A Random Walk Down Wall Street
Summary
Ch-1
Part 1 – Stock and their values
Firm Foundations and Castles in the Air
This novel is basically going to talk about the complex world of finance and practical advice on
investment opportunities and strategies. This book is a succinct guide for the individual investor
because it was believed that individual investor has scarcely a chance today against Wall Street's
professionals because of the technique wall street people use but s when the stock market tanked in
October 1987 , it was the steady investors who kept their heads and then saw the value of their holdings
eventually recover and continue to produce attractive returns. primarily it is a book about common
stocks an investment medium that not only has provided generous long-run returns in the past but also
appears to represent good possibilities for the years ahead
A random walk is one in which future steps or directions cannot be predicted on the basis of past
actions. When the term is applied to the stock market, it means that short-run changes in stock prices
cannot be predicted. . On Wall Street, the term "random walk" is an obscenity. . By the 1990s, some
academics joined the professionals in arguing that the stock market was at least somewhat predictable
after all.
investing is a method of purchasing assets to gain profit in the form of reasonably predictable income
(dividends, interest, or rentals) and/or appreciation over the long term. When the evil Luthor bought
land in Arizona with the idea that California would soon slide into the ocean, thereby quickly producing
far more valuable beach-front property, he was speculating. Had he bought such land as a long-term
holding after examining migration patterns, housing-construction trends, and the availability of water
supplies, he would probably be regarded as investing particularly if he viewed the purchase as likely to
produce a dependable future stream of cash returns. investments have to produce a rate of return
equal to inflation.
if we are to cope with even a mild inflation, we must undertake investment strategies that maintain
our real purchasing power; otherwise, we are doomed to an ever-decreasing standard of living.
Investing in Theory
Traditionally, the pros in the investment community have used one of two approaches to asset
valuation: the firm-foundation theory or the castle-in-the-air theory. During the 1970s, a third theory,
born in academia and named the new investment technology
There are two basic theories for stocks’ valuation, one based
on stocks’ actual characteristics, another based solely on human
psychology.
The Firm-Foundation Theory
The firm-foundation theory argues that each investment instrument, be it a common stock or a piece of
real estate, has a firm anchor of something called intrinsic value, which can be determined by careful
analysis of present conditions and future prospects. When market prices fall below (rise above) this
firm foundation of intrinsic value, a buying (selling) opportunity arises, because this fluctuation will
eventually be corrected or so the theory goes. Investing then becomes a dull but straightforward
matter of comparing something's actual price with its firm foundation of value.
In The Theory of Investment Value, Williams presented an actual formula for determining the intrinsic
value of stock. Williams based his approach on dividend income. In a fiendishly clever attempt to keep
things from being simple, he introduced the concept of "discounting" into the process. Discounting
basically involves looking at income backwards. Rather than seeing how much money you will have next
year (say $1.05 if you put $1 in a savings bank at 5 percent interest), you look at money expected in the
future and see how much less it is currently worth (thus, next year's $1 is worth today only about 95¢,
which could be invested at 5 percent to produce approximately $1 at that time)
Williams actually was serious about this. He went on to argue that the intrinsic value of a stock was
equal to the present (or discounted) value of all its future dividends
The firm-foundation theory holds that assets have an “intrinsic
value” based on their present conditions and future
potential. The firm-foundation theorist will calculate the stock’s
intrinsic value by summing (1) the value of its present dividends and
(2) the estimated growth of its dividends in the future.
Once an intrinsic value is established, the investor will make buying
and selling decisions based on the difference between the actual price
of the stock and the intrinsic value (because, according to the
theory, the price will eventually regress to the intrinsic value).
The Castle-in-the-Air Theory
It was his opinion that professional investors prefer to devote their energies not to estimating intrinsic
values, but rather to analyzing 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. The successful investor
tries to beat the gun by estimating what investment situations are most susceptible to public castle-
building and then buying before the crowd. Keynes, applied psychological principles rather than
financial evaluation to the study of the stock market
, the optimal strategy is not to pick those faces the player thinks are prettiest, or those the other players
are likely to fancy, but rather to predict what the average opinion is likely to be about what the average
opinion will be, or to proceed even further along this sequence. In this kind of world, there is a sucker
born every minute and he exists to buy your investments at a higher price than you paid for them. Any
price will do as long as others may be willing to pay more.
The castle-in-the-air theory - an asset is only worth what someone
else will pay for it. A castle-in-the-air investor makes money
by investing in stocks she thinks other investors will value.
