Wednesday, May 31, 2006

A Random Walk Down Wall Street (Burton Malkiel) 0 comments

"A Random Walk" was first published in 1973, more than 30 years ago. Since then it has gone through seven more editions (the latest being 2003) and it is rightly recognised as one of the top investment books.

The author Burton Malkiel occupies both sides of the fence in the investment arena: he started as a market professional and still sits on the board of large investment funds, yet at the same time he is a top academic and an economist at Princeton University. It is this mix of experience that provides a unique perspective into the investment world in this book, where he explores professional investing and its practice, the main academic theories on investing, and gives an overview of various investment options available to the investment newbie.

The coverage of the book is one of the most comprehensive I've ever seen, and is useful in introducing the investor to the various perspectives. It is structured in a logical manner: Part One deals with a historical perspective starting with the 16th-century Dutch tulip bulb craze through the modern days till the dot-com craze, one of the best short descriptions of investing history I've ever read. The author then progresses to introduce the investing techniques employed by professionals in Part Two; these are fundamental analysis and technical analysis. He describes the shortcomings of both, although it is clear to me that whereas his bone of contention with technical analysis is the logic of the method itself, his concerns with fundamental analysis is more with the quality of the practitioners rather than the concept itself.

Part Three deals with the academics' theories on investing. These are the portfolio theory of Harry Markowitz, the capital asset pricing model (CAPM) of William Sharpe and the efficient market (EMH) theory. Of these the EMH is subject to rigorous exploration and is the most worth reading. Part Four, the past part, explains the various investment options at the investor's disposal, starting with the different instruments (stocks, bonds, real estate), then the customising of one's portfolio in relation to one's risk perception and time horizon, then finally the various methods of investing: index funds, mutual funds, DIY (do-it-yourself) and the respective pros and cons.

Perhaps what strikes me most about the author's ideas are his highly pragmatic approach as expressed in the book. In particular, two ideas: firstly, that one not only relies on business fundamentals to pick stocks (he calls it the "firm foundation" theory), but also by estimating what investment themes/situations are most likely to capture the attention of the investing public (the "castle-in-the-air" theory). In case one thinks the latter sounds rather trivial, it was actually used to great effect by the great economist Keynes himself in making great stock market profits through conceptualising investing themes ahead of the public (his background as an economist clearly helped). The second main idea that struck me is a different perspective of the Efficient Market theory (link to my own perspective), that the efficiency of the market lies in its not being easily exploitable by investors without assuming a corresponding amount of risk. For example, the mania during the dot-com boom is often quoted as an example of gross market inefficiency in valuation; however, this is a post-event observation; during the boom, given the momentum, the investor would have to assume a high level of risk if he perceives the market to be pricing the dot-com stocks inefficiently and starts to short them down. This view emanates from the author's recognition that price and valuation is often a dynamic process; there is no "real" or "correct" price to a certain company's value.

Read this book as a good introductory guide to investing, without all the dryness of say, Security Analysis or The Intelligent Investor by Ben Graham.




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