The Astute Investor, Second Edition
Moneymaking
Stock Market Advice
From the Masters
By Eric L.
Prentis
Copyright © 2012 Eric L. Prentis
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The intended purpose of The Astute Investor is to present faithful and useful information on stock market investing. Stock market buy, sell, or hold recommendations are not made in this book and should not be assumed. Professional services—such as legal, accounting, tax, insurance, or registered investment advice, etc.—are not offered in this text. If you desire professional services, please contact legally licensed professionals directly.
This book is also available in print at online booksellers.
Table of Contents
Introduction
Stock
Market Success Is Easy: Once You Know How
What Is An Astute
Investor?
Questions Asked
Questions Answered
Who Should
Purchase This Book
Website Commands
Do Not Use Bull Or Bear
The
S&P 500 Index As A Proxy
Technical Analysis
Bibliography
Chapter
1: Investment Principles And Strategies
Investing
Defined
Seven Principles Of Investing
Probabilistic Approach To
Investing
Investment Foresight
Investing Is Not
Gambling
Diversification Vs. Concentration
Avoid Investment
Pitfalls
Chapter
2: Theory And Practice
Time And Timing
Random
Walk Theory For Stock Prices
Random Walk Theory Paradox
Business
Cycles
Leading Economic Indicator Paradox
How American Roulette
And The S&P 500 Index Differ
Mr. Market
The Efficient
Market Hypothesis
Critique Of The Efficient Market Hypothesis
The
Random Walk Theory Critique
Stock Market Taxonomy
Chapter
3: Equity And Bond Fundamentals
Bond
Fundamentals
Equity Fundamentals
Corporate Management’s
Financial Responsibilities
Price-To-Earnings
Ratio
Price-To-Earnings Standards
Price-To-Earnings Ratio
Calculation
Discounting
Forward Price-To-Earnings
Ratio
Standard & Poor’s
S&P 500 Estimated Future
Reported Earnings
Prevailing Interest Rates
S&P 500 Index
Expected Fair Valuation Model
Chapter
4: Stock Market Technical Analysis
Goal Of The
Astute Investor
Pricing In The Stock Market
Inefficient Capital
Markets
Observe Market Signals
Premise Of Stock Market
Cycles
Investor Perspective
Monthly Data And Moving
Averages
Share Volume
Four Stock Market Stages
Stage 1
Stage
2
Stage 3
Stage 4
Stock Market Long-Term Trends
Monthly
Moving Average (MA) Trend Lines
Moving Average Convergence
Divergence (MACD)
Japanese Candlestick Graphing
Techniques
Technical Analysis
Computer Graphs
Custom
Graphs
Stage 1: Mark-Down – Downtrend
Stage 2: Market Bottom
– Accumulation
Stage 3: Mark-Up – Uptrend
Stage 4: Market
Top – Distribution
Back Testing
Chapter
5: Trading Psychology
Basic Human
Nature
Vanity
Greed
Will To Believe
Types Of
Investors
Rational Action
Non-Rational Emotions
Irrational
Influences
Chapter
6: Intrinsic, Market And Bargain Values
Graham-Dodd’s
Margin-of-Safety
Margin-of-Safety For Bonds
Margin-of-Safety
For Common Stock
Margin-of-Safety Conclusions
Fisher’s
Investment Style
Warren Buffett’s Investment Style
Step 1:
Calculating Intrinsic, True Or Fair Value
Step 2: Calculating
Market Value Capitalization
Step 3: Calculating Bargain Valu
Step
4: Calculating Margin-of-Safety Multiple
Step 5: Additional
Crucial Factors
Chapter
7: Interest Rate Principles
Interest
Defined
Why Interest Rates Adjust Through Time
The U.S.
Government And Money Supply
The Federal Reserve
FOMC
Organization And Procedures
Yield Curve
Dynamic Yield
Curves
Yield Curves In Practice
Business Cycle Indicators
Chapter
8: Interpreting The News
Discounting The
News
Expected News
Unexpected News
What Moves The
Markets
Discounted News Theory
Nightly News Investing: A Losing
Proposition
The News And The Media
Inside Information
Stock
Market Tips
Market Newsletters And Advice
Chapter
9: Being Contrarian
Contrarian
Philosophy
Comparing The Contrarian Approach
Contrarians
Evaluate Financial Experts
The Psychology Of Contrarian
Investing
Contrarian Implementation
Contrarian Investing
Method
Contrarian Investing: Additional Factors
Chapter
10: The Ten-Step Method For Investment Success
March
2004: Bringing The Parts Together
Step # 1: Investment Goal And
Strategy
Step # 2: Political-Economic Conditions
Step # 3: S&P
500 Index Expected Fair Valuation Model
Step # 4: S&P 500
Index Nine-Month MA Trend Line
Step # 5: Human Nature And Desired
Character Traits
Step # 6: Intrinsic, Market And Bargain
Values
Step # 7: Yield Curve
Step # 8: Discounted News
Theory
Step # 9: March 2004: Invest With the Crowd
Step # 10:
March 2004: Investment Analysis Results
Chapter
11: Retirement Planning
Asset Allocation
I.