2 The Madness of Crowds
In this chapter, Malkiel discusses the role of psychology in market behavior, focusing on
speculative bubbles. He begins by citing examples of bubbles throughout history, such
as the Dutch Tulip Mania of the 17th century, the South Sea Bubble of the 18th century,
and the Wall Street Crash of 1929. He argues that bubbles are caused by a
combination of factors, including:
Dutch tulip mania
Investors tend to follow the crowd, and when they see other investors buying a
particular asset, they are more likely to buy it themselves, even if they don't believe it is
a good investment.
When a bubble is forming, investors are not buying assets because they believe they
are fundamentally undervalued. Instead, they are buying them because they believe
other investors will buy them at a higher price in the future. during the Dutch Tulip Mania
of the 17th century, tulip bulbs were selling for prices that were many times the value of
the land they were grown on. At the time, people believed that tulip prices would only
continue to rise, and they were willing to pay exorbitant prices to get in on the action.
Of course, all bubbles eventually burst. When this happens, investors who are caught
up in the bubble can lose a lot of money. For example, the Dutch Tulip Mania ended in
a crash that wiped out many investors.
, the best way to protect yourself is to avoid investing in assets that are clearly overvalued.
The South Sea Bubble
The South Sea Bubble was a financial bubble that occurred in England in 1720. The
bubble was caused by a combination of factors, including:
The English government had recently borrowed a large sum of money to finance the
War of the Spanish Succession. In order to repay the debt, the government granted a
monopoly on trade with South America to the South Sea Company. Investors were
excited about the potential profits of trade with South America, and they began to buy
shares of the South Sea Company at increasingly high prices. As the price of South
Sea Company shares continued to rise, more and more investors bought them, even if
they didn't know much about the company or the risks involved.
The South Sea Bubble eventually burst in September 1720, when it became clear that
the South Sea Company was not going to be able to live up to the expectations of
investors. The collapse of the bubble led to widespread financial ruin and a loss of
confidence in the English government.
Malkiel uses the South Sea Bubble to illustrate the dangers of financial bubbles and the
importance of investing for the long term. He argues that bubbles are inevitable, and
that they can have a devastating impact on investors who are caught up in them. He
also argues that it is impossible to predict when a bubble will burst, which is why
investors should avoid trying to time the market.
Malkiel recommends that investors invest in a diversified portfolio of assets and hold
their investments for the long term. This will help them to reduce their risk and protect
their capital.
The Florida Real Estate Craze
Investors were excited about the potential profits of investing in Florida real estate. They
believed that the state's population would continue to grow and that property prices
would continue to rise. As the price of Florida real estate continued to rise, more and
more investors bought it, even if they didn't know much about the state or the risks
involved. Investors were afraid of missing out on the profits that everyone else seemed
to be making.
The Florida Real Estate Craze eventually burst in 1926, when it became clear that there
was too much supply of real estate and not enough demand.
Wall Street Lays an Egg
The stock market crash of 1929 led to a sharp decline in economic activity and a wave
of bankruptcies. The crash also had a significant psychological impact on Americans,
who lost faith in the stock market and the economy..
The stock market crash of 1929 is a cautionary tale for investors. It shows that even the
most intelligent and rational people can be susceptible to the madness of crowds. It also
shows that the stock market is not a one-way street to riches. Investors should be wary
of financial bubbles and should invest for the long term.
AN AFTERWORD
What is hard to avoid is the alluring temptation to throw your money away on short, get rich-quick
speculative binges.
The afterword of Burton Malkiel's book A Random Walk Down Wall Street discusses the
importance of investing for the long term and the dangers of trying to time the market.
Malkiel argues that the stock market is a random walk, meaning that it is impossible to
predict future stock prices. He also argues that the best way to invest in the stock
market is to invest in a diversified portfolio of assets and hold your investments for the
long term.
Malkiel begins the afterword by discussing the different types of investors. He divides
investors into two categories: speculators and investors. Speculators try to predict
future stock prices and make quick profits. Investors, on the other hand, invest in
the stock market for the long term and do not try to time the market.
Malkiel argues that the stock market is too complex for anyone to predict future stock
prices with accuracy. He points to the fact that even the most experienced investors
often fail to beat the market.
Invest for the long term. Don't try to time the market.
Invest in a diversified portfolio of assets. This includes stocks, bonds, and cash.
Rebalance your portfolio regularly.
Don't panic sell. If the market goes down, don't sell your investments. Hold on to them
for the long term.
