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

by Burton G. Malkiel

The bitcoin system works through a secure public ledger called a blockchain. A coded and password-protected (but anonymous) entry on the ledger records ownership of the bitcoin.

Not really anonymous. In fact the ledger of transactions is how the federal government has prosecuted people conducting various crimes financed by Bitcoin.

It is the extreme volatility in the value of the bitcoin that makes it fail the second and third common definitions of money. An asset that gains and loses a substantial percentage of its initial value each day will serve neither as a useful unit of account nor as a dependable store of value. It is in this volatility that the peril of the bitcoin resides.

Rule 1: A rational investor should be willing to pay a higher price for a share the larger the growth rate of dividends and earnings.

Corollary to Rule 1: A rational investor should be willing to pay a higher price for a share the longer an extraordinary growth rate is expected to last.

Rule 2: A rational investor should pay a higher price for a share, other things equal, the larger the proportion of a company’s earnings paid out in cash dividends or used to buy back stock.

Rule 3: A rational (and risk-averse) investor should pay a higher price for a share, other things equal, the less risky the company’s stock.

when interest rates are very low, fixed-interest securities provide very little competition for the stock market and stock prices tend to be relatively high.

Rule 4: A rational investor should pay a higher price for a share, other things equal, the lower the interest rates.

Caveat 1: Expectations about the future cannot be proven in the present. Predicting future earnings and dividends is a most hazardous occupation. It is extremely difficult to be objective; wild optimism and extreme pessimism constantly battle for top place.

Caveat 2: Precise figures cannot be calculated from undetermined data.

It is intrinsically impossible to calculate the intrinsic value of a share. There is, I believe, a fundamental indeterminateness about the value of common shares even in principle. God Almighty does not know the proper price-earnings multiple for a common stock.

Caveat 3: What’s growth for the goose is not always growth for the gander.

Rule 1: Buy only companies that are expected to have above-average earnings growth for five or more years.

Rule 2: Never pay more for a stock than its firm foundation of value.

Rule 3: Look for stocks whose stories of anticipated growth are of the kind on which investors can build castles in the air.

Even the legendary Benjamin Graham, heralded as the father of fundamental security analysis, reluctantly came to the conclusion that fundamental security analysis could no longer be counted on to produce superior investment returns.

And investors who do wish to seek higher returns by assuming greater risk should buy and hold low-beta stocks on margin, thereby increasing their risk and returns. We shall see in chapter 11 that some “smart beta” and “risk parity” strategies are designed to execute that exact strategy.

Even if the investor believed that his losing stock would recover in the future, it would pay to sell the stock and purchase a stock in the same industry with similar prospects and risk characteristics.

If You Do Trade: Sell Losers, Not Winners

We know that investors desire high rewards (high returns) and low risk (low volatility). The Sharpe Ratio combines both of those elements in one statistic. The numerator is the return from the strategy, or more commonly, the excess return over the risk-free rate (usually the three-month Treasury bill rate). The denominator is the risk or volatility of the strategy measured by the standard deviation of the returns (how variable they have been over time).

One of Bridgewater’s greatest successes had been the development of “risk parity” investment techniques. The evidence-based principle on which it rests is that relatively safe assets often provide higher returns than are appropriate for their level of risk, while riskier assets are relatively overpriced and return less than they should. Investors can therefore improve their results by leveraging low-risk assets, buying them with some borrowed money, so as to increase their risk and return,

With few exceptions, I sell before the end of each calendar year any stocks on which I have a loss. The reason for this timing is that losses are deductible (up to certain amounts) for tax purposes, or can offset gains you may already have taken. Thus, taking losses can lower your tax bill. I might hold a losing position if the growth I expect begins to materialize and I am convinced that my stock will eventually work out. But I do not recommend too much patience in losing situations, especially when prompt action can produce immediate tax benefits.