Goal Selection
II. Planning Horizon
III. Risk Vs. Expected
Returns
IV. Risk Tolerance
Risk Vs. Volatility
Volatility
Tolerance
Volatility Vs. Total Return
Retirement Planning: 20
Years Vs. 30 Years
Preretirement Planning Example
At
Retirement: The Example Continued
Chapter
12: Discounted Market Hypothesis
Mr. Market In
Context
Stock Market Maps And Territories
Life And Happiness
Model
Discounted Market Hypothesis
Discounted Market
Hypothesis: A Formulation
Where Have The Random Walk Theorists
Gone Wrong?
Importance Of The Discounted Market
Hypothesis
Discounted Market Hypothesis: Conclusion
Conclusion
Practical
Benefits
Synopsis Of The Efficient Market Hypothesis
Critique
Paradoxes In The Stock Market
Ironies In The Stock
Market
Discounted Market Hypothesis: Summary Conclusions
The
Astute Investor Firsts
Continued Communication
About The
Author
Correct investment theories, strategies and methods explain how to make money in the stock market. Beginning and experienced investors, requiring practical knowledge to be successful when investing, find this book informative and convenient to use.
Is the stock market undervalued or overvalued? Is the market in a long- term upward trend or long-term downward trend? What stock should you buy? Monitoring interest rates help you recognize a market top or bottom, what are they? Learn how to answer these questions. This book presents where to find data on the Internet, how to calculate investment models, what the model results signify and how you can best use the information to perform “due diligence.”
Ask fundamental questions important to stock market investors. Answer them by becoming an astute investor. From beginning investors to financial service professionals, all find the practical ten-step method for investment success instructive.
Data to run the models presented are available using specific website commands, described in detail. Learn technical analysis techniques to assist market timing. The Astute Investor helps individuals feel confident taking control of their investment money to build wealth and a secure future. The essential investment wisdom and moneymaking advice from thirty-seven classic investment books from the masters on investing, ensures that you learn from the best in a short period.
Stock Market Success Is Easy: Once You Know How
Most investors, unfortunately, find out about the stock market the hard way—simply by doing. Learning by doing, common in many workplaces, is expensive when learning investing. By reading this book and applying its lessons, investors avoid many pitfalls that await those who begin investing without this knowledge.
The Astute Investor is distinctive, unique and superior to any other book on investing. Learn about market valuation, trend, interest rate monitoring and calculating intrinsic value, and many more topics. Read this book to understand the following three keys to investment success: 1) using forward-looking data; 2) knowing what the political-economic conditions are; and 3) investment perspective.
U.S. political factors such as fiscal and monetary policies have a major influence on the overall market. Learn to guard against the human weaknesses of vanity, greed and the will to believe. Discover that professional traders in the market look ahead using foresight to discount the news. Contrarians recognize the importance of crowd psychology. Learn the contrarian investment method. Become an expert at performing due diligence when performing the ten-step method for investment success.
Investors learn that correct investing is not a random activity, nor mere chance or luck, but a rigorous undertaking that requires reducing risk as much as possible before the act of investing. Accomplish this by relying on proper strategy, analysis, evaluation and judgment.
The goal is to point readers toward essential investment knowledge and to what that knowledge means, transforming naïve investors into astute investors.
What Is An Astute Investor?
An astute investor has foresight and is critically discerning, shrewd, subtle, sagacious and keenly aware of what information and facts are the most significant in investing. Astute investors plan and know where to find data necessary to run appropriate investment models and how to interpret these models’ results for decision making when investing. Astute investors are seekers of truth. They possess market vision, investment intelligence and practical stock market experience.
How investors implement the information presented here and the effort put forth when investing ultimately establishes how successful you will be when investing in the stock market. Understanding this book and applying it correctly, makes knowledgeable individuals investment winners versus naïve investors. The important questions concerning investing follow.
Questions Asked
Millions of Americans invest in the stock market using common stock, in mutual funds, or through self-directed retirement accounts (401(k), 403(b), IRA, or Roth IRA plans). The Astute Investor helps investors answer the following fundamental investment questions:
PART I
1) What investment principles and strategies are important?
2) What investment theory and practice are fundamental for investors?
3) Is the stock market currently overvalued or undervalued?
4) Is the stock market in a long-term uptrend or a long-term downtrend?
5) Why do human emotions get in the way of intelligent investing?
6) How are intrinsic, true or fair value, market value capitalization, bargain value and margin-of-safety multiple calculated and what do they mean?
7) What interest rates typically indicate a long- term stock market top?
8) Why do stock market prices often respond “illogically” to the news?
9) Being contrarian sounds simple, why is it so difficult in practice?
10) What is the practical ten-step method for investment success?
PART II
11) How can I double retirement income safely?
12) What new investment theories safeguard investment success?
Each of the chapter topics in The Astute Investor inform investors by helping him or her answer these fundamental investment questions for themselves.
Questions Answered
The following chapter synopses highlight the methods presented, to allow investors to answer essential investment questions, by presenting ten major investment firsts in this book, including easy to understand examples. The goal is to transform novice and experienced investors alike, into astute investors.
PART I
1) Understand investment principles and diversification versus concentration strategies. Learn the importance of investment foresight. Recognize investment pitfalls.
2) Study current stock market theory and practice of for perspective on intrinsic, true and fair value of individual companies in the marketplace. The stock market taxonomy categorizes the stock market for better communication.
