Click here to Download A Random Walk Down Wall Street PDF Book by Burton Malkiel Language English having PDF Size 5.5 MB and No of Pages 370.
I will take you on a random walk down Wall Street, providing a guided tour of the complex world of finance and practical advice on investment opportunities and strategies. Many people say that the individual investor has scarcely a chance today against Wall Street’s professionals. They point to professional investment strategies using complex derivative instruments and high-frequency trading.
A Random Walk Down Wall Street PDF Book by Burton Malkiel
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They read news reports of accounting fraud, mammoth takeovers, and the activities of well-financed hedge funds. This complexity suggests that there is no longer any room for the individual investor in today’s markets. Nothing could be further from the truth. You can do as well as the experts—perhaps even better. It was the steady investors who kept their heads when the stock market tanked in March 2009.
And then saw the value of their holdings eventually recover and continue to produce attractive returns. And many of the pros lost their shirts in 2008 buying derivative securities they failed to understand, as well as during the early 2000s when they overloaded their portfolios with overpriced tech stocks. This book is a succinct guide for the individual investor.
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It covers everything from insurance to income taxes. It tells you how to buy life insurance and how to avoid getting ripped off by banks and brokers. It will even tell you what to do about gold and diamonds. But primarily it is a book about common stocks—an investment medium that not only provided generous long-run returns in the past but also appears to represent good possibilities for the years ahead.
The lifecycle investment guide described in Part Four gives individuals of all age groups specific portfolio recommendations for meeting their financial goals, including advice on how to invest in retirement. 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.
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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.
It is difficult to ascribe to any one individual the credit for originating the firm-foundation theory. S. Eliot Guild is often given this distinction, but the classic development of the technique and particularly of the nuances associated with it was worked out by John B. Williams. 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 certificate at 5 percent interest. A Random Walk Down Wall Street PDF Book
You look at money expected in the future and see how much less it is worth currently (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.
Investors were advised to “discount” the value of moneys received later. Because so few people understood it, the term caught on and “discounting” now enjoys popular usage among investment people. It received a further boost under the aegis of Professor Irving Fisher of Yale, a distinguished economist and investor. The logic of the firm-foundation theory is quite respectable and can be illustrated with common stocks.
The theory stresses that a stock’s value ought to be based on the stream of earnings a firm will be able to distribute in the future in the form of dividends. 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. A Random Walk Down Wall Street PDF Book
One of the scams perpetrated by Enron management was the establishment of a myriad of complex partnerships that obfuscated the true financial position of the firm and led to an overstatement of Enron’s earnings. Here is how one of the simpler ones worked. Enron formed a joint venture with Blockbuster to rent out simpler ones worked. Enron formed a joint venture with Blockbuster to rent out movies online.
The deal failed several months later. But after the venture was formed, Enron secretly set up a partnership with a Canadian bank that essentially lent Enron $115 million in exchange for future profits from the Blockbuster venture. Of course, the Blockbuster deal never made a nickel, but Enron counted the $115 million loan as a “profit.” Wall Street analysts applauded and called Ken Lay, Enron’s chairman, the “mastermind of the year.”
Other partnerships, with names like Cheruco (named for Chewbacca, the Star Wars Wookie), Raptor, and Jedi, had similar effects, since the Force was clearly with Enron. And the Force was generous. Before the law caught up with him, Andrew Fastow, Enron’s chief financial officer, made $30 million in fees for running “independent” partnerships. A Random Walk Down Wall Street PDF Book
The partnerships were kept off Enron’s financial statements, which had the effect of inflating earnings and obscuring losses and indebtedness. The accounting firm of Arthur Andersen certified the books as “fairly stating” Enron’s financial condition. And Wall Street was delighted to collect lucrative fees from the creative partnerships that were established. Deception appeared to be a way of life at Enron.
The Wall Street Journal reported that Ken Lay and Jeff Skilling, Enron’s top executives, were personally involved in establishing a fake trading room to impress Wall Street security analysts, in an episode employees referred to as “The Sting.” The best equipment was purchased, employees were given parts to play arranging fictitious deals, and even the phone lines were painted black to make the operation look particularly slick.
The whole thing was an elaborate charade. In 2006, Lay and Skilling were convicted of conspiracy and fraud. A broken man, Ken Lay died later that year. One employee, who lost his job and his retirement savings when Enron collapsed into bankruptcy, took to the web, where he sold Tshirts with the message “I got lay’d by enron.” But Enron was only one of a number of accounting frauds that were perpetrated on unsuspecting investors. A Random Walk Down Wall Street PDF Book Download
Various telecom companies overstated revenues through swaps of fiber-optic capacity at inflated prices. Tyco created “cookie jar” reserves and accelerated pre-merger outlays to “springload” earnings from acquisitions. WorldCom admitted that it had overstated profits and cash flow by $7 billion, by classifying ordinary expenses.
