Book Review: A Random Walk Down Wall Street

A Random Walk Down Wall Street: The Time-Tested Strategy for Successful Investing 
By Burton Gordon Malkiel 

Money Lying on the Ground and an Ape Throwing Darts: two stories in A Random Walk Down Wall Street strike me the most. First, if you are walking on the street and see a $100 bill lying on the ground, you should not pick it up. Second, a blindfolded ape throwing darts at a newspapers financial pages could select a portfolio that would do just as well as one carefully selected by experts. And these two stories illustrate the main point of the book: the stock market is efficient and no one can earn above-average returns without accepting above-average risks. Therefore, an average person who invests in index funds can even do better than a professional who actively manages a fund. Besides this thesis, the book also introduces some investment vehicles and strategies. The question is: should I recommend this book as an introduction book to an intelligent friend with no investment experience?

The answer to this question depends on what my friend’s situation is. Specifically, it would concern my friend’s intended length of investment, market she chooses to invest in and her purpose of investing. In the following, I will mainly talk about situations where I won’t recommend the book to my friend. The book’s Efficient Market Hypothesis might not work well if my friend wants to invest short-term. If she sees a $100 bill on the street, why wouldn’t she pick it up just because it should or will disappear eventually? (The EMH says that the bill should or will disappear.) In other words, if my friend wants to invest in the short-term, why would she refuse to grab the short-term benefits just because it will disappear in the long run? Say that if my friend needs to send her children to college in four years, she can only invest the inheritance for the next four years. She might be better off by investing in an actively management fund. She probably will get much money by buying some tech stocks in 1995 and selling them in 1999, even though the internet bubble busted later on. If one is investing in a short period of time, the book’s theory will not necessarily apply since the thesis is based on long term. In this case, I won’t recommend the book to my friend. Instead, she will benefit more from a book that introduces different strategies on how to select stocks or fund managers.

The place the ape (average investor) is at also matters. "King Kong was a king and a god in the world he knew, but now he comes to civilization merely a captive", says Carl Denham in King Kong. Index funds might not outperform the actively managed ones at certain places. For example, if my friend is in China, she might be better off by hiring a good manager to manage her funds because the Chinese stock market is highly speculative and relatively opaque. According to the China Securities Regulatory Commission, as high as 65% to 70% of the investors in the Chinese stock market consists of private individuals. Partly because individuals tend to aim at the short-term rather than the long term compared to institutions, the Chinese stock market can swing dramatically and easily go out of norm. In the book, the market always adjusts itself to normal state. However, if abnormality is the rule, rather than the exception, like the Chinese stock market, the abnormal state becomes the new norm. Since it would be difficult to tell when the market will correct itself, one can do better by just following the trends or the new norm. Moreover, information from the public companies is not highly transparent, which prevents the market from performing efficiently. Since the Efficient Market Hypothesis is a condition for the superiority of index funds over actively managed funds, sticking with index funds, as promoted by the book, might not work well. Sometimes, the big mutual fund management companies have insider information that helps them take advantage of market inefficiencies and perform better than the index funds. (Note that the Chinese law system is not mature enough to prevent that from happening.) In fact, a recent research on S and P has shown that in some areas, stock picking outperforms passive investing. For example, more than half of actively managed large- and small-cap value funds beat the benchmarks in the past five-year period. Actively managed large-cap value funds did particularly well, returning 2.2% per year on average, versus 0.63% for the index; actively managed small value funds earned 3.79% per year, versus 2.96% for the index. The average actively managed international small-cap fund returned 4.91% per year over the last five years, more than triple the index. Index funds might be the King and God of stock market in some areas, but merely a captive to actively managed funds in other areas.

Moreover, the purpose of investing matters. If my friend is on the street to appreciate the spectacular architectures, a $100 bill lying on the ground will not be appealing to her. If my friend wants to invest to have fun, she would not derive much pleasure from just passively investing in index funds. Rather, I would recommend some other book that goes into the details of how to pick stocks to her. In another case, if my friend is investing to learn about companies or behavior of equities, she would not learn much with index funds. On the other hand, if my friend just wants to get rich slowly, the book by Malkiel is the right one. Lastly, you never know if your friend will be the next Warren Buffet. It is always worth a try. If I recommend the random walk book to my friend up front, she might become a passive investor and just give up picking her stocks and developing her own investment strategies.

A potential Warren Buffet might just get covered up in the mascot of a blindfolded ap.
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Editorial Staff

M&A Activity Review

SAP Moves to Acquire Success Factors
Success Factors is a Web-based software company and is valued around $40 a share. This move by SAP comes in response to rival Oracle’s acquisition of RightNow Technologies for $1.43 billion this past October. This move highlights the purchase of smaller software companies as larger companies look to compete in cloud technology.