3) Presenting, in chapter 3, a step-by-step discounting approach, to calculate the forward price-to-earnings (P/E) ratio and the Standard & Poor’s (S&P) 500 Index Expected Fair Valuation (EFV) Model. Use S&P 500 website data to help determine whether the stock market is either overvalued or undervalued.
4) The S&P 500 Index Nine-Month Moving Average (MA) Trend Line gives perspective and confirming indicators check on stage 1 through stage
4 market cycles. Know if the stock market is in either a long-term upward trend or a long-term downward trend. Discover a helpful charting website. Use the perspective of monthly S&P 500 Index trend lines, with specific confirming indicators, to validate long-term stock market trends.
5) Basic human nature and the human mind are unchanging. Learn about symbols, herd mentality and how investors’ rational, non-rational and irrational thinking and conduct undermine and even subvert the most intelligent investors’ thoughts and actions.
6) The Graham-Dodd-Buffett margin-of-safety approach to value investing for all companies requires looking for and recognizing corporate bargains. Learn how to calculate intrinsic, true or fair value. Study a step-by-step real-life example of intrinsic, true or fair value using free cash flow, market value capitalization, bargain value and margin-of-safety multiple.
7) Yield curves and comparing 3-month U.S. Treasury bill interest rates with 30-year Treasury bond interest rates integrate political and economic conditions and help indicate market tops and bottoms. The spread between the Federal Reserve federal funds interest rate and the 30-year U.S. Treasury bond (T-bond) interest rate normally discounts an eventual U.S. economic recession and identifies a long-term stock market peak. Learn how to accomplish this.
8) Interpreting the news requires understanding the expected news discounting process. Learn to be skeptical of market pundits and conventional wisdom by avoiding stock tips. Avoid paying attention to news headlines. Understand why investors find the discounted news theory (DNT) important. The discounted news theory is the correct premise to explain the sophisticated methods of professional traders in the stock market and as the basis for the discounted market hypothesis (DMH).
9) Being contrarian is easy in theory but difficult to implement, and challenges the witty saying, “In theory, practice is simple.” Recognize the incorrect self-selected market adviser’s strategy of being contrarian is just another form of taking stock tips. Opposing the market and pride of opinion are costly if practiced by investors. Learn the correct approach to being contrarian.
10) The practical ten-step method for investment success brings together all the previously discussed points in chapters 1 through 9. And forms for the astute investor a systematic approach to evaluating the stock market and individual companies. Study real examples using S&P 500 Index data, interest rates and eBay Inc. annual report information.
PART II
11) Learn about retirement planning, using asset allocation over the super long-term and a dollar-cost-averaging buy-and-hold strategy for core investing in the S&P 500 Index versus corporate bonds. What investors learn in this chapter should double their income during retirement. Use and understand volatility tolerance for asset allocation determination in retirement planning.
12) The first time in a book on investing, learn about the discounted market hypothesis (DMH). In addition, the discounted news theory follows the expected news discounting process and supports the DMH. The new theories explain the look-ahead ability of the S&P 500 Index to predict coming political-economic conditions and long-term stock market cycles. The DMH, supported by The Life And Happiness Model, gives the theoretical foundation for why the ten-step method for investment success works in practice.
Who Should Purchase This Book
Reading, understanding and acting according to The Astute Investor transforms all investors into astute investors. Individuals requiring this book include:
1) Investors who want to understand a perplexing stock market, desire learning essential investment knowledge, including information from the thirty-seven classic books on investing.
2) Investors who demand more than just theory, but practical examples from real life, important website addresses and how to find data on the Internet to run these investment models.
3) Those with self-directed retirement accounts (e.g., 401(k) plans), who want to ensure a better retirement for their family
4) Financial services professionals who want to better answer client questions.
Knowing stock market results in advance is impossible. However, put probabilities in your favor by purchasing, reading and implementing the material in The Astute Investor.
Website Commands
Market data are essential for investors to run investment models for themselves. Therefore, bold letters identify websites with defined commands necessary to find specific current data and information. First, the website logon address. Then, as explained in the brackets, find where to look on the computer screen or where to click. Or as sometimes necessary what to type. An example follows.
Logon: http://finance.lycos.com
Where: [Where to look on the computer screen (e.g., on the top heading, along the left column, or in the main body) and the name of what to look for]
Click: [What specifically to click on the computer screen to find the next screen or the necessary data]
Type: [Sometimes necessary to type in information]
Many steps may be necessary, consequently, many Where, Click and Type instructions may be mandatory.
Do Not Use Bull Or Bear
Many investors know that a bull market is a stock market that is trading higher, by approximately twenty percent and bear markets trade lower, by approximately twenty percent. Wall Street and the financial media often use the terms, bull market and bear market.
Constant strings of connected mental images describe our thought process. The terms bull or bear fixates the investor’s mind on either a powerful charging bull or a roaring provoked bear. Unfortunately, neither image is easy to forget. Investor emotions, discussed in chapter 5, can cloud proper action in the stock market. Because the terms bull and bear are emotionally charged words, they create in the investor’s mind a mental block that works against proper analysis.
Investment poise is essential for success. Erasing emotionally charged images is beneficial. Therefore, do not use the term bull or bear to describe the stock market. Instead, describe the stock market is as being either in a long-term upward trend or in a long-term downward trend. Investors should now feel flexible in recognizing the stock market’s state and their best response to it.
