A Random Walk Down Wall Street by Burton Gordon Malkiel; 23 editions; The Time-Tested Strategy for Successful Investing, Ninth Edition. A Random Walk Down Wall Street: The Time-Tested Strategy for Successful Investing (Ninth Edition) [Burton G. Malkiel] on inevosisan.ml *FREE* shipping on . pdf. A Random Walk Down Wall Street: The Time-Tested Strategy for Successful Investing . The message of the original edition was a very simple one: Investors would be far better off . That's why I think you'll enjoy this random walk down Wall Street. In the ninth edition of this book, I presented the case of Carl P.
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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. Malkiel, Burton G. A random walk down Wall Street: the time-tested strategy for successful investing. [Revised and updated 11th ed.]. W. W. Norton, p. inevosisan.mlsful. inevosisan.mlnpdf. ISBN: | pages | 13 Mb.
The logic of the firm-foundation theory is quite respectable and can be illustrated with common stocks. It stands to reason that the greater the present dividends and their rate of increase, the greater the value of the stock; thus, differences in growth rates are a major factor in stock valuation. Now the slippery little factor of future expectations sneaks in. Security analysts must estimate not only long-term growth rates but also how long an extraordinary growth can be maintained.
When the market gets overly enthusiastic about how far in the future growth can continue, it is popularly held on Wall Street that stocks are discounting not only the future but perhaps even the hereafter.
The point is that the firm-foundation theory relies on some tricky forecasts of the extent and duration of future growth. The foundation of intrinsic value may thus be less dependable than is claimed. The firm-foundation theory is not confined to economists alone. It was that easy.
Of course, instructions for determining intrinsic value were furnished, and any analyst worth his or her salt could calculate it with just a few taps of the personal computer. John Maynard Keynes, a famous economist and successful investor, enunciated the theory most lucidly in 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.
According to Keynes, the firm-foundation theory involves too much work and is of doubtful value. Keynes practiced what he preached. In the depression years in which Keynes gained his fame, most people concentrated on his ideas for stimulating the economy.
It was hard for anyone to build castles in the air or to dream that others would. Nevertheless, in his book The General Theory of Employment, Interest and Money, Keynes devoted an entire chapter to the stock market and to the importance of investor expectations. With regard to stocks, Keynes noted that no one knows for sure what will influence future earnings prospects and dividend payments.
Disclosure of the Topic of Personal Investment
It is analogous to entering a newspaper beauty-judging contest in which one must select the six prettiest faces out of a hundred photographs, with the prize going to the person whose selections most nearly conform to those of the group as a whole. The smart player recognizes that personal criteria of beauty are irrelevant in determining the contest winner. A better strategy is to select those faces the other players are likely to fancy.
This logic tends to snowball. After all, the other participants are likely to play the game with at least as keen a perception. So much for British beauty contests. The newspaper-contest analogy represents the ultimate form of the castle-in-the-air theory of price determination.
An investment is worth a certain price to a downloader because she expects to sell it to someone else at a higher price. The investment, in other words, holds itself up by its own bootstraps. The new downloader in turn anticipates that future downloaders will assign a still higher value. In this kind of world, a sucker is born every minute—and he exists to download 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. There is no reason, only mass psychology. All the smart investor has to do is to beat the gun—get in at the very beginning.
Robert Shiller, in his best-selling book Irrational Exuberance, argues that the mania in Internet and high-tech stocks during the late s can be explained only in terms of mass psychology.
At universities, so-called behavioral theories of the stock market, stressing crowd psychology, gained favor during the early s at leading economics departments and business schools across the developed world. In an exchange economy the value of any asset depends on an actual or prospective transaction.
He believed that every investor should post the following Latin maxim above his desk: Res tantum valet quantum vendi potest. A thing is worth only what someone else will pay for it. My first task will be to acquaint you with the historical patterns of pricing and how they bear on the two theories of pricing investments.
It was Santayana who warned that if we did not learn the lessons of the past we would be doomed to repeat the same errors. Therefore, in the pages to come I will describe some spectacular crazes— both long past and recently past. Some readers may pooh- pooh the mad public rush to download tulip bulbs in seventeenth- century Holland and the eighteenth-century South Sea Bubble in England.
This is one of the peculiarly dangerous months to speculate in stocks in. In their frenzy, market participants ignore firm foundations of value for the dubious but thrilling assumption that they can make a killing by building castles in the air. Such thinking has enveloped entire nations. The psychology of speculation is a veritable theater of the absurd.
Several of its plays are presented in this chapter. In each case, some of the people made money some of the time, but only a few emerged unscathed. History, in this instance, does teach a lesson: Although the castle-in-the-air theory can well explain such speculative binges, outguessing the reactions of a fickle crowd is a most dangerous game.
It would appear that not many have read the book. Skyrocketing markets that depend on purely psychic support have invariably succumbed to the financial law of gravitation. Unsustainable prices may persist for years, but eventually they reverse themselves. Such reversals come with the suddenness of an earthquake; and the bigger the binge, the greater the resulting hangover. Few of the reckless builders of castles in the air have been nimble enough to anticipate these reversals and to escape when everything came tumbling down.
Its excesses become even more vivid when one realizes that it happened in staid old Holland in the early seventeenth century.
