A Random Review

One of the best books you can read about investing is Burton Malkiel’s A Random Walk Down Wall Street, which I have long recommended.

The random walk theory holds that the movement of individual stock prices, or the market as a whole, is largely random, because everything that can be known about which way stocks are headed is already reflected in their price. The market is “efficient.” It evaluates every known fact, hope and worry, and unless you know stuff no one else knows (and why would you?), you have no edge.

I don’t entirely buy that, because it makes market players out to be more coldly rational than I think we actually are. Sometimes things go to irrational extremes.

Even Malkiel doesn’t entirely buy it. If I remember right, he describes himself as “a random walker with a crutch;” i.e., the market is very hard to beat, but not impossible.

Of course, in any given year lots of people will beat it, just as on any given day, there will be some big winners at Las Vegas, even at the slots. But over time, the people who beat the market one year very often underperform it the next year.

Anyway, one of you, Ken Powell, took my recommendation to read this book and reports as follows:

I thought it was an excellent book. I did think, however, that Malkiel rather blithely dismissed the performance of the Peter Lynches and Warren Buffetts of the world. The flip side is that the value investors of the world tend to dismiss efficient-market theory, which is equally crazy. In a sense, they’re relying on the relative efficiency of the market to raise the price of the stock they bought to where it reflects its “true” value. They count on exploiting isolated inefficiencies of the market AND the ultimate overall efficiency of the market.

So, after a fair amount of reading, I think Burton Malkiel has it mostly right, but Benjamin Graham/Warren Buffett also have it mostly right. I get much more enjoyment out of trying my hand at finding “inefficiencies” than in buying an index fund. Fortunately, I can afford to support this hobby. Anyway, thanks for pointing me to Malkiel’s book.

In the interest of full disclosure, perhaps I should tell you that Ken sent me that message in July — 1996. It can take me a while to get to these things. But in this case it surely doesn’t matter. The debate over efficient markets never dies.

The answer would seem to be: In a place like America, with big stocks, widely followed, and lots of rules on accounting and disclosure, the market is largely efficient. But even there, a big insight . . . like the way the end of the Cold War could lead to globalization and a boost for stocks like Coca-Cola, which Buffett bought just a few years ago at a tiny fraction of today’s price . . . well, was that luck? Or does it help to be really smart and common sensical? My guess is that it helps. But common sense also suggests that most amateurs are not likely to beat the pros, working at it full time — not least because most pros don’t manage to beat the averages either.