The S&P 500 Index As A Proxy
The Standard & Poor’s (S&P) 500 Index is the recommended average and proxy for the overall stock market in The Astute Investor. Other averages, such as the Dow Jones Industrial Average (DJIA), the NASDAQ Composite, the NASDAQ-100 (NDX), the Russell 2000, or the Wilshire 5000 do not work or not nearly as well as the S&P 500 Index.
The Wilshire 5000 includes all equities on the NYSE Euronext [Deutsche Boerse merges with the NYSE in February 2011, the new company is yet unnamed], NASDAQ and the NYSE Amex Equities exchanges. Nevertheless, it does not work as well as the S&P 500 Index in this book’s approach. Perhaps because the Wilshire 5000 includes smaller more volatile companies in its average than the S&P 500 Index.
Technical Analysis
Use technical analysis on the overall stock market, as represented by the S&P 500 Index. For example, look at S&P 500 Index double tops and bottoms, head and shoulders tops and bottoms and outside reversal days to help when identifying changes in long-term stock market trends. In addition, learn about the S&P 500 Index Nine-Month Moving Average (MA) Trend Line and confirming indicators such as the S&P 500 Index Two-Month MA Trend Line, the Moving Average Convergence Divergence (MACD), higher-highs and higher-lows, in chapter 4.
Technical analysis for an astute investor is recommended for the S&P 500 Index using monthly data. Please do not use any other stock market average or on any individual corporate stock. Do not assume other technical analysis techniques work for the S&P 500 Index method, such as flags, pennants or price gaps. Also, do not use technical analysis for an industry index, such as the semiconductor index (SOX).
Bibliography
The Astute Investor incorporates the essential investment wisdom and moneymaking advice from thirty-seven classic investment books from the masters on investing, presented in the bibliography section. Individuals study from the best and save considerable time learning how to invest. The glossary contains a financial dictionary of investment words. Investment principles and strategies are next, in Part I – chapter 1.
Chapter 1: Investment Principles And Strategies
Introduction
Investing defined. Seven investment principles give investors a better appreciation of what it means to have a sound approach to the field of investing. Certainty in the stock market is impossible. Learn instead, a probabilistic approach to determine when to be in the market. Understand the goal of investing and stock diversification versus concentration as a strategic decision. Study investment foresight, indispensable for successful investing. Learn the difference between investing and pure gambling. Avoid existing investment pitfalls.
Investing Defined
You may invest in many items—common stock, bonds, plant and equipment, rare coins, art, real estate, education, etc. The goal is the owner’s invested excess funds produce current income or for a future financial benefit to the investor. Earn money using the following three methods.
1) Employment, exchanging time for money.
2) Lending money, expecting its return on time and with interest.
3) Risking money—as in the equity markets—with the expectation that a larger payout compensates for the expected higher risk.
The Astute Investor explores and discusses the last two investment methods to earn money in common stock and bonds.
Investing requires the most advantageous strategies and analysis leading to proper evaluation and judgment for purchasing or selling common stock or fixed-income securities (bonds) for either capital appreciation and/or predictable income over a long planning horizon. A discussion of a safe or pure investment follows.
A Safe Or Pure Investment
A safe investment is loaning money, backed up by sufficient collateral. Take legal action, against the borrower, if payment of interest and repayment of principal on time is not forthcoming, and then attach the collateral for eventual sale by the new owner. Perform due diligence to protect principal and to expect a satisfactory return, then sign the contract.
A pure investment is acquiring securities based exclusively upon the safety of the principal and the security of income. The investor buys securities based on an assessment of safety and timely repayment of principal and income compensation.
For safe or pure investments, expect to receive interest and dividends are over the duration of the investment. Consequently, hold the securities with composure. The owner expects the return of the principal and contracted interest payments will be on time. Investors consider United States Treasury bills, notes and bonds safe or pure riskless investments.
Time
Time is critical when investing. Funds are committed expecting repayment on time. Moreover, the money earned will cover any inflation risk, return risk and the period the funds are not available to the lender.
Investment is primarily an attempt to secure a rental from the borrowers of funds for a conditional use of the owner’s money. Lenders attempt to stockpile, for their forthcoming claim, current surplus spending capacity, expecting a larger total amount of funds when needed in the future. Investing assumes a pragmatic assessment of income from dividends, interest payments, or rental fees with any capital appreciation over the term of the investment.
The owner normally estimates the periods for investments to match the required return of the funds for any future use. The need for high predictability of timely replacement of the principal and earnings income over the longer-term separates investing from the more risky and normally shorter-term business of speculating. Investing only on the long side of the market is appropriate and is next.
Investing On The Long Side Of The Market
Astute investors will always invest in equities (common stock) on the long side of the market, or in other words, always expecting that stock prices will increase in value. Select an individual corporate stock based on its projected outperforming of other stock in its industry, sector, or the market taken as a whole.
An investor may go to a neutral position, into cash or a money market fund, when the long-term prospects of the stock market are poor and pointing downward.
Shorting stock, i.e., going short of the stock market and selling securities one does not own, is too speculative a position and is not an appropriate option for an astute investor looking for investments. Please see The Astute Speculator for information on shorting stock, risk management, futures and options trading and other speculative topics. The following investment principles help prospective investors participate in investing with the proper understanding and attitude about investing.