The events leading to this speculative frenzy were set in motion in when a newly appointed botany professor from Vienna brought to Leyden a collection of unusual plants that had originated in Turkey.
Over the next decade or so, the tulip became a popular but expensive item in Dutch gardens. Many of these flowers succumbed to a nonfatal virus known as mosaic. It was this mosaic that helped to trigger the wild speculation in tulip bulbs. Slowly, tulipmania set in. Then they would download an extra-large stockpile to anticipate a rise in price. Tulip-bulb prices began to rise wildly. The more expensive the bulbs became, the more people viewed them as smart investments.
Charles Mackay, who chronicled these events in his book Extraordinary Popular Delusions and the Madness of Crowds, noted that the ordinary industry of the country was dropped in favor of speculation in tulip bulbs: People who said the prices could not possibly go higher watched with chagrin as their friends and relatives made enormous profits.
The temptation to join them was hard to resist. Bulb prices reached astronomical levels. Part of the genius of financial markets is that when there is a real demand for a method to enhance speculative opportunities, the market will surely provide it. A call option conferred on the holder the right to download tulip bulbs call for their delivery at a fixed price usually approximating the current market price during a specified period.
He was charged an amount called the option premium, which might run 15 to 20 percent of the current market price. An option on a tulip bulb currently worth guilders, for example, would cost the downloader only about 20 guilders.
If the price moved up to guilders, the option holder would exercise his right; he would download at and simultaneously sell at the then current price of He then had a profit of 80 guilders the guilders appreciation less the 20 guilders he paid for the option. Thus, he enjoyed a fourfold increase in his money, whereas an outright download would only have doubled his money. Such devices helped to ensure broad participation in the market.
The same is true today. The history of the period was filled with tragicomic episodes. One such incident concerned a returning sailor who brought news to a wealthy merchant of the arrival of a shipment of new goods. The merchant rewarded him with a breakfast of fine red herring. It was a costly Semper Augustus tulip bulb.
The sailor paid dearly for his relish—his no longer grateful host had him imprisoned for several months on a felony charge. Historians regularly reinterpret the past, and some financial historians who have reexamined the evidence about various financial bubbles have argued that considerable rationality in pricing may have existed after all. One of these revisionist historians, Peter Garber, has suggested that tulip- bulb pricing in seventeenth-century Holland was far more rational than is commonly believed.
Garber makes some good points, and I do not mean to imply that there was no rationality at all in the structure of bulb prices during the period. The Semper Augustus, for example, was a particularly rare and beautiful bulb and, as Garber reveals, was valued greatly even in the years before the tulipmania.
But Garber can find no rational explanation for such phenomena as a twenty-fold increase in tulip-bulb prices during January of followed by an even larger decline in prices in February. Apparently, as happens in all speculative crazes, prices eventually got so high that some people decided they would be prudent and sell their bulbs.
Soon others followed suit. Like a snowball rolling downhill, bulb deflation grew at an increasingly rapid pace, and in no time at all panic reigned. Government ministers stated officially that there was no reason for tulip bulbs to fall in price—but no one listened. Dealers went bankrupt and refused to honor their commitments to download tulip bulbs.
And prices continued to decline. Down and down they went until most bulbs became almost worthless—selling for no more than the price of a common onion. Right you are, but years ago in England this was one of the hottest new issues of the period.
And, just as you guessed, investors got very badly burned. The story illustrates how fraud can make greedy people even more eager to part with their money. At the time of the South Sea Bubble, the British were ripe for throwing away money.
A long period of prosperity had resulted in fat savings and thin investment outlets. In those days, owning stock was considered something of a privilege. They reaped rewards in several ways, not least of which was that their dividends were untaxed. Also, their number included women, for stock represented one of the few forms of property that British women could possess in their own right.
As a reward, it was given a monopoly over all trade to the South Seas. The public believed immense riches were to be made in such trade and regarded the stock with distinct favor. From the very beginning, the South Sea Company reaped profits at the expense of others. Holders of the government securities to be assumed by the company simply exchanged their securities for those of the South Sea Company. Not a single director of the company had the slightest experience in South American trade.
But even this venture did not prove profitable, because the mortality rate on the ships was so high. The directors were, however, wise in the art of public appearance. An impressive house in London was rented, and the boardroom was furnished with thirty black Spanish upholstered chairs whose beechwood frames and gilt nails made them handsome to look at but uncomfortable to sit in.
In the meantime, a shipload of company wool that was desperately needed in Vera Cruz was sent instead to Cartagena, where it rotted on the wharf for lack of downloaders. To further his purpose, Law acquired a derelict concern called the Mississippi Company and proceeded to build a conglomerate that became one of the largest capital enterprises ever to exist.
The Mississippi Company attracted speculators and their money from throughout the Continent. The price of Mississippi stock rose from to 2, in just two years, even though there was no logical reason for such an increase.
At one time the inflated total market value of the stock of the Mississippi Company in France was more than eighty times that of all the gold and silver in the country. Meanwhile, back on the English side of the Channel, a bit of jingoism now began to appear in some of the great English houses.