Buffet to Buy Omaha Newspaper 
Warren Buffet looks to by the publisher of the Nebraska principal daily newspaper. Berkshire Hathaway reportedly is buying Buffet’s hometown newspaper. Terms of the deal have not been revealed, but this marks an interesting buy of the Omaha World -- Herald company.
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Editorial Staff

Market Recap (Dec. 5)

The Dow Jones Industrial Average (DJIA) finished the week up 7% despite a late downturn as the market closed on Friday. This marks the second biggest weekly gain in the index’s history. The S&P 500 and the Nasdaq Composite finished the week up 7.4% and 7.6% respectively. Investors responded positively to reports early in the week that unemployment had fallen to 8.6% and that 120,000 nonfarm jobs were created in the month of November. This is a broad indicator that the US’ ailing economy is improving, but analysts are quick to caution that we are not out of the woods yet.

There are still major concerns looming over the European debt crisis and although domestic manufacturing is on the rise, the interdependencies in world economies could create serious problems as Europe slides into a recession. The leaders of the 17-nation Euro zone will meet for a summit on Thursday and Friday of this upcoming week and investors will continue to follow measures to ease the debt crisis closely.

The European Central Bank (ECB) recently pledged 200 billion euros to the International Monetary Fund to be used in alleviating the fiscal woes of countries such as Italy, Greece, and Spain. Oil finished the week at over $100/barrel and energy stocks performed extremely well on the whole. This sector is awaiting a final decision on a proposal from TransCanada (TRP) to build a pipeline from Canada to the Gulf of Mexico. While the Obama administration has initially rejected the idea over concerns about safety and the environmental impact the pipeline may have, House Republicans have introduced a bill to legislatively force approval. Proponents of the project say the pipeline would create 20,000 jobs and release problematic oil gluts in places like Cushing, OK.

Financial stocks posted huge gains as three out of four companies listed on the DJIA ended with positive numbers for the week. European banks benefited from Angela Merkel’s comments early in the week on plans to reach a tighter fiscal union in the EU. American bank shares responded well to the positive labor reports but, like every other sector of the economy, are still extremely vulnerable to economic unrest in Europe.
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Editorial Staff

Interview with P&G CEO Bob McDonald

The CEO of P & G talks about his global career experience, P & G's expansionary strategies and offer career advice for college students.

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Editorial Staff

Occupy Wall Street: Where Is It Headed?

As the Occupy Wall Street movement continues to sweep the nation, and the 99% continue to cry for accountability and justice within the financial system -- we should take heed in not only their movement, but also the glaring reality that the group is fighting a battle they simply cannot win. For despite the growing number of Occupy groups that have sprung up across the nation (both on and off college campuses) -- these protesters face a discouragingly long uphill battle. Starting with the negative media surrounding the group’s often fragmented goals, and ending with a financial situation that is often too complicated to explain to the average American -- OWS was doomed from the start. The blame the group seeks falls to no one individual, nor can the economies downturn be traced to one specific event. Beyond the desperate cries for Wall Street executives to be held accountable for what they have done -- what the movement has failed to realize is that they are not protesting the greed and corruption of the financial system, but those of American society. The full-bodied, drastic changes OWS wish to see implemented would only come only at the cost of broad-spectrum changes to American consumer culture and massive disruptions to the American economy.

Without even taking a stance on the movement, it is easy to see that the group’s vision completely outdistances the realities of our current situation. There is no doubt that the glaring disparities in wealth, education and living standards need to be addressed within our society -- but protesting the men and women who have the means and the ability to keep themselves in the 1% is not the best way to get there. To attack the principals of capitalism -- the foundation upon which this nation was built -- is but to alienate yourself to a position where you can no longer create the meaningful change you wish to create.
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Editorial Staff

AMR Corp. Files Chapter 11

American Airlines’ parent company AMR Corporation filed for Chapter 11 bankruptcy protection last Monday. The company currently faces $29.6 billion in debt that continues to grow as a result of operating losses. During reorganization, the airline company will likely aim to reduce labor costs, leaving many worried that wage-cuts and layoffs may come in the near future. AMR stated that American Airlines expects to continue normal business operations throughout the reconstruction process. Specifically, American and American Eagle assured customers that they would fly normal schedules, honor tickets and reservations, maintain frequent flyer miles, and continue to pay employee wages as well as provide health benefits.