Seven Principles Of Investing
Astute investors should approach investing in an intelligent and businesslike manner. Unfortunately, beginners often enter the investment field with almost a total indifference of what it takes to be a success.
The typical business or professional person may spend perhaps a decade learning and practicing his or her vocation to save money to invest in the stock market. Yet these successful individuals think the same study and knowledge is not required when entering a security investment venture. Running a business or being a doctor, lawyer, engineer, or educator is unlike being an expert on Wall Street.
The following seven investment principles give prospective investors an understanding of what it means to have a sensible approach to the field of investing.
1) Individuals should first understand the nature of investing. Do not assume outsized profits from securities, be they common stock or bonds. If investors put forth extensive study and know security valuations then factor that knowledge into the equation, but only then.
Study the stock market or individual companies. Take a significant amount of time. Investing requires intellectual exertion that is much different from pure gambling, which is blind luck. To be a consistent winner in the stock market, investors should not simply rely on the kindness of strangers or chance. But, they should assess the risk and try to reduce it.
2) View purchasing securities as having an interest in or having a claim, alongside others, in the expected earnings of a corporation. When an individual decides to invest in securities, he or she is beginning a commercial undertaking. Treat it like any other monetary transaction, with caution and with one’s eyes wide open. Expected earnings are a key variable. Think of corporations without a history of solid earnings as speculative and therefore not appropriate for investing.
3) It is always best for investors to have the correct knowledge and to feel confident in making investment decisions. Learning, by reading and understanding this book and having the confidence to make one’s investment decisions are the investor’s goals. Barring that, investors may invest with those they have confidence in and who have demonstrated superior results and the highest integrity in investing. This book gives investors the capacity to understand and oversee their investment manager’s performance.
4) Analysis and calculation is the cornerstone of successful investing. Do not decide to invest after listening to a market adviser give seemingly well-argued reasons the market is either undervalued or overvalued. Do not base investment actions simply on the proclamations of charismatic individuals who use his or her exceptional intellect to offer plausible explanations of what the market may do. Be skeptical of all free advice, especially from advisers on television.
Do not base proper investing on hopefulness the market or stock prices will behave a certain way. But, only on studying the uncompromising facts, data and making the appropriate mathematical calculations. Only when calculations or technical data indicate a good possibility of securing an acceptable profit, should one undertake an investment.
An investor’s most powerful advantage over all others participating in the stock market, be they the company’s employees or stock market floor traders, is the power to “just say no.” Just say no to any scheme with “little to earn” and the possibility of “much to lose.” The astute investor’s goal is realistic returns, while having compelling proof that one’s investment capital is not in jeopardy.
5) Investors should have the courage of their convictions. Following one’s judgment is the goal. When investors have the knowledge, perform the calculations, review the appropriate technical data, form a conclusion based on these data and mathematical calculations, and determine their judgment is reliable. Investors now require courage to act on their convictions.
Astute investors should not vacillate simply because others do not share their resolve. Whether a few or a crowd agree with one’s judgment is immaterial. It does not verify if you are right or wrong. Determine correctness solely on using the right technical data, running appropriate mathematical models and maintaining sound judgment.
In investment virtues, first come proper knowledge, then sound judgment and finally the courage to act. Acquire confidence with investing experience in the stock market. Expect that after investors comprehend the contents of The Astute Investor, they will gain necessary stock market experience only by putting this valuable knowledge into action.
6) Limit one’s investment ambitions and reach to one’s area of competence. If investors do not feel comfortable or proficient in a particular area of investing, stay out. Satisfactory returns are the goal. Superior returns may initially look attainable in an unfamiliar field, but are often more difficult to achieve than first projected.
Do not feel pressured to jump into the latest hot industry merely because it is receiving large amounts of press or one’s neighbor recently did well in it. Staying focused on what the investor knows is paramount.
7) Accomplish successful investing not simply by relying on clear-cut facts or a rote mathematical formula, the key is investment judgment. Mark Twain (1835-1910) says, “Intelligence is another word for judgment.” Comprehend what the facts and mathematical formula results mean, and the affect this information will have on the stock market and its participants are important. Facts, technical data, mathematical models, knowledge, proper decisions and the willingness to apply this understanding and act on one’s convictions separate successful investors from the mediocre.
Investors may discover something significant about a corporation, but the inexperienced cannot capitalize on this information. A long-standing truth is, “Possessing critical relevant facts, even if most investors are unaware of them, does not guarantee stock market success.” The power of these facts to the investor rests solely with an understanding of what the market will do with the data and then to act correctly that gives investors the ability to make money from information. Achieve sound judgment for decisions by careful study of the facts in combination with extensive practical experience.
With the proper principles, investing requires a probabilistic approach, foresight and the most beneficial strategies and analysis leading to proper evaluation and judgment for purchasing or selling common stock or fixed-income securities for either capital appreciation and/or predictable income over a long planning horizon. Consequently, accept a probabilistic approach when investing in the stock market, next.
Probabilistic Approach To Investing
A foolproof scientific method for flawless execution in the stock market is not available, nor will it ever be. This book offers knowledge of what is important to observe in the market, what it means and gaining the practical experience to recognize and take advantage of market signals.