Why should all the money be going to the French Mississippi Company? What did England have to counter this? This was free enterprise at its finest. This was boldness indeed, and the public loved it. Fights broke out among other investors surging to download. But the public was ravenous. On June 15 yet another issue was floated. This time the payment plan was even easier—10 percent down and not another payment for a year. Half the House of Lords and more than half the House of Commons signed on.
The speculative craze was in full bloom. Not even the South Sea Company was capable of handling the demands of all the fools who wanted to be parted from their money. Investors looked for other new ventures where they could get in on the ground floor.
Just as speculators today search for the next Google, so in England in the early s they looked for the next South Sea Company. Promoters obliged by organizing and bringing to the market a flood of new issues to meet the insatiable craving for investment. Increasingly the promotions involved some element of fraud, such as making boards out of sawdust. There were nearly one hundred different projects, each more extravagant and deceptive than the other, but each offering the hope of immense gain.
Like bubbles, they popped quickly—usually within a week or so. The public, it seemed, would download anything. New companies seeking financing during this period were organized for such purposes as the building of ships against pirates; encouraging the breeding of horses in England; trading in human hair; building hospitals for bastard children; extracting silver from lead; extracting sunlight from cucumbers; and even producing a wheel of perpetual motion.
Not being greedy himself, the promoter promptly closed up shop and set off for the Continent. He was never heard from again. Not all investors in the bubble companies believed in the feasibility of the schemes to which they subscribed. Whom the gods would destroy, they first ridicule. Signs that the end was near appeared with the issuance of a pack of South Sea playing cards. Each card contained a caricature of a bubble company, with an appropriate verse inscribed underneath.
One of these, the Puckle Machine Company, was supposed to produce machines discharging both round and square cannonballs and bullets.
Puckle claimed that his machine would revolutionize the art of war. The eight of spades, shown on the following page, described it as follows: Many individual bubbles had been pricked without dampening the speculative enthusiasm, but the deluge came in August with an irreparable puncture to the South Sea Company. Realizing that the price of the shares in the market bore no relationship to the real prospects of the company, the directors and officers sold out in the summer.
The news leaked and the stock fell. Soon the price of the shares collapsed and panic reigned. The chart below shows the spectacular rise and fall of the stock of the South Sea Company. Government officials tried in vain to restore confidence, and a complete collapse of the public credit was barely averted. Similarly, the price of Mississippi Company shares fell to a pittance as the public realized that an excess of paper currency creates no real wealth, only inflation.
To protect the public from further abuses, Parliament passed the Bubble Act, which forbade the issuing of stock certificates by companies. For more than a century, until the act was repealed in , there were relatively few share certificates in the British market. Could the same sort of thing happen in more modern times? America, the land of opportunity, had its turn in the s. And given our emphasis on freedom and growth, we produced one of the most spectacular booms and loudest crashes civilization has ever known.
Conditions could not have been more favorable for a speculative craze. The country had been experiencing unrivaled prosperity. Such analogies were even made in the opposite direction.
The price increases are illustrated in the table below. Nevertheless, only about one million people owned stocks on margin in Still, the speculative spirit was at least as widespread as in the previous crazes and was certainly unrivaled in its intensity. More important, stock-market speculation was central to the culture. Manipulation on the stock exchange set new records for unscrupulousness. No better example can be found than the operation of investment pools. One such undertaking raised the price of RCA stock 61 points in four days.
Generally such operations began when a number of traders banded together to manipulate a particular stock. They appointed a pool manager who justifiably was considered something of an artist and promised not to double-cross each other through private operations. The pool manager accumulated a large block of stock through inconspicuous downloading over a period of weeks. If possible, he also obtained an option to download a substantial block of stock at the current market price.
Pool members were in the swim with the specialist on their side. The book gave information about the extent of existing orders to download and sell at prices below and above the current market. Now the real fun was ready to begin. Generally, at this point the pool manager had members of the pool trade among themselves. For example, Haskell sells shares to Sidney at 40, and Sidney sells them back at 40?. Next comes the sale of a 1,share block at 40?
These sales were recorded on ticker tapes across the country, and the illusion of activity was conveyed to the thousands of tape watchers who crowded into the brokerage offices of the country.
Such activity, generated by so-called wash sales, created the impression that something big was afoot. Now tipsheet writers and market commentators under the control of the pool manager would tell of exciting developments in the offing.
If all went well, and in the speculative atmosphere of the —29 period it could hardly miss, the combination of tape activity and managed news would bring the public in. The pool manager began feeding stock into the market, first slowly and then in larger and larger blocks before the public could collect its senses. At the end of the roller-coaster ride, the pool members had netted large profits and the public was left holding the suddenly deflated stock.
Many individuals, particularly corporate officers and directors, did quite well on their own. In July Mr. Wiggin became apprehensive about the dizzy heights to which stocks had climbed and no longer felt comfortable speculating on the bull side of the market. He was rumored to have made millions in a pool boosting the price of his own bank. Selling short is a way to make money if stock prices fall. It involves selling stock you do not currently own in the expectation of downloading it back later at a lower price.
Immediately after the short sale, the price of Chase stock began to fall, and when the crash came in the fall the stock dropped precipitously. When the account was closed in November, he had netted a multimillion-dollar profit from the operation.
Conflicts of interest apparently did not trouble Mr. In fairness, it should be pointed out that he did retain a net ownership position in Chase stock during this period.
