be decided by mass psychology rather than intrinsic value.

 Chapter 5: Technical and Fundamental Analysis
Technical analysis is the method of predicting the appropriate time to buy or sell a stock used by those believing in the castle-in-the-air view of stock pricing. They consider the investment game as one of anticipating how the other players will behave and they think all information about earnings, dividends, and the future performance of company is automatically reflected in the company’s past market prices. But if everyone tries to act on it simultaneously, no buy or sell signal can be worthwhile and if market may well be a most efficient mechanism, technical analysis is not effective.
Fundamental analysis is the technique of applying the tenets of the firm-foundation theory to the selection of individual stocks. They believe that eventually the market will reflect the security’s real worth. For fundamental analysis, there are for valuation rules imply that a security’s firm-foundation value will be higher, 1) the larger growth rate and the longer its duration 2) the larger dividend 3) the less risky 4) the lower interest rate. But at the same time we must bear in mind three important caveats. 1) Expectations about the future cannot be proven in the present. 2) Precise figures cannot be calculated from undetermined data. 3) Assessment for growth has changed for past periods and will change future continuously too.
Analysts using a combination of technical and fundamental analysis follow the three rules,
1) Buy stocks that are expected to have above-average earnings growth for five or more years
2) Never pay more for a stock than its firm foundation value
3) Look for stocks whose stories of anticipated growth are of the kind on which investors can build castles in the air.

 Chapter 6: Technical analysis and the Random-walk Theory
The technical analyst believes that knowledge of stock’s past behavior can help predict its future behavior and believes momentum. But writer of this book insists that the history of stock price movements contains no useful information that will enable an investor consistently to outperform a buy-and-hold strategy in managing a portfolio under the weak form of the random walk hypothesis.
Even though technical analyst have developed some more elaborate systems such as “The Filter System, The Dow Theory, The relative-Strength System, Price-Volume Systems, The Hemline Indicator, The Super Bowl Indicator, The Odd-Lot Theory” etc., they can predict sometimes but cannot predict continuously and exactly. Therefore writer of this book suggests there is no technical scheme whatever could walk for any length of time and advises for investors to follow the buy-and-holding strategy which has another major advantage to postpone or avoid capital gain taxes.

 Chapter 7: How good is Fundamental Analysis ?
There are two opposing views for fundamental analysis. One is Wall Streeters’s view, which is that fundamental analysis is becoming more powerful all the time. The other is the academic view, which is that fund managers and their analysts can do no better at picking stocks than a rank amateur.
Writer of this book believes that five factors that help explain why security analysts have such difficulty in predicting the future. These are 1) the influence of random events(unpredictable), 2) the production of dubious reported earnings through “creative” accounting procedures, 3) errors made by the analysts themselves, 4) the loss of the best analysts to the sales desk or to portfolio management, and 5) the conflicts of interest facing securities analysts at firms with large investment banking operations.
Even though above two opposite views are argued by fund managers, academic communities and random walkers, writer of this book insists that investors need not ignore their opinion and might reconsider their faith on professional advisers. Although it is abundantly clear that professionals do not consistently beat the average, he admits that exceptions to the rule of the efficient market exist.

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