According to the Financial Times, this marks the end of company’s decade-long attempt to avoid Chapter 11. In 2003, American chose to avoid bankruptcy, while many of its peers chose to use Chapter 11 to reduce structural costs and cut pension plans, putting American at comparative disadvantage. For example, the company claims that it is currently paying at least $600 million more for labor contracts than other airlines such as Delta and United who were able to eliminate existing contracts after filing chapter 11. Federal bankruptcy rules allows a company filing for Chapter 11 the ability to reject contracts. As such, AMR will be able to take a stronger stance when it renegotiates with labor unions. This will be one of the first steps AMR will take in its attempt to use reorganization to become more efficient, competitive, and financially secure.
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Editorial Staff

Interview with David Cutcliffe

Duke Football Coach David Cutcliffe discusses the financial aspects of the team and team management.

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Editorial Staff

Corporate Finance Activity Review

Starbucks Acquires Juice Company 
Starbucks bought Evolution Fresh, a juice company, for $30 million. The recent purchase represents a shift for the company in seeking juice profits. Starbucks main competitors in the juice industry will be Odwalla, owned by Coca-Cola, and Naked Juice, owned by PepsiCo. In purchasing Evolution Fresh, Starbucks is looking to expand its menu and entice a different sort of customers.

Energy BP Fails to Sell Argentinian Oil Company Stake
Energy BP plans to sell its majority stake in Pan American Energy, an Argentinean oil producer, for an estimated $7.1 billion. However, the potential deal ended after the buyer, Bridas Corporation backed out.

TransCanada Pipeline 
The approval process for the Keystone XL pipeline has been delayed; the pipeline would cross the international border with Canada and new possible alternate routes are being discussed. Initial estimates on the cost of the project have reached $1.9 billio. 
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Editorial Staff 

Market Recap (Nov. 14)

After opening the week strong, the Dow Jones Industrial Average (DJIA) sustained severe losses at the opening bell on Wednesday, finishing the day down 3.2%. This overnight drop was caused predominantly by the news that Italy’s borrowing costs would continue to rise. Investors acted on concerns about the credit status of Italy and instability in the Eurozone in general. The market bounced back on Friday as plans for an interim government after the imminent resignation of Prime Minister Silvio Berlusconi began to emerge. As expected, Berlusconi resigned on Saturday as the lower chamber of Italy’s parliament approved new austerity measures in a revised budget bill. Mario Monti, an economist and former European commissioner, was announced as Berlusconi’s successor effective Sunday night. Investors will likely react favorably to this decision by parliament given the extremely negative perception that the international community at large held with respect to Berlusconi’s leadership.

Europe’s debt crisis remains one of the most significant roadblocks to sustainable increases in the markets. On the whole, the economy is slowly recovering as is reflected in generally fair valuations and better-than-expected quarterly earnings reports. Eurostat will release reports on industrial production and inflation within the Eurozone on November 14 and November 16 respectively. These reports will provide important insight into the overall economic health of the countries that investors have been so focused on. Investors are also worried about the increasing spreads in yield premiums between Germany and other large Eurozone countries such as France, Austria, and Belgium. If these spreads do not tighten over the next week, the market will likely fall off the gains it made late this past week.

Earnings reports from Walt Disney Corp. (DIS +0.95%) were released this week. Disney announced a rise in fourth-quarter earnings Thursday afternoon, giving investors a pleasant surprise. Bond markets were closed for Veteran’s Day on Friday but positive developments over the weekend in Europe (specifically in Italy) should promulgate a bond selloff on Monday that could push equities even higher. Of course, this increase will likely not be sustainable unless regulators can come up with a viable plan to keep Italy’s and other struggling countries’ borrowing costs low.
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Editorial Staff

MF Global Winds Up

The liquidation of MF Global resulted in 1,066 layoffs this past week. After MF Global filled for bankruptcy on October 31st of this year, the court appointed trustee has been overseeing the brokerage firm. FBI investigators are investigating the company and searching for $600 million missing in customer money. The CME group pledged $300 million to aid MF Global’s current customers. However, the recent lay-offs will not make up for the missing money.
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Editorial Staff 

Market Recap (Oct. 24)

Dow industrials bounced back from a rocky start to ride a Friday rally to a 1.4% gain for the week. This week is the fourth straight that the DJIA has seen overall returns, a mark not matched since January of this year. The S&P 500 rose by 1.1% while the NASDAQ 100 dropped by the same amount. Trading opened down this week as investor confidence was shaken following pessimistic comments made by German Chancellor Angela Merkel’s spokesperson Steffen Seibert. Seibert indicated that an agreement on a solution for the European sovereign debt crisis would likely not be reached at the EU summit planned for October 23. Markets remained volatile over the course of the week as new information was leaked on prospects for the summit. The euro recouped the losses it sustained earlier in the week on Friday as German finance minister Wolfgang Schaeuble contradicted Merkel and said that he hoped for a resolution.