Nevertheless, the rules in existence today would not allow an insider to make short-swing profits from trading his own stock. On September 3, , the market averages reached a peak that was not to be surpassed for a quarter of a century. As Babson implied, he had been predicting the crash for several years and he had yet to be proven right.
In the last frantic hour of trading, American Telephone and Telegraph went down 6 points, Westinghouse 7 points, and U. Steel 9 points. It was a prophetic episode. After the Babson Break the possibility of a crash, which was entirely unthinkable a month before, suddenly became a common subject for discussion. Confidence faltered. September had many more bad than good days.
At times the market fell sharply. Bankers and government officials assured the country that there was no cause for concern.
The declines in stock prices had led to calls for more collateral from margin customers. Unable or unwilling to meet the calls, these customers were forced to sell their holdings. This depressed prices and led to more margin calls and finally to a self-sustaining selling wave.
The volume of sales on October 21 zoomed to more than 6 million shares. The ticker fell way behind, to the dismay of the tens of thousands of individuals watching the tape from brokerage houses around the country. Nearly an hour and forty minutes had elapsed after the close of the market before the last transaction was actually recorded on the stock ticker.
Many issues dropped 40 and 50 points during a couple of hours. Only October 19 and 20, , rivaled in intensity the panic on the exchange. More than A million-share day in would be equivalent to a multibillion-share day in because of the greater number of listed shares. Prices fell almost perpendicularly, and kept on falling, as is illustrated by the following table, which shows the extent of the decline during the autumn of and over the next three years.
Again, there are revisionist historians who say there was a method to the madness of the stock-market boom of the late s. Harold Bierman Jr. After all, very intelligent people, such as Irving Fisher and John Maynard Keynes, believed that stocks were reasonably priced. Bierman goes on to argue that the extreme optimism undergirding the stock market might even have been justified had it not been for inappropriate monetary policies.
Nevertheless, history teaches us that very sharp increases in stock prices are seldom followed by a gradual return to relative price stability. Even if prosperity had continued into the s, stock prices could never have sustained their advance of the late s. In most periods since , these funds have sold at discounts of 10 to 20 percent from their asset values.
From January to August , however, the typical closed-end fund sold at a premium of 50 percent. Moreover, the premiums for some of the best-known funds were astronomical. Goldman, Sachs Trading Corporation sold at twice its net asset value. Tri-Continental Corporation sold at percent of its asset value. It was irrational speculative enthusiasm that drove the prices of these funds far above the value at which their individual security holdings could be downloadd.
I have no apt answer, but I am convinced that Bernard Baruch was correct in suggesting that a study of these events can help equip investors for survival. The consistent losers in the market, from my personal experience, are those who are unable to resist being swept up in some kind of tulip-bulb craze.
A Random Walk Down Wall Street: The Time-Tested Strategy for Successful Investing
It is not hard to make money in the market. What is hard to avoid is the alluring temptation to throw your money away on short, get-rich-quick speculative binges. It is an obvious lesson, but one frequently ignored. The examples I have just cited, plus a host of others, have persuaded more and more people to put their money under the care of professional portfolio managers— those who run the large pension and retirement funds, mutual funds, and investment counseling organizations.
Although the crowd may be mad, the institution is above all that. One would think that the hardheaded, sharp- penciled reasoning of the pros would guarantee that the extravagant excesses of the past would no longer exist.
And yet professional investors participated in several distinct speculative movements from the s through the s. In each case, professional institutions bid actively for stocks not because they felt such stocks were undervalued under the firm-foundation principle, but because they anticipated that some greater fools would take the shares off their hands at even more inflated prices.
Growth companies such as IBM and Texas Instruments sold at price- earnings multiples of more than A year later they sold at multiples in the 20s and 30s. Questioning the propriety of such valuations became almost heretical. Though these prices could not be justified on firm-foundation principles, investors believed that downloaders would still eagerly pay even higher prices.
Lord Keynes must have smiled quietly from wherever it is that economists go when they die. I recall vividly one of the senior partners of my firm shaking his head and admitting that he knew of no one with any recollection of the —32 crash who would download and hold the high-priced growth stocks.
But the young Turks held s way. The horrible thing is, it has happened. The new-issue mania rivaled the South Sea Bubble in its intensity and also, regrettably, in the fraudulent practices that were revealed. Jack Dreyfus, of Dreyfus and Company, commented on the mania as follows: Change the name from Shoelaces, Inc. A word that no one understands entitles you to double your entire score. Therefore, we have six times earnings for the shoelace business and 15 times earnings for electronic and silicon, or a total of 21 times earnings.
Multiply this by two for furth-burners and we now have a score of 42 times earnings for the new company. Let the numbers below tell the story. Ten years later, the shares of most of these companies were almost worthless.
A Random Walk Down Wall Street
Today, none exist. Yes, the SEC was there, but by law it had to stand by quietly. As long as a company has prepared and distributed to investors an adequate prospectus, the SEC can do nothing to save downloaders from themselves.
For example, many of the prospectuses of the period contained the following type of warning in bold letters on the cover. But just as the warnings on packs of cigarettes do not prevent many people from smoking, so the warning that this investment may be dangerous to your wealth cannot block a speculator from forking over his money.
