Chapters 2

CONTENTSPreface 13
Acknowledgments from Earlier 17 Editions

Part OneStocks and Their Value
1. Firm Foundations and Castles in the 23 Air
What Is a Random 24 Walk?
Investing as a Way of Life 26 Today
Investing in 28 Theory
The Firm-Foundation 29 Theory
The Castle-in-the-Air Theory 31 How the Random Walk Is
to Be 33
Conducted
2. The Madness of 35 Crowds
The Tulip-Bulb 36 Craze
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The South Sea 39 Bubble
The Florida Real Estate 45 Craze
Wall Street Lays an 46 Egg
An 53 Afterword
3. Stock Valuation from the Sixties through the 55 Nineties
The Sanity of 55 Institutions
The Soaring 57 Sixties
The New "New Era": The Growth-Stock/New-Issue 57
Craze
Synergy Generates Energy: The Conglomerate 61 Boom
Performance Comes to the Market: The Bubble in Concept
69 Stocks
The Sour 73 Seventies
The Nifty 73 Fifty
The Roaring 76 Eighties
The Triumphant Return of New 76 Issues
Concepts Conquer Again: The Biotechnology 78 Bubble
The Chinese Romance with the Lycoris Plant 80 Some
Other Bubbles of the 81
1980s
What Does It All 85 Mean?
The Nervy 85 Nineties
The Japanese Yen for Land and 85 Stocks
The Internet Craze of the Late 90 1990s
A Final 94 Word
4. The Firm-Foundation Theory of Stock 95 Prices
The "Fundamental" Determinants of Stock 96 Prices
Two Important 103 Caveats
Testing the 106 Rules
One More 108 Caveat
What's Left of the Firm 111 Foundation?
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Part TwoHow the Pros Play the Biggest Game in Town
5. Technical and Fundamental 117 Analysis
Technical versus Fundamental 118 Analysis
What Can Charts Tell 119 You?
The Rationale for the Charting 124 Method
Why Might Charting Fail to 126 Work?
From Chartist to 127 Technician
The Technique of Fundamental 128 Analysis
Why Might Fundamental Analysis Fail to 132 Work?
Using Fundamental and Technical Analysis 134 Together
6. Technical Analysis and the Random-Walk 138 Theory
Holes in Their Shoes and Ambiguity in Their 138 Forecasts
Is There Momentum in the Stock 140 Market?
Just What Exactly Is a Random 142 Walk?
Some More Elaborate Technical 145 Systems
The Filter 146 System
The Dow 146 Theory
The Relative-Strength 147 System
Price-Volume 148 Systems
Reading Chart 148 Patterns
Randomness Is Hard to 149 Accept
A Gaggle of Other Technical Theories to Help You Lose
150 Money
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" 172
Accounting Procedures3. The Basic Incompetence of Many
of the Analysts Themselves 174
4. The Loss of the Best Analysts to the Sales Desk or to
Portfolio 177 Management
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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 193 Viewpoint
Part ThreeThe 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
The Capital-Asset Pricing Model (CAPM) 224 Let's Look at
the 229
Record
An Appraisal of the 232 Evidence
The Quant Quest for Better Measures of Risk: Arbitrage
Pricing 234 Theory
A Summing 237 Up
10. The Assault on the Random-Walk Theory: Is the Market
Predictable after 240 All?
Predictable Patterns in the Behavior of Stock 242 Prices
1. Stocks Do Sometimes Get on One-Way Streets 243 2. But
Eventually Stock Prices Do Change Direction and Hence
244
Stockholder Returns Tend to Reverse Themselves
3. Stocks Are Subject to Seasonal Moodiness, Especially at
the Beginning 247 of the Year and the End of the Week
Predictable Relationships between Certain "Fundamental"
Variables and Future 249 Stock Prices
1. Smaller Is Often Better 249
2. Stocks with Low Price-Earnings Multiples Outperform
Those with High 251 Multiples
