Chapter 1 - Firm Foundations and Castles in the Air

"A random walk is one in which future steps or directions cannot be predicted on the basis of past actions." (p. 24)

Asset Valuation

The firm-foundation theory

Each investment instrument has "intrinsic value." Fluctuations around this value create buying and selling opportunities, because the fluctuations will eventually be corrected.

In The Theory of Investment Values, John B. Williams argues that the intrinsic value of a stock is equal to the present or discounted value of all its future dividends. But forecasting the extent and duration of future growth is tricky.

Warren Buffett allegedly followed the firm-foundation theory approach.

The castle-in-the-air theory

This theory focuses on the psychology of the market crowd. Profits are made by foreseeing changes a short time ahead of the general public.

John Maynard Keynes

"In this kind of world, there is a sucker born every minute- and he exists to buy your investments at a higher price than you paid for them." (p. 32)

Comments

The author mentions the spectacular crazes that he will describe in the next chapter. It seems like every decade had one or more crazes. I first started reading this book in 1999 on recommendation by Alex Gould, instructor for a financial economics course I took. I vaguely recall thinking about where the .com trend was headed. Now as I re-start to read this book, we can add one more to the list. Looking ahead, I'm sure there will be many more crazes in our lifetimes. Just don't be the last sucker.