The SEC can warn fools, but it cannot keep them from parting with their money. Fraud and market manipulation are different matters. Here the SEC can take and has taken strong action. Indeed, many of the little-known brokerage houses on the fringes of respectability, which were responsible for most of the new issues and for manipulation of their prices, were suspended for a variety of peculations.
The tronics boom came back to earth in Many professionals refused to accept the fact that they had speculated recklessly. Very few pointed out that it is always easy to look back and say when prices were too high or too low. Fewer still said that no one seems to know the proper price for a stock at any given time.
Synergy Generates Energy: The Conglomerate Boom Part of the genius of the financial market is that if a product is demanded, it is produced. The product that all investors desired was expected growth in earnings per share.
By the mid- s, creative entrepreneurs suggested that growth could be created by synergism.
Synergism is the quality of having 2 plus 2 equal 5. This magical, surefire new creation was called a conglomerate. The consolidations were carried out in the name of synergism. Ostensibly, the conglomerate would achieve higher sales and earnings than would have been possible for the independent entities alone. In fact, the major impetus for the conglomerate wave of the s was that the acquisition process itself could be made to produce growth in earnings per share.
Indeed, the managers of conglomerates tended to possess financial expertise rather than the operating skills required to improve the profitability of the acquired companies. By an easy bit of legerdemain, they could put together a group of companies with no basic potential at all and produce steadily rising per- share earnings. The following example shows how this monkey business was performed.
Suppose we have two companies—the Able Circuit Smasher Company, an electronics firm, and Baker Candy Company, which makes chocolate bars. Each has , shares outstanding. The two firms sell at different prices, however. The management of Able Circuit would like to become a conglomerate.
It offers to absorb Baker by swapping stock at the rate of two for three. We have a budding conglomerate, newly named Synergon, Inc. In addition, the shareholders of Baker who were bought out need not pay any taxes on their profits until they sell their shares of the combined company.
The top three lines of the following table illustrate the transaction. Synergon offers to absorb Charlie Company on a share-for-share exchange basis. Here we have a case where the conglomerate has literally manufactured growth. None of the three companies was growing at all; yet simply by virtue of their merger, our conglomerate will show the following earnings growth: The trick that makes the game work is the ability of the electronics company to swap its high-multiple stock for the stock of another company with a lower multiple.
But when these earnings are averaged with the electronics company, the total earnings including those from selling chocolate bars could be sold at a multiple of And the more acquisitions Synergon could make, the faster earnings per share would grow and thus the more attractive the stock would look to justify its high multiple.
The whole thing is like a chain letter—no one would get hurt as long as the growth of acquisitions proceeded exponentially. Although the process could not continue for long, the possibilities were mind-boggling for those who got in at the start.
Or perhaps as subscribers to the castle-in-the-air theory, they only believed that other people would fall for it. Figgie, Figgie International is a real example of how the game of manufacturing growth was actually played. In the middle of , four mergers were completed in a twenty-five-day period. These newly acquired companies, all selling at relatively low price-earnings multiples, helped to produce a sharp growth in earnings per share.
Figgie, the president of Automatic Sprinkler, performed the public relations job necessary to help Wall Street build its castle in the air.
He was careful to point out that he looked at twenty to thirty deals for each one he bought. Wall Street loved every word of it.
Figgie was not alone in conning Wall Street. Managers of other conglomerates almost invented a new language in the process of dazzling the investment community. They talked about market matrices, core technology fulcrums, modular building blocks, and the nucleus theory of growth.
No one from Wall Street really knew what the words meant, but they all got the nice, warm feeling of being in the technological mainstream. Conglomerate managers also found a new way of describing the businesses they had bought. Instead of going down with merger activity, the price-earnings multiples of conglomerate stocks rose for a while. Prices and multiples for a selection of conglomerates in are shown in the following table. The music slowed drastically for the conglomerates on January 19, , when the granddaddy of the conglomerates, Litton Industries, announced that earnings for the second quarter of that year would be substantially less than had been forecast.
It had recorded 20 percent yearly increases for almost a decade. In the selling wave that followed, conglomerate stocks declined by roughly 40 percent before a feeble recovery set in. Worse was to come. In July, the Federal Trade Commission announced that it would make an in-depth investigation of the conglomerate merger movement.
Again the stocks went tumbling down. The SEC and the accounting profession finally made their move and began to make attempts to clarify the reporting techniques for mergers and acquisitions. The sell orders came flooding in. Shortly afterwards, the SEC and the U.
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Assistant Attorney General in charge of antitrust indicated a strong concern about the accelerating pace of the merger movement.
The aftermath of this speculative phase revealed two disturbing factors. First, conglomerates could not always control their far-flung empires. Second, the government and the accounting profession expressed concern about the pace of mergers and about possible abuses. This result in itself makes the alchemy game almost impossible, for the acquiring company has to have an earnings multiple larger than the acquired company if the ploy is to work at all.
An interesting footnote to this episode is that during the s and early s deconglomeration came into fashion. Many of the old conglomerates began to shed their unrelated, poor-performing acquisitions to boost their earnings. Many of these sales were financed through a popular innovation, the leveraged downloadout LBO. Under an LBO the downloadr, often the management of the division assisted by professional deal makers, puts up a very thin margin of equity, borrowing 90 percent or more of the funds needed to complete the transaction.