Which should have been charged against earnings, as capital investments, which were not deducted from the bottom line. The analyst’s goal is to ring as many cash registers as possible, and the fullest cash registers for the major brokers are to be found in the investment banking division. It wasn’t always that way. In the 1970s, before the demise of fixed commissions and the introduction of “discount” brokerage firms.
The retail brokerage operation paid the tab and analysts could feel they were really working for their customers—the retail and institutional investors. But that profit center faded in importance with competitive commissions, and the only gold mines left were trading profits and the underwriting of new issues for new or existing firms (where fees can run to hundreds of millions of dollars) and advising firms on borrowing facilities, restructuring, acquisitions, etc. A Random Walk Down Wall Street PDF Book Download
And so it came to pass that “ringing the cash registers” meant helping the brokerage firm obtain and nurture banking clients. And that’s how the conflicts arose. Analysts’ salaries and bonuses were determined in part by their role in assisting the underwriting department. When such business relationships existed, analysts became nothing more than tools of the investment banking division.
One indication of the tight relationship between security analysts and their investment banking operations has been the traditional paucity of sell recommendations. There has always been some bias in the ratio of buy to sell recommendations, since analysts do not want to offend the companies they cover. But as investment banking revenues became a major source of profits for the major brokerage firms.
Research analysts were increasingly paid to be bullish rather than accurate. In one celebrated incident, an analyst who had the chutzpah to recommend that Trump’s Taj Mahal bonds be sold because they were unlikely to pay their interest was summarily fired by his firm after threats of legal retaliation from “The Donald” himself. Later, the bonds did default. A Random Walk Down Wall Street PDF Book Download
Small wonder that most analysts have purged their prose of negative comments that might give offense to current or prospective investment banking clients. During the Internet bubble, the ratio of buy to sell recommendations climbed to 100 to 1, particularly for firms with large investment banking businesses. To be sure, when an analyst says “buy” he may mean “hold.”
And when he says “hold” he probably means this as a euphemism for “dump this piece of crap as soon as possible.” But investors should not need a course in deconstruction semantics to understand the recommendations, and most individual investors sadly took the analysts at their word during the Internet bubble. There is convincing evidence that analyst recommendations are tainted by the very profitable investment banking relationships of the brokerage firms.
Several studies have assessed the accuracy of analysts’ stock selections. Brad Barber of the University of California studied the performance of the “strong buy” recommendations of Wall Street analysts and found it nothing short of “disastrous.” Indeed, the analysts’ strong buy recommendations underperformed the market as a whole by 3 percent per month. A Random Walk Down Wall Street PDF Book Free
While their sell recommendations outperformed the markets by 3.8 percent per month. Even worse, researchers at Dartmouth and Cornell found that stock recommendations of Wall Street firms without investment banking relationships did much better than the recommendations of brokerage firms that were involved in profitable investment banking relationships with the companies they covered.
A study from Investors.com found that investors lost over 50 percent when they followed the advice of an analyst employed by a Wall Street firm that managed or comanaged the initial public offering of the recommended stock. Research analysts were basically paid to tout the stocks of the firm’s underwriting clients. And analysts lick the hands that feed them.
Researchers in cognitive psychology have documented that people deviate in systematic ways from rationality in making judgments amid uncertainty. One of the most pervasive of these biases is the tendency to be overconfident about beliefs and abilities and overoptimistic about assessments of the future. One class of experiments illustrating this syndrome consists of asking a large group of participants. A Random Walk Down Wall Street PDF Book Free
About their competence as automobile drivers in relation to the average driver in the group or to everyone who drives a car. Driving an automobile is clearly a risky activity where skill plays an important role. Answers to this question easily reveal whether people have a realistic conception of their own skill in relationship to others. In the case of college students, 80 to 90 percent of respondents invariably say that they are more skillful.
Safer drivers than others in the class. As in Lake Wobegon, (almost) all the students consider themselves above average. In another experiment involving students, respondents were asked about likely future outcomes for themselves and their roommates. They typically had very rosy views about their own futures, which they imagined to include successful careers, happy marriages, and good health.
When asked to speculate about their roommates’ futures, however, their responses were far more realistic. The roommates were believed to be far more likely to become alcoholics, suffer illnesses, get divorced, and experience a variety of other unfavorable outcomes. These kinds of experiments have been repeated many times and in several different contexts. For example, in the business management best-seller In Search of Excellence. A Random Walk Down Wall Street PDF Book Free
Peters and Waterman report that a random sample of male adults were asked to rank themselves in terms of their ability to get along with others. One hundred percent of the respondents ranked themselves in the top half of the population. Twentyfive percent believed that they were in the top 1 percent of the population. Even in judging athletic ability, an area where selfdeception would seem more difficult.
At least 60 percent of the male respondents ranked themselves in the top quartile. Even the klutziest deluded themselves about their athletic ability. Only 6 percent of male respondents believed that their athleticism was below average. Daniel Kahneman has argued that this tendency to overconfidence is particularly strong among investors. More than most other groups, investors tend to exaggerate their own skill and deny the role of chance. They overestimate their own knowledge, underestimate the risks involved, and exaggerate their ability to control events.