A number of S&P 500 companies released third quarter earnings reports this week. The tech sector as a whole generally reported losses and missed earnings targets while a recent spate of mergers and acquisitions in the energy industry has boosted that sector. Bank of America (BAC) reported a profit of $6.2 billion while Goldman Sachs (GS) reported only their second quarterly net loss since the company went public in 1999. The market reaction to BofA’s report was mixed, however, as much of those profits were due to accounting methods and a one time sale of China Construction Bank stock.

McDonald’s (MCD) stock price rose to record heights following third-quarter earnings gains of 8.6% on the back of same-stores sales growth. By and large, big corporations returned healthy profits and are maintaining healthy balance books. Demand is still sluggish in the US market where the economy is still stagnating but many S&P 500 companies are offsetting this by increasing their exposure to overseas markets. Ultimately, while this is good for the S&P, small business owners are left at a huge disadvantage moving forward.

Bottom Line: the markets are currently in flux, waiting for any potential resolutions from this weekend’s summit. Investors are seeking clarity on recapitalization for European banks and how much Greek bondholders’ losses will affect those banks.
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Editorial Staff

M&A Activity Review

Kinder Morgan Acquires Rival 
Pipeline giant Kinder Morgan announced that it will buy rival company El Paso Corp. for $21.1 billion in cash and stock. With the acquisition, Kinder Morgan will become the largest operator of nature-gas pipelines in the United States. This deal puts increased faith in the future of natural gas a potential energy source and will catapult Kinder Morgan to the fourth largest energy company in America. Kinder Morgan recently became a public company this year and raised $2.9 Billion in its February IPO.

Groupon Strides Toward I.P.O.
Groupon, which is heading towards its public offering, expects to sell 30 million shares at about $16 to $18 a share, valuing the company at as much as $11.4 billion. Groupon hopes to break even before their public offering around November 3rd. Groupon is an internet start up that finds discounts at local restaurants and stores, and now is approaching 150 millions subscribers. 

Carlyle and Blackstone Compete for Merger Market 
The Carlyle Group and Blackstone were active in the merger market during the first three quarters this year, with Carlyle group completing 20 deals assessed at $4.1 billion and Blackstone signed 11 deals approximately valued at $16.9 billion. Overall data from Q3 from 2011 was up 7.4% from Q3 2010, and private equity firms completed $76.4 billion worth of deals internationally.
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Editorial Staff 

Legal/Regulatory News

Court Cracks Down on SEC / Citigroup Case 
Citigroup Case Judge Jed Rakoff of the District Court in Manhattan denied a settlement between Citigroup and the Security and Exchange Commission. Citigroups was seeking to pay $285 million to the SEC without having to admit any illegal practices. This signifies a crackdown by the courts in wanting companies to acknowledge their offenses.

Congressman Barney Frank Denies Re-Election Campaign
Barney Frank stated that he will not seek reelection in 2012. Frank was one of the longest serving members in the House of Representatives. Frank blamed the redistricting constraints that would be placed on him and the challenges were too difficult to overcome.

Icahn vs. Ackman
The court battle between Carl Icahn and William Ackman has finally ended. The two men have become wealthy due to the success of hedge funds; and their seven-year case is finally settled. Mr. Ackman and Mr. Icahn were fighting over $4.5 million suit, a minute amount in terms of their overall worth.

Rajaratnam Faces Hefty Fines and Prison Time
A federal judge convicted Raj Rajaratnam -- the former hedge fund manager and founder of the Galleon Group -- of insider trading The judge ordered Rajaratnam to pay the largest ever penalty of $92.8 million assessed against an individual; Rajaratnam was also sentenced to 11 years in prison.

Insider Trading in Denver 
Denver Hedge fund manager Drew Brownstein was convicted of insider trading. Mr. Brownstein admitted to making nearly $2.5 million on an insider trading tip about Mariner Energy. Brownstein received the information from a friend, Mr. Drew Peterson, who has also pleaded guilty. The typical sentencing guidelines call for 37 to 46 months of jail time with the plea.

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Editorial Staff

Market Recap (Mar. 27)

Market Recap (March 20)

Interview with Rachel Cook

Please join Duke Business Network for an interview with Rachel Cook, a filmmaker who is making a documentary on microlending for enterprising women. Prior to being a filmmaker, Duke graduate Rachel was a trader in Chicago and New York.


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Editorial Staff

Market Recap Video (Feb. 6)