Page 3 A Random Walk Down Wall Street Including A Life-Cycle Guide To Personal Investing Burton G. Malkiel Chemical Bank Chairman's Professor of Economics At Princeton University Page 4 Copyright © 1999, 1996, 1990, 1985, 1981, 1975, 1973 by W. W. Norton & Company, Inc. All rights reserved Printed in the United States of America The text of this book is composed in Zapf Elliptical with the display set in Berling. Desktop composition by Justine Burkat Trubey Manufacturing by the Haddon Craftsmen, Inc. Library of Congress Cataloging-in-Publication Data Malkiel, Burton G. A random walk down Wall Street : including a life-cycle guide to personal investing / Burton G. Malkiel. p. cm. Rev. ed. of: a random walk down Wall Street. c1996. Includes bibliographical references and index. ISBN 0-393-04781-4 1. Investments. 2. Stocks. 3. Random walks (Mathematics) I. Malkiel, Burton G. Random walk down Wall Street. II. Title. HG4521 .M284 1999 332.6—dc21 98-50671 CIP W. W. Norton & Company, Inc., 500 Fifth Avenue, New York, N.Y. 10110 http://www.wwnorton.com W. W. Norton & Company Ltd., 10 Coptic Street, London WC1A 1PU 2 3 4 5 6 7 8 9 0 Page 7 CONTENTS Preface 13 Acknowledgments from Earlier Editions 17 Part One Stocks and Their Value 1. Firm Foundations and Castles in the Air 23 What Is a Random Walk? 24 Investing as a Way of Life Today 26 Investing in Theory 28 The Firm-Foundation Theory 29 The Castle-in-the-Air Theory 31 How the Random Walk Is to Be Conducted 33 2. The Madness of Crowds 35 The Tulip-Bulb Craze 36 The South Sea Bubble 39 The Florida Real Estate Craze 45 Wall Street Lays an Egg 46 An Afterword 53 3. Stock Valuation from the Sixties through the Nineties 55 The Sanity of Institutions 55 The Soaring Sixties 57 The New "New Era": The Growth-Stock/New-Issue Craze 57 Synergy Generates Energy: The Conglomerate Boom 61 Performance Comes to the Market: The Bubble in Concept Stocks 69 The Sour Seventies 73 The Nifty Fifty 73 The Roaring Eighties 76 The Triumphant Return of New Issues 76 Concepts Conquer Again: The Biotechnology Bubble 78 Page 8 The Chinese Romance with the Lycoris Plant 80 Some Other Bubbles of the 1980s 81 What Does It All Mean? 85 The Nervy Nineties 85 The Japanese Yen for Land and Stocks 85 The Internet Craze of the Late 1990s 90 A Final Word 94 4. The Firm-Foundation Theory of Stock Prices 95 The "Fundamental" Determinants of Stock Prices 96 Two Important Caveats 103 Testing the Rules 106 One More Caveat 108 What's Left of the Firm Foundation? 111 Part Two How the Pros Play the Biggest Game in Town 5. Technical and Fundamental Analysis 117 Technical versus Fundamental Analysis 118 What Can Charts Tell You? 119 The Rationale for the Charting Method 124 Why Might Charting Fail to Work? 126 From Chartist to Technician 127 The Technique of Fundamental Analysis 128 Why Might Fundamental Analysis Fail to Work? 132 Using Fundamental and Technical Analysis Together 134 6. Technical Analysis and the Random-Walk Theory 138 Holes in Their Shoes and Ambiguity in Their Forecasts 138 Is There Momentum in the Stock Market? 140 Just What Exactly Is a Random Walk? 142 Some More Elaborate Technical Systems 145 The Filter System 146 The Dow Theory 146 The Relative-Strength System 147 Price-Volume Systems 148 Reading Chart Patterns 148 Randomness Is Hard to Accept 149 A Gaggle of Other Technical Theories to Help You Lose Money 150 Page 9 The Hemline Indicator 151 The Super Bowl Indicator 153 The Odd-Lot Theory 153 A Few More Systems 155 Technical Market Gurus 155 Why Are Technicians Still Hired? 159 Appraising the Counterattack 160 Implications for Investors 163 7. How Good Is Fundamental Analysis? 165 The Views from Wall Street and Academia 166 Are Security Analysts Fundamentally Clairvoyant? 166 Why the Crystal Ball Is Clouded 170 1. The Influence of Random Events 171 2. The Creation of Dubious Reported Earnings through "Creative" Accounting Procedures 172 3. The Basic Incompetence of Many of the Analysts Themselves 174 4. The Loss of the Best Analysts to the Sales Desk or to Portfolio Management 177 Do Security Analysts Pick Winners? The Performance of the Mutual Funds 178 Can Any Fundamental System Pick Winners? 186 The Verdict on Market Timing 187 The Semi-strong and Strong Forms of the Random-Walk Theory 190 The Middle of the Road: A Personal Viewpoint 193 Part Three The New Investment Technology 8. A New Walking Shoe: Modern Portfolio Theory 199 The Role of Risk 200 Defining Risk: The Dispersion of Returns 201 Exhibit 201 Expected Return and Variance: Measures of Reward and Risk 201 Documenting Risk: A Long-Run Study 204 Reducing Risk: Modern Portfolio Theory (MPT) 206 Diversification in Practice 211 9. Reaping Reward by Increasing Risk 220 Beta and Systematic Risk 221 Page 10 The Capital-Asset Pricing Model (CAPM) 224 Let's Look at the Record 229 An Appraisal of the Evidence 232 The Quant Quest for Better Measures of Risk: Arbitrage Pricing Theory 234 A Summing Up 237 10. The Assault on the Random-Walk Theory: Is the Market Predictable after All? 240 Predictable Patterns in the Behavior of Stock Prices 242 1. Stocks Do Sometimes Get on One-Way Streets 243 2. But Eventually Stock Prices Do Change Direction and Hence Stockholder Returns Tend to Reverse Themselves 244 3. Stocks Are Subject to Seasonal Moodiness, Especially at the Beginning of the Year and the End of the Week 247 Predictable Relationships between Certain "Fundamental" Variables and Future Stock Prices 249 1. Smaller Is Often Better 249 2. Stocks with Low Price-Earnings Multiples Outperform Those with High Multiples 251 3. Stocks that Sell at Low Multiples of Their Book Values Tend to Produce Higher Subsequent Returns 253 4. Higher Initial Dividends and Lower Price-Earnings Multiples Have Meant Higher Subsequent Returns 254 5. The "Dogs of the Dow" Strategy 258 And the Winner Is . . . 