The tax collector helps out by allowing the bought-out entity to increase the value of its depreciable asset base. The combination of high interest payments and larger depreciation charges ensures that taxes for the new entity will remain low or nonexistent for some time.
If things go well, the owners can reap windfall profits. A number of the early LBOs of the s proved to be quite successful.
Later in the decade, however, as the LBO wave accelerated and the prices paid for the companies tended to increase as did their associated debt levels, fewer of these transactions fulfilled expectations. As the economy turned less robust in the late s and early s, the high fixed-interest costs of companies in debt up to their eyeballs placed these entities in considerable financial jeopardy. The financial fallout in the early s from the explosion of some of the most poorly considered LBOs injured not only many individual investors but many banks and life insurance companies as well.
Performance Comes to the Market: And perform some funds did—at least over short periods of time. This performance brought large amounts of new money into the fund.
The public found it fashionable to bet on the jockey rather than the horse. How did these jockeys do it? They concentrated the portfolio in dynamic stocks, which had a good story to tell, and at the first sign of an even better story, they would quickly switch.
For a while the strategy worked well and led to many imitators. And so performance investing took hold of Wall Street in the late s. Because near-term performance was especially important investment services began to publish monthly records of mutual-fund performance , it was best to download stocks with an exciting concept and a compelling and believable story that the market would recognize now—not far into the future.
Enter Cortes W. His concept was a youth company for the youth market. First, he sold an image—one of affluence and success. Adding to his image was an expensive set of golf clubs propped up by his office door. Apparently the only time the clubs were used was at night when the office cleanup crew drove wads of paper along the carpet. The concept that Wall Street bought from Randell was that a single company could specialize in servicing the needs of young people.
NSM built its early growth via the merger route, just as the ordinary conglomerates of the s had done. The difference was that each of the constituent companies had something to do with the college-age youth market, from posters and records to sweatshirts and summer job directories.
What could be more appealing to a youthful gunslinger than a youth-oriented concept stock—a full-service company to exploit the youth subculture? The following table clearly shows that institutional investors are at least as adept as the general public at building castles in the air. My favorite example involved Minnie Pearl.
Minnie Pearl was a fast-food franchising firm that was as accommodating as all get-out. After all, what better name could be chosen for performance-oriented investors? On Wall Street a rose by any other name does not smell as sweet.
As the table indicates, both companies laid an egg—and a bad one at that. Why did the stocks perform so badly? One general answer was that their price-earnings multiples were inflated beyond reason. In addition, most of the concept companies of the time ran into severe operating difficulties.
The reasons were varied: These companies were run by executives who were primarily promoters, not sharp-penciled operating managers. Fraudulent practices also were common. They would never come crashing down like the speculative favorites of the s. Nothing could be more prudent than to download their shares and then relax on the golf course.
There were only four dozen or so of these premier growth stocks. And because most pros realized that picking the exact correct time to download is difficult if not impossible, these stocks seemed to make a great deal of sense.
So what if you paid a price that was temporarily too high? These stocks were proven growers, and sooner or later the price would be justified. In addition, these were stocks that—like the family heirlooms— you would never sell. You made a decision to download them, once, and your portfolio-management problems were over. These stocks provided security blankets for institutional investors in another way, too. They were respectable.
Your colleagues could never question your prudence in investing in IBM. True, you could lose money if IBM went down, but that was not considered a sign of imprudence as it would be to lose money in a Performance Systems or a National Student Marketing. Like greyhounds in chase of the mechanical rabbit, big pension funds, insurance companies, and bank trust funds loaded up on the Nifty Fifty one- decision growth stocks.
Hard as it is to believe, institutions started to speculate in blue chips. Institutional managers blithely ignored the fact that no sizable company could ever grow fast enough to justify an earnings multiple of 80 or They once again proved the maxim that stupidity well packaged can sound like wisdom.
In the debacle that followed, the premier growth stocks fell completely from favor. The craze made the promoters of the s look like pikers. The total value of new issues during was greater than the cumulative total of new issues for the entire preceding decade. For investors, initial public offerings IPOs were the hottest game in town. This was not some philistine outfit peddling discount clothing or making computer hardware.
This was a truly aesthetic enterprise. The pictures were originally owned by—this is absolutely true—a man named Garry Gross. While Fine Arts saw nothing wrong with the pictures of the prepubescent eleven-year-old Brooke, her mother did.
The ending, in this case, was a happy one for Brooke: The ending was not quite as blissful for Fine Arts, or for most of the other new issues ushered in during the craze. Fine Arts morphed into Dyansen Corporation, complete with gallery in the glitzy Trump Tower, and eventually defaulted in on a loan made by—are you ready for this? Probably the offering of Muhammad Ali Arcades International burst the bubble.
This offering was not particularly remarkable, considering all the other garbage coming out at the time. It was unique, however, in that it showed that a penny could still download a lot.
Most did not like what they saw. The result was a dramatic decline in small-company stocks in general and in the market prices of initial public offerings in particular.