Possessing certain solutions is impossible when investing. Expecting to participate in the stock market, judging by an exact standard, is absurd and dangerous to an individual’s finances.
A strategy to evaluate and predict the future course of the stock market will never be a mathematical certainty. Instead, probabilities put prospects in the investor’s favor. Reducing risk as much as possible and having the probability of making money being on the side of the investor are the objectives.
Stressing answers when learning about the stock market is often shortsighted. Investors find it more instructive to study asking the correct questions rather than to know only a momentary correct answer, such as in a market newsletter. The right answers are only for specific times and places, while the correct questions and solution methods transcend both.
Investors quickly learn the stock market is always changing and that success comes only by balancing market probabilities and not by attaching oneself to one correct answer for all-time. Finding certain universal answers to the stock market is impossible, so it is better to rely on probabilities.
The successful approach offered here is an evaluation method based on correct premises and observations of past associations that will likely be to the astute investor’s advantage over a long planning horizon. Knowledge and the experience of working with real situations are vital for success when investing in the stock market. The following section emphasizes how important foresight is for investment success.
Investment Foresight
Investors with foresight envision or imagine what will happen in the future based on all the necessary information available to them and then adequately prepare and properly position themselves for the expected consequences. Investment foresight requires proper concepts, accurate information, and then looking ahead and making a reasoned inference that predicts the future.
Financial analysis is probabilistic in nature and not definite and of course not like making the many more certain calculations in the physical sciences. However, performing financial analysis is imperative for a systemic investigation of whether to invest in the stock market or in an individual stock. Augmenting financial analysis, use foresight to make a projection or estimation of how good business and political conditions will be in the future. Furthermore, determining management’s competence, honesty and energy are mandatory for informed investment judgment.
Financial analysis, business prospects, political conditions and talented management all govern the ability to earn an adequate return on an investment. The return of one’s principal depends on investment foresight to make a correct judgment. Foreseeing the future is the stock market’s function. Investors with foresight and vision participate in this process, next.
Investment Vision
Vision requires astute investors to see what others around them do not see. Investors may watch the same things. The difference being their comprehension is not the same. To foresee requires imagining in advance, ordering or prioritizing images and considering them beforehand. Foresight and order gives priority to observations. After reading this book with comprehension, the currently non-seeing unaware investor will be able to understand political-economic and stock market conditions and know how best to respond to them.
Looking ahead, vision and foresight are not easy. This book helps investors prioritize their focus to improve their foresight capabilities. The ultimate discovery that most investors make in the stock market is they must examine and interpret political-economic conditions to help them foresee investment probabilities.
The stock market richly rewards investors with truthful and accurate vision, images and foresight. Foresight and vision for investors require them to imagine what will happen in the future, based on all the information available to them, and to use reasoned inference, next.
Reasoned Inference
Foresight in investing requires comprehending past facts and conditions combined with correct premises, concepts and reasoning, developed over time, to understand how the future should probably appear. This is justification for thinking, called reasoned inference (please see chapter 12 for additional use). Reasoned inference is, “Deriving logical conclusions from factual knowledge or evidence based on premises known or assumed to be true.” Investment foresight, concerning the expected market condition before its occurrence, is the key factor in intelligent investing.
Investors with acute foresight achieve stock market success. Find a practical example of using investment foresight in chapter 3 for a better understanding of this fundamental investment trait. Those with foresight acquire a preference for looking beyond today to see the probable route that future proceedings are likely to take.
In the short run, stock prices use the exploring-compensating condition to search for the intrinsic, true or fair value in the marketplace and experience many short-term dips and bulges. Discussed in chapter 4, is how these short-term dips and bulges normally move around intrinsic, true or fair value. Astute investors should be looking ahead and striving to understand the truth of the marketplace, regardless of short-term dips and bulges.
Working on developing foresight is indispensable for a successful investor. The individual with the most practiced and attuned investment foresight may proceed with confidence. Without foresight, investors are simply hoping this time their chance in the market will work out. Moving away from merely gambling and taking chances to the more secure position that investment foresight affords best secures investment success.
Investors Must Not Be Delusional Dreamers
Investors must not be delusional dreamers. Recognize affairs as they are. Do not hope for the impossible. Hope is a belief in desires. Do not base investing simply on one’s hopes or desires. Decide using proper concepts, the appropriate knowledge, facts, analysis and sound judgment.
Avoid being like the knight-errant Don Quixote, on a delusional quest with Sancho Panza to find Dulcinea del Toboso, riding Rocinante to enforce an archaic chivalric code by attacking windmills.
The stock market balances investors’ opinions and weighs them on the scale of the market. Over the long term, however, investors’ opinions are an infinitesimal consequence in the face of facts, truth and the cold hard reality of market cycles associated with political-economic conditions that ultimately determine stock prices.
The political-economic conditions, over the long term, are stronger than any single person or organization trading in the stock market and consequently eventually overwhelm wrong opinions. Eventually, the market goes where it wants to go.
Human beings, generally, are superstitious. An investment error often follows from one’s desire to hold an erroneous belief. In addition, an investor may try to will their belief to be true—often with disastrous results. Human beings are by nature proud, which is why when investment belief and investment reality collide, often we maintain the belief while ignoring reality. This is cognitive dissonance at work.