259 The Performance of Professional Investors 259 Concluding Comments 267 Appendix: The Market Crash of October 1987 270 [...]... Peter Asch, Leo Bailey, Jeffrey Balash, William Baumol, G Gordon Biggar, Jr., Lester Chandler, Barry Feldman, William Grant, Sol Malkiel, Richard Quandt, Michael Rothschild, H Barton Thomas, and Robert Zenowich It is particularly appropriate that I emphasize the usual caveat that the above-named individuals are blameless for any errors of fact or judgment in these pages Many have warned me patiently and... Ethan Hugo, David Banyard, and Deborah Jenkens Yexiao Xu provided invaluable research assistance, and Linda Wheeler offered exceedingly skillful editorial assistance Superb typing support was provided by Barbara Johnson, Barbara Mains, Kay Kerr, Pia Ellen, Claire Cabelus, and especially Phyllis Durepos Donald Lamm, Robert Kehoe, and Deborah Makay continued to make my association with W W Norton a most... new material in this book has been included to explain these financial innovations and to show how you as a consumer can benefit from them This edition takes a hard look at the basic thesis of earlier editions of Random Walk that the market prices stocks so efficiently that a blindfolded chimpanzee throwing darts at the Wall Street Journal can select a portfolio that performs as well as those managed... investment returns and to see how they are accumulating at a faster rate than your salary And it's also stimulating to learn about new ideas for products and services, and innovations in the forms of financial investments A successful investor is generally a well-rounded individual who puts a natural curiosity and an intellectual interest to work to earn more money Investing in Theory All investment returns—whether... Shane Antos and Jonathan Curran, who provided indispensable and superb research assistance Lugene Whitley made extraordinary contributions in transforming various illegible drafts and dictating tapes into readable text Phyllis Durepos also provided valuable typing assistance Ed Parsons and Mark Henderson of W W Norton provided indispensable assistance in bringing this edition to publication Patricia Taylor... most pleasant one Joan Ryan and Claire Bien were extremely helpful in preparing new and updated charts Michele Petersen also assisted in many ways Finally, Rugby was particularly cooperative in agreeing to chew shoes and pillows instead of this manuscript The first edition of Random Walk was dedicated to Jonathan, without whom the original manuscript would have been completed a year earlier Because of... Mutual-Fund Costs 400 The Malkiel Step 401 A Paradox 405 Some Last Reflections on Our Walk 406 A Random Walker's Address Book and Reference Guide to Mutual Funds 409 Bibliography 429 Index 445 Page 13 PREFACE It has now been close to thirty years since I began writing the first edition of A Random Walk Down Wall Street The message of the original edition was a very simple one: Investors would be far better... pin-striped suits do not like being compared with bare-assed apes They retort that academics are so immersed in equations and Greek symbols (to say nothing of stuffy prose) that they couldn't tell a bull from a bear, even in a china shop Market professionals arm themselves against the academic onslaught with one of two techniques, called fundamental analysis and technical analysis, which we will examine... has? The answer is that there have been enormous changes in the financial instruments available to the public A book meant to provide a comprehensive investment guide for individual investors needs to be updated to cover the full range of investment products available In addition, investors can benefit from a critical analysis of the wealth of new information provided by academic researchers and market... her salt could calculate it with just a few taps of the calculator or personal computer Perhaps the most successful disciple of the Graham and Dodd approach was a canny midwesterner named Warren Buffett, who is often called "the sage of Omaha." Buffett has compiled a legendary investment record, allegedly following the approach of the firmfoundation theory Page 31 The Castle-in-the-Air Theory The castle-in-the-air . Burkat Trubey Manufacturing by the Haddon Craftsmen, Inc. Library of Congress Cataloging-in-Publication Data Malkiel, Burton G. A random walk down Wall Street : including a life-cycle guide to. Page 3 A Random Walk Down Wall Street Including A Life-Cycle Guide To Personal Investing Burton G. Malkiel Chemical Bank Chairman's Professor of Economics At Princeton University Page. Value 1. Firm Foundations and Castles in the Air 23 What Is a Random Walk? 24 Investing as a Way of Life Today 26 Investing in Theory 28 The Firm-Foundation Theory 29 The Castle-in-the-Air