In the course of a year, many investors lost as much as 90 percent of their money. The prospectus cover of Muhammad Ali Arcades International featured a picture of the former champ standing over a fallen opponent. But many others did, particularly stocks of those companies on the bleeding edge of technology. As has been true time and time again, it was the investors who got stung. Concepts Conquer Again: The biotech revolution was likened to that of the computer, and optimism regarding the promise of gene- splicing was reflected in the prices of biotech company stocks.
Genentech, the most substantial company in the industry, came to market in During the first twenty minutes of trading, the stock almost tripled in value. Other new issues of biotech companies were eagerly gobbled up by hungry investors who saw a chance to get into a multibillion-dollar new industry on the ground floor.
Interferon, a cancer-fighting drug, drove the first wave of the biotech frenzy. Analysts continually predicted an explosion of earnings two years out for the biotech companies and were continually disappointed. But the technological revolution was real, and even weak companies benefited under the umbrella of the technology potential. In the s, speculative growth stocks might have sold at 50 times earnings.
In the s, some biotech stocks sold at 50 times sales. As a student of valuation techniques, I was fascinated to read how security analysts rationalized these prices.
Because biotech companies typically had no current earnings and realistically no positive earnings expected for several years and little sales, new valuation methods had to be devised. Even if the planned product involved nothing more than the drawings of a genetic engineer, a potential sales volume and a profit margin were estimated.
Perhaps U. Food and Drug Administration approval would be delayed. Interferon was delayed for several years. Would the market bear the projected fancy drug price tags? Would much of the potential profit from a successful drug be siphoned off by the marketing partner of the biotech company, usually one of the major drug companies? In the mids, none of these potential problems seemed real. But during the late s, most biotechnology stocks lost three-quarters of their market value. Even real technology revolutions do not guarantee benefits for investors.
In the fast-paced world of entrepreneurs who strike it rich before they can shave, Barry Minkow was a genuine legend of the s.
There he began soliciting jobs by phone. By age ten he was actually cleaning carpets. With Minkow working a punishing schedule, the business flourished. He was proud of the fact that he hired his father and mother to work for the business. By age eighteen, Minkow was a millionaire. He drove a red Ferrari and lived in a lavish home with a large pool, which had a big black Z painted on the bottom.
Was more than times earnings too much to pay for a mundane carpet-cleaning company? Of course not, when the company was run by a spectacularly successful businessman, who could also show his toughness. It turned out that ZZZZ Best was cleaning more than carpets—it was also laundering money for the mob. The spectacular growth of the company was produced with fictitious contracts, phony credit card charges, and the like.
Minkow was also charged with skimming millions from the company treasury for his own personal use. After his release in December , he became senior pastor at Community Bible Church in California, where he held his congregation in rapt attention with his evangelical style. He has written several books, including Cleaning Up and Down, But Not Out, has conducted a daily nationally syndicated radio program, and uses his charismatic skills as a much-in- demand lecturer. He has also been hired as a special adviser for the FBI on how to spot fraud.
The lessons of market history are clear. The stock market at times conforms well to the castle-in-the-air theory. For this reason, the game of investing can be extremely dangerous. And if you download the new issue after it begins trading, usually at a higher price, you are even more certain to lose. Investors would be well advised to treat new issues with a healthy dose of skepticism.
Certainly investors in the past have built many castles in the air with IPOs. Remember that the major sellers of the stock of IPOs are the managers of the companies themselves. They try to time their sales to coincide with a peak in the prosperity of their companies or with the height of investor enthusiasm for some current fad. In such cases, the urge to get on the bandwagon—even in high-growth industries— produced a profitless prosperity for investors.
It is important to note that we are not alone. Indeed, one of the largest booms and busts of the late twentieth century involved the Japanese real estate and stock markets. From to , the value of Japanese real estate increased more than 75 times. Theoretically, the Japanese could have bought all the property in America by selling off metropolitan Tokyo. Just selling the Imperial Palace and its grounds at their appraised value would have raised enough cash to download all of California.
The stock market countered by rising like a helium balloon on a windless day. Stock prices increased fold from to Firm-foundation investors were aghast at such figures. They read with dismay that Japanese stocks sold at more than 60 times earnings, almost 5 times book value, and more than times dividends.
In contrast, U. The high prices of Japanese stocks were even more dramatic on a company-by-company comparison. Supporters of the stock market had answers to all the logical objections that could be raised.
Were price-earnings ratios in the stratosphere? The answer was that this simply reflected the low interest rates at the time in Japan. Was it dangerous that stock prices were five times the value of assets? Not at all. The book values did not reflect the dramatic appreciation of the land owned by Japanese companies.
Moreover, Japanese profitability had been declining, and the strong yen was bound to make it more difficult for Japan to export. Although land was scarce in Japan, its manufacturers, such as its auto makers, were finding abundant land for new plants at attractive prices in foreign lands. And rental income had been rising far more slowly than land values, indicating a falling rate of return on real estate. Finally, the low interest rates that had been underpinning the market had already begun to rise in Much to the distress of those speculators who had concluded that the fundamental laws of financial gravity were not applicable to Japan, Isaac Newton arrived there in Interestingly, it was the government itself that dropped the apple.
And so the central bank restricted credit and engineered a rise in interest rates. The hope was that further rises in property prices would be choked off and the stock market might be eased downward. The stock market was not eased down; instead, it collapsed. The fall was almost as extreme as the U.