At stock market long-term bottoms, when reality becomes too painful for hopeful optimists, investors often sell their investments at the wrong time. Over and again, investment delusional dreamers try to cover up their mistakes by selling during panics so they do not have to continue to acknowledge large paper losses. Feeling uncomfortable tension becomes unbearable.
Investing Is Not Gambling
Betting on the flip of a fair coin is a contest of pure chance that requires only luck. This is pure gambling. However, investing, if performed properly, is not pure gambling but as a strategic enterprise. Pure gambling entails no reasoned inference, nor does it presuppose calculation—investing does. The following paragraph contains perhaps the forty-five most important words concerning investing.
Proper investing demands both correct reasoning and compulsory calculation. Successful investing comes from eliminating risk, as much as possible, from the investment act before committing. Winning in the stock market does not happen merely because one takes a risk. Instead, achieve success by reducing risk.
Why do successful businesspersons and professionals, who are intelligent, cautious and experienced in their fields, invest without first knowing what they are doing? Presumably, because they think it looks so easy. They may straightforwardly pick out a stock on nothing more than a hunch based on outside advice, invest and then hope to root it on to victory.
Do not use the naïve approach to investing. The adage, “It is easier to make money than to keep it,” readily applies when discussing the stock market. An investor’s intelligence contests all others. You win by correctly assessing the facts, making the proper judgment and acting appropriately. Diversification versus concentration is a major concern when determining an investment strategy—a discussion follows.
Diversification Vs. Concentration
The goal of successful investing is safety of principal and security of the expected income. A strategy is a plan, scheme, or approach worked out before attempting to secure, through a course of action, the intended stated goal.
Plan and schedule the means to ensure achieving the ends. The central decision facing investors is how much of their capital to invest in how many different companies’ stock. This is the strategic diversification versus concentration issue.
Unsystemic Risk
Individual company stock has event risks that are peculiar to only that specific corporation. The individual company may go bankrupt, resulting in the complete loss of one’s entire investment. Alternatively, the company may suffer a devastating loss, such as a natural disaster or losing a major lawsuit brought by the government or by competitors, which severely depresses earnings over the expected life of the investment. These are unique risks associated with individual companies traded on the stock exchange. Unsystemic risk occurs within companies.
Putting one’s entire life savings in only one company’s stock is risky. Investing all of one’s money in one company’s stock may turn out horribly. Proper investing does not permit purchasing stock in only one company. This is not an appropriate strategy for investors. Sufficient diversification of an investment portfolio effectively eliminates the unsystemic risks from individual companies.
Systemic Risk Or Market Risk
Unavoidable risk, even if all unsystemic risks can be, is systemic risk or market risk. Systemic or market risk is overall political-economic conditions that determine stock prices.
Systemic or market risk uncertainties have a tendency to move most stock prices together and this risk cannot be diversified away regardless of the number of companies or types of stock in an investment portfolio. Adequate diversification eliminates unsystemic risk, but never the systemic or market risk because of overall political-economic conditions.
Diversification requires adding adequate number and different company stock shares together into a stock portfolio, by illuminating the impact of unsystemic risk on the portfolio’s returns, as presented next.
Diversifying a Portfolio
Diversifying a portfolio is an investment management decision. The goal is to spread the risk among an adequate number of different stock securities and across many different industries that are likely to be vulnerable to different types of unsystemic risks. Diversification associated with a broad selection of common stock has the added benefit of reducing the variability of the overall portfolio value.
The Standard & Poor’s 500 Index is an example of a broadly diversified portfolio that includes many different industries and represents approximately 75 percent of the market capitalization of U.S. companies traded on the three major stock exchanges. Use the Standard & Poor’s (S&P) 500 Index as a well-diversified portfolio suitable for investment purposes. Investing using the S&P 500 Index, rather than an individual stock, is similar to being in the insurance industry, is next.
The S&P 500 Index Acts Much Like The Insurance Industry
Investing in the S&P 500 Index works much like the insurance industry. By collecting publicly traded corporations into a well-diversified S&P 500 Index stock market portfolio, this eliminates the unsystemic risk associated with an individual company or industry.
The S&P 500 Index is a well-diversified portfolio across many industries, removing the unsystemic risk of individual corporations. Assume that within the S&P 500 Index, one company takes advantage of another company’s failures within their stock market grouping. All these pluses and minuses eventually average out in the stock market. Therefore, average stock prices match systemic political-economic conditions.
As with life insurance policies, spreading the risk among all the policyholders allows paying benefits, even though the person’s specifics at any point are unknowable to the company writing the policy.
By taking an S&P 500 Index stock market position, investors are assuming the role of the insurance company and spreading their risk with diversification over many companies and sectors in the economy. The S&P
500 Index now takes on the characteristics of overall political-economic conditions. Which individual corporation wins or loses within the stock market industry grouping is not as important as where the long-term cycle, because of the political-economic condition, is heading.
Diversification is a recognized strategy used when investing. The question of how much diversification is enough is important. In general, the more knowledge the investor has the fewer number of companies need be in the portfolio. Warren Buffett, a knowledgeable investor, has had nearly seventy-five percent of the common stock assets of Berkshire Hathaway’s stock, the investment company he manages, in only five different companies. This is an example of portfolio concentration, next.