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3. Stocks that Sell at Low Multiples of Their Book Values
Tend to Produce 253 Higher Subsequent Returns
4. Higher Initial Dividends and Lower Price-Earnings
Multiples Have 254 Meant Higher Subsequent Returns
5. The "Dogs of the Dow" Strategy 258 And the Winner 259
Is . . .
The Performance of Professional 259 Investors
Concluding 267 Comments
Appendix: The Market Crash of October 270 1987
Part FourA Practical Guide for Random Walkers and Other
Investors
11. A Fitness Manual for Random 277 Walkers
Exercise 1: Cover Thyself with 278 Protection
Exercise 2: Know Your Investment 281 Objectives
Exercise 3: Dodge Uncle Sam Whenever You 289 Can
Pension Plans and 289 IRAs
Keogh 290 Plans
Roth 293 IRAs
Tax-Deferred 294 Annuities
Exercise 4: Be Competitive; Let the Yield on Your Cash
Reserve Keep Pace 295 with Inflation
Money-Market Mutual Funds 295 Money-Market Deposit
Accounts 297 Bank Certificates 299 Tax-Exempt Money-
Market Funds 300
Exercise 5: Investigate a Promenade through Bond Country
301 Zero-Coupon Bonds Can Generate Large Future
Returns 302 No-Load Bond Funds Are Appropriate
Vehicles for Individual Investors 303 Tax-Exempt Bonds
Are Useful for High-Bracket Investors 305 Hot TIPS:
Inflation Indexed Bonds 307 Should You Be a Bond-Market
Junkie? 309
Exercise 6: Begin Your Walk at Your Own Home; Renting
Leads to Flabby 310 Investment Muscles
Exercise 7: Beef Up with Real Estate Investment Trusts 313
Exercise 8: Tiptoe through the Investment Fields of Gold
and Collectibles 318
Exercise 9: Remember that Commission Costs Are Not
Random Some Are 322 Cheaper than Others
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Exercise 10: Diversify Your Investment Steps 324
A Final Checkup 324 12. Handicapping the Financial Race:
A Primer in Understanding and Projecting 326
Returns from Stocks and BondsWhat Determines the
Returns from Stocks and Bonds? 326 Three Eras of
Financial Market Returns 331
Era I: The Age of Comfort 333 Era II: The Age of Angst
334 Era III: The Age of Exuberance 340
The Age of the Millennium 342
Appendix: Projecting Returns for Individual Stocks 347 13.
A Life-Cycle Guide to Investing 351 Four Asset Allocation
Principles 352 1. Risk and Reward Are Related 352
2. Your Actual Risk in Stock and Bond Investing Depends
on the Length of 352 Time You Hold Your Investment
3. Dollar-Cost Averaging Can Reduce the Risks of Investing
in Stocks and 356 Bonds
4. The Risks You Can Afford to Take Depend on Your Total
Financial 360 Situation
Three Guidelines to Tailoring a Life-Cycle Investment 362
Plan
1. Specific Needs Require Dedicated Specific 363 Assets
2. Recognize Your Tolerance for Risk 363
3. Persistent Savings in Regular Amounts, No Matter How
Small, Pays Off 367
The Life-Cycle Investment Guide 368
14. Three Giant Steps Down Wall Street 372
The No-Brainer Step: Investing in Index Funds 373
The Index Fund Solution: A Summary 375
A Broader Definition of 378 Indexing
A Specific Index Fund 382 Portfolio
The Tax-Managed Index 383 Fund
The Do-It-Yourself Step: Potentially Useful Stock-Picking
386 Rules
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The Substitute-Player Step: Hiring a Professional Wall-
Street Walker 391 Risk Level 394 Unrealized Gains 394
Expense Ratios 395
The Morningstar Mutual-Fund Information Service 395 A
Primer on Mutual-Fund Costs 398 Loading Fees 399
Expense Charges 399 Comparing 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

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CONTENTSPreface 13

Acknowledgments from Earlier 17 Editions

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