The Japanese Nikkei stock-market index reached a high of almost 40, on the last trading day of the s. By mid- August , the index had declined to 14,, a drop of about 63 percent. In contrast, the Dow Jones Industrial Average fell 66 percent from December to its low in the summer of although the decline was over 80 percent from the September level.
Japanese Stock Prices Relative to Book Values, — shows quite dramatically that the rise in stock prices during the mid-and late s represented a change in valuation relationships. The fall in stock prices from on simply reflected a return to the price-to-book- value relationships that were typical in the early s. The air also rushed out of the real estate balloon during the early s.
Various measures of land prices and property values indicate a decline roughly as severe as that of the stock market.
The bursting of the bubble destroyed the myth that Japan was different and that its asset prices would always rise. The entire world economy almost crashed when the U. Comparing either of these bubbles to the tulip-bulb craze is undoubtedly unfair to the flowers.
The Internet was associated with both: The promise of the Internet spawned the largest creation and largest destruction of stock market wealth of all time. The updraft encourages more people to download the stocks, which causes more TV and print coverage, which causes even more people to download, which creates big profits for early Internet stockholders. The successful investors tell you at cocktail parties how easy it is to get rich, which causes the stocks to rise further, which pulls in larger and larger groups of investors.
But the whole mechanism is a kind of Ponzi scheme where more and more credulous investors must be found to download the stock from the earlier investors. Eventually, one runs out of greater fools. Even highly respected Wall Street firms joined in the hot- air float. A few months later, hundreds of Internet companies were bankrupt, proving that the Goldman report was inadvertently correct.
The cash burn rate was not a long- term risk—it was a short-term risk. The price-earnings multiples of the stocks in the index that had earnings soared to over Surveys of investors in early revealed that expectations of future stock returns ranged from 15 percent per year to 25 percent or higher.
If Cisco grew its earnings at 15 percent per year, it would still be selling at a well above average multiple ten years later. And if Cisco returned 15 percent per year for the next twenty-five years and the national economy continued to grow at 5 percent over the same period, Cisco would have been bigger than the entire economy. Obviously, there was a complete disconnect between stock-market valuations and any reasonable expectations of future growth.
And even blue-chip Cisco lost over 90 percent of its market value when the bubble burst and the forecasted growth never happened. By comparison, the bubble in the overall index is hardly noticeable. Dozens of companies, even those that had little or nothing to do with the Net, changed their names to include Web-oriented designations such as dot-com, dotnet, or Internet.
Three researchers from Purdue University, M. Cooper, D. Dimitrov, and P. Two items require particular emphasis. First, class attendance is important. Considerable material will be covered each week and the class builds rapidly on materials. It will be difficult for a student to keep up without attending all of the classes. Second, it is important that the student carefully read each assignment and workout the problems and quizzes at the end of each chapter.
While selected problems will be assigned it is recommended that the student read through all problems and understand how they should be approached. Students need to have access to the Internet and to Excel, as some assignments will use real data. These are available on the university computer labs. Learning Goals This course acquaints MBA students with the theoretical and more practical aspects of investment analysis, for security selection and portfolio management purposes.
The goal is to expose students to material that any participant in the investments industry — from private investor to pension fund consultant to portfolio manager — will find useful. Logically, the study of investment pricing techniques and of the institutional background in which investment professionals operate should precede the study of how these professionals do or ought to behave. The course, which consists of six main parts, is organized accordingly. After an introduction and a brief review of general finance concepts, Part I of the course presents the institutional environment in which portfolio managers operate.
We discuss participants; instruments and their markets; and the way that securities are traded. Part II is short. It starts with the basic elements of modern portfolio theory: return both nominal and real , risk, and the trade-off that risk-averse investors must make between the two. It then covers portfolio mechanics. We then explain how to use the CAPM in practice, i. Parts IV and V analyze the two categories of financial instruments that nowadays account for most trading activity: fixed income assets and interest-rate derivatives securities.
Part IV deals with securities that provide fixed periodic income, such as municipal and other local government bonds, US Treasury Bills, Notes and Bonds, and mortgage-backed securities. The material includes the computation of bond yields, and the measurement of the term structure of interest rates.
Part V discusses portfolio-management techniques that are specific to fixed-income securities. Topics include overviews of interest-rate risk measurement including duration and convexity and management, and credit risk including credit spreads and credit crunches. Time permitting, yield-curve and spread-convergence trading techniques and bond-portfolio hedging shall be discussed.
Credit derivatives and hedging techniques shall be introduced. Part VI then presents the key elements of fundamental analysis for equities. Learning Outcome Students attending this class will learn Modern portfolio theory; Term structure of interest rate; Interest rate risk measurement and management; Fundamental analysis of for equities. Required Texts We will use only parts of the following text. Other newspapers may also be useful for the purpose of the class, but often lack significant amounts of relevant information.As long as there are stock markets there will be mistakes made by the collective judgment of investors.
Consigliato a chi vuole un introduzione sul mondo della borsa. As Seth Klarman has stated: "Buffett's argument has never, to my knowledge, been addressed by the efficient-market theorists; they evidently prefer to continue to prove in theory what was refuted in practice".
Here the SEC can take and has taken strong action. Incompetence Analysts are often careless, lazy and incompetent.
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