A Random Walk

Though not exactly a book related to value investing, this oft-cited work of Princeton economist Burton Malkiel discusses many important features of stock market investing. An understanding of its prime contentions is useful for beginners and experts alike.

Considering the madness of crowds as described in the previous chapter, many investors believe it prudent to attempt to grow their savings and wealth using professional money managers. While professional/institutional money management has grown tremendously in the last few decades (in 1960, only half of all trades were from institutional managers, while today closer to 90% of trades are institutional), Malkiel attempts to show that such managers fall prey to the same vagaries as do individual investors.

Starting from when he first started working on Wall Street in 1959, Malkiel walks the reader through several crazes Wall Street went through over the years that cost investors dearly:

1) The "Tronics" Boom of the early 1960s

Investors were hungry for growth stocks, and the market provided them, as 1959-1962 saw more issues than at any other period. IPOs would trade at several multiples of their prices only weeks after the fact, and regular companies would add a "tronics" suffix to their names in order to boost their stock prices. In 1962, the party ended, with "growth" stocks suffering far more than the general market.

2) The Conglomerate Boom

Two plus two equals five for these acquirers of the mid-1960s. Companies in totally unrelated industries were merging and "creating value" for shareholders with back-end "synergies". Companies trading at high multiples would buy companies trading at lower multiples and thus show earnings per share growth. The combined company would then trade at the multiple of the acquiring company, thereby increasing value like magic! Not only did multiples not drop after such acquisitions, but they would actually rise, seemingly due to the earnings per share "growth" that was occurring. The bottom fell out in 1969 when multiples for conglomerates came crashing back down to earth.

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