Portfolio Concentration
Warren Buffett demonstrates his expertise and superior results when investing. His expertise allows him to concentrate on a limited number of companies when investing. The better the investor is at financial analysis and possessing investment foresight, the more capable he or she is in building their portfolio of fewer companies that represent excellent returns.
As one becomes an investment expert, after extensive study and experience, the vast fortunes, such as Warren Buffett’s Berkshire Hathaway, concentrate in a fewer number of different common stock companies.
Five companies in a portfolio may not be adequate diversification for most investors. Selecting an S&P 500 Index fund, rather than a limited concentration for equity investment, ensures an appropriate number of companies and spreading of risk across all major industries.
Diversification rather than concentration in an investment portfolio is especially important and required for all novice investors. For most investors, the correct choice for proper diversification is the S&P 500 Index, assumed here. Avoid the following investment pitfalls for new investors.
Avoid Investment Pitfalls
There are many common investment pitfalls that attracts novice investors, strenuously resist them, next.
Promotional Stock
Inexperienced investors may decide to diversify with some promotional stock that are small and not well known and are not earning profits. Promotional stock with especially volatile stock prices may seem enticing to the unwary.
During a boom economy and a sky-high stock market, new companies form with their stock selling to investors through an initial public offering (IPO). IPOs normally occur late in the political-economic upward cycle, primarily to fill the investing public’s almost insatiable appetite for equities. Based on our definition of investing, promotional speculative stock with no earnings are not appropriate for an investment portfolio.
New investors should begin investing by purchasing the largest and best known companies that are consistent earners and possess the most liquid stock, with the ability to turn it quickly into cash at close to fair value—such as the S&P 500 Index.
Poor Timing
The investing public rarely knows the value of a stock, only its stock price. In general, the investing public’s dealings do not concern what requires doing, given the political-economic conditions, but result from emotions. The investing public often waits to invest until stock market advances are well along, because they fear losing money.
As more and more of the investing public comes into the stock market late in the long-term upward cycle, unaware investors think the good times and outsized market prices will last forever. Investors may be astute enough not to continue buying at the long-term market top. However, they may unfortunately also neglect to take their profits at this peak time.
The investing public makes the big money during the boom-bubble times, on paper, but neglects to turn large paper profits into cash. The expectation by the investing public here is the promise is of continued explosive growth and outsized profits. Astute investors should follow the practical ten-step method for investment success for much better long-term timing results.
Low-Priced Stock
In general, do not purchase a stock priced at less than ten dollars a share for an investment portfolio. Low-priced stock shares, typically are in the portfolios of novice investors. Because of less staying power, beginner investors sell stock when times are difficult for whatever price is available.
The second reason is that many institutional mutual funds have requirements in their bylaws that limit purchasing stock that is under ten dollars a share. Consequently, this severely restricts the purchasing power necessary to pull low-priced stock upward after a severe long-term market decline. This keeps unwary investors locked into low-priced stock that do not demonstrate adequate price recovery, even as the overall stock market responds to newly favorable political-economic conditions.
Always avoid penny stock, those shares priced less than one dollar per share, they are not safe for proper investing.
Summary
Investing requires the most advantageous strategy and analysis leading to proper evaluation and judgment for purchasing or selling common stock or fixed-income securities for either capital appreciation and/or predictable income over a long planning horizon. Investors prefer suitable high- quality securities at proper or reasonable prices, which match the investor’s scheduled needs and should believe that all relevant factors or odds are favorable before investing.
A probabilistic approach and foresight are necessary traits for being a successful investor. Produce a course of action, a plan or a specific method, thought out in advance, to achieve the most advantageous investment results. Do not think of investing as pure gambling. The Astute Investor offers an assembly of significant questions, facts, premises, assumptions and plans to help investors develop the foresight they need to be successful investors. This is the practical ten-step method for investment success.
Individual companies’ stock have unsystemic risk while diversified portfolios, such as the S&P 500 Index, have only systemic or market risk. Diversification versus concentration is a strategic choice for an investment portfolio. Knowledgeable investors with widespread experience can concentrate with fewer companies in their portfolio.
Avoid promotional and low-priced stock. The safer choices for investors are the largest and best-known companies that are consistent earners and possess the most liquidity. Most investors should select the broadly diversified S&P 500 Index portfolio.
Chapter 2: Theory And Practice
Introduction
The importance of time when investing, as well as in our lives, is investigated. Understand the hypothesis in finance explaining the stock market, the random walk theory (RWT). Study the RWT and leading economic indicators to identify stock market paradoxes. Discover the difference between a true random walk process, such as American roulette, and the stock market.
Mr. Market graphically illustrates the emotional nature of how the investing public on occasion contributes to stock market excesses. Learn how to treat the demonstrative and often irrational Mr. Market. Recognize the drawbacks of the efficient market hypothesis (EMH), based on the RWT. Learn three versions of the EMH, and their weaknesses.
The stock market taxonomy categorizes the overall stock market for better investor comprehension. One axis of the taxonomy represents the dimension of time and the other whether you are considering the S&P 500 Index or an individual stock for investment purposes. Do not assume that correctly using investment techniques in one category of the taxonomy to work within another category.
Time And Timing
Time describes change. Change or fluctuation in the variability of stock prices is the nature of the stock market. Time flows into the future, irreversibly. Continuous successions of events occur through time. Understanding time and timing are critical to comprehending and taking advantage of events in the stