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Malkiel Submitted by: Chinda Tankhoun, Claudia Davila, Tashi RinzingFirm Foundation Theory: Firm Foundation Theory Each investment instrument has an intrinsic value Intrinsic value can be determined by careful analysis of present conditions and future prospects Inversely related to market prices A stock’s value ought to be based on the stream of earnings a firm will be able to distribute in the future as dividends Warren Buffett is a strong believer of this theoryCastle in the Air Theory: Castle in the Air Theory John Maynard Keynes enunciated the theory in 1936 Concentrates on psychic values Analyzes how the crowd of investors is likely to behave in the future during periods of optimism According to Keynes, most people look at the short term benefits rather than long term benefits “A thing is worth only what someone else will pay for it” The Tulip Bubble: The Tulip Bubble Started in 1593 and went well into the 1600s. Prices of bizarre tulip bulbs soared As prices went up, more and more people bought them Call options gave tulip speculators the right to buy tulip bulbs at a fixed price Speculators with call options lost money Finally crashed in 1637 The South Sea Bubble: The South Sea Bubble South Sea Company formed in 1711 The company was granted exclusive rights to trade with South America under treaty with Spain Stock issue price went from £300 to £1000 in the same year Crowd continued to buy stocks even when stock price more than tripled (herd mentality) Crowd believed in the greater fool theory Peaked in 1720 Finally crashed The “Tronics Boom”: The “Tronics Boom” The word “growth” was a magic word in the sixties Growth companies (IBM, Texas Instruments) sold at price earnings more than 80 Investors considered companies with the word “electronics” to be profitable even if the company had nothing to do with electronics Crashed in 1962 The Conglomerate Bubble: The Conglomerate Bubble Mergers & Acquisitions very popular “Synergism” was the entrepreneurs main philosophy “Synergism” known as the quality of having 2 plus 2 equal 5 Electronic companies merged with other growth companies to increase stock prices Peaked in 1967 and after 1968 it began to slow downThe Biotechnology Bubble: The Biotechnology Bubble Started in 1980 Valuation levels of biotechnology stocks reached very high levels Used the product asset valuation method based on estimates Crashed in 1987 The ZZZZ Bubble: The ZZZZ Bubble Barry Minkow started his own carpet cleaning company Became a millionaire by the age of 18 Investors put a lot of faith and had great expectations in him Company stocks over valued Caught for fraud, money laundering, and ties with the Mob Went to jail in 1989 at the age of 23The Japanese Real Estate and Stock Markets: The Japanese Real Estate and Stock Markets Between 1955 to 1990, value of Japanese real estate increased more than 75 times Total value of Japanese property valued at $20 trillion Peaked in 1989 when Japanese stocks had a total market value of $ 4 trillion Interest rates rose sharply in 1990 thereby leading to the collapse of the stock market The Internet or dot-com Bubble: The Internet or dot-com Bubble Stephen Paternot and Todd Krizelman started a company called “TheGlobe.com” After their IPO, their price per share went from $ 9 to $97 immediately TheGlobe.com caused the internet bubble Stock prices in internet companies soared to great heights Market finally crashed thereby marking the beginning of a mild but lengthy recessionThe Random Walk Theory: The Random Walk Theory The “cycles” in the stock charts are no more true cycles than the runs of luck or misfortune of the ordinary gambler Any systematic relationships that exist are so small that they are not useful for an investor A simple buy and hold strategy typically makes us much more money Simply buying and holding a diversified portfolio will enable you to save in investment expense, brokerage charges, and taxes All investors are risk adverse (Want high returns and guaranteed outcomes) The Modern Portfolio Theory: The Modern Portfolio Theory Diversification International diversification No actual relation between beta and rate of return Returns are sensitive to general market swings, changes in interest and inflation rates, changes in national income and exchange rates Three Giant Steps Down Wall Street: Three Giant Steps Down Wall Street Investing in index funds Produce rates of return of 2% Tax friendly (Capital gains) Relatively predictable Diversification (small investors) Minimal expenseThree Giant Steps Down Wall Street continued…: Three Giant Steps Down Wall Street continued… Do it yourself! Purchase stocks that appear to sustain above average earnings for at least 5 years Never pay more for a stock that can be reasonably justified by a firm foundation of value Buy stocks with the kinds of stories of anticipated growth on which investors can build castles in the air Trade as little as possibleThree Giant Steps Down Wall Street continued…: Three Giant Steps Down Wall Street continued… Hire a Professional Wall Street Walker Mutual fund managers Mutual fund costs (fees & charges) Morning Star Service Fundamental Paradox If everyone knows about a good buy, its price will rise until it is no longer particularly attractive for investment Conclusion: Conclusion There is no such thing as “buy low P/E stocks” or “buy small company stocks” that will perpetually produce unusually high risk adjusted returns Anomalies do exist as well as exploited opportunities Investing is an art that requires a certain talent and the presence of a mysterious force called “luck” You do not have the permission to view this presentation. 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