A Random Walk Down Wall Street Notes


This is a running document of the notes that I take while reading Burton G. Malkiel's book, A Random Walk Down Wall Street.

Table Of Content

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  1. Chapter 5 - Technical and Fundamental Analysis

Chapter 5 - Technical and Fundamental Analysis

Technical vs. Fundamental Analysis

There are two main methods to accurately predict the future course of stock prices:

  1. Technical analysis
  2. Fundamental analysis

Technical analysis is essentially the making and interpreting of stock charts. They study the past (both the movement of common stock prices and the volume of trading) for a clue to the direction of future change.

Fundamental analysis examines a company's assets, its expected growth rate of earnings and dividends, intrest rates, and risk.

The Technique of Fundamental Analysis

There is a difference between a stock's current price and its true value.

In estimating the firm-foundation of a stock, the fundamentalist needs to estimate the firm's future stream of earnings and dividends.

The worth of the share is taken to be the present or discounted value of all the cash flows the investor is expected to receive.

The analyst must estimate the firm's:

4 Basic Determinants to Help Estimate the Proper Value of any Stock

1. The expected growth rate

Compound intrest is very important.

A simple way to determine how long it takes for money to double in compound intrest is by using the rule of 72

&Time = 72 / text(Intrest Rate)&

Evaluating Securities 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

2. The expected dividend payout

If 2 companies are the same growth rate, you are better off with the one that returns more cash to the shareholder.

Example: Suppose you were considering the purchase of a stock with an anticipated 8.5% growth rate and you knew that, on average, stocks with 8.5% growth sold at 18 times earnings. If the stock you were considering sold at a price-earnings multiple of 20, you might reject the idea of buiing the stock in favor of one more reasonably priced in terms of current market norms. On the other hand, if your stock sold at a multiple below the average in the market for that growth rate, the security is said to represent good value for your money

Evaluating Securities 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

3. The degree of risk

One theory suggests that the bigger the swings — relative to the market as a whole — in an individual company's stock prices, the greater the risk.

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

4. The level of market interest

Investors should consider purchasing high-yielding bonds if their yielding intrest rate is high enough

Evaluating Securities Rule 4: A rational investor should pay a higher price for a share, other things equal, the less lower the intrest rates

The 4 valuation rules imply that a security's firm-foundation value (and its price-earnings multiple) will be higher if:

Using Fundamental and Technical Analysis Together

Three rules the author suggests to judge whether individual stocks are attractive for purchase:

  1. Buy only companies that are expected to have above-average earnings for 5 or more years
    • an extrordinary long-run earnings growth rate is the single most important element contributing to the success of most stocks
  2. Never pay more for a stock that its firm foundation of value
    • generally, the earnings multiple for the market as a whole is a helpful bench mark
    • growth stocks selling at multiples in line with or not very much above this multiple often represent good value
  3. Look for stocks whose stories of anticipated growth are of the kind of which investors can build castles in the air

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© 2023 by Ryan Rickgauer