A Random Walk Down Wall Street: The Time-Tested Strategy for Successful Investing

by Burton G. Malkiel

Take a company that you’ve heard lots of good things about. You study the company’s prospects, and you conclude that it can maintain a high growth rate for a long period. How long? Well, why not ten years? You then calculate what the stock should be “worth” on the basis of the current dividend payout, the expected future growth rate, and the general level of interest rates, perhaps making an allowance for the riskiness of the shares. It turns out to your chagrin that the price the stock is worth is just slightly less than its present market price. You now have two alternatives. You could regard the stock as overpriced and refuse to buy it, or you could say, “Perhaps this stock could maintain a high growth rate for eleven years rather than ten. After all, the ten was only a guess in the first place, so why not eleven years?” And so you go back to your computer, and lo and behold you now come up with a worth for the shares that is larger than the current market price. Armed with this “precise” knowledge, you make your “sound” purchase. The reason the game worked is that the longer one projects extraordinary growth, the greater is the stream of future dividends. Thus, the present value of a share is at the discretion of the calculator. If eleven years was not enough to do the trick, twelve or thirteen might well have sufficed. There is always some combination of growth rate and growth period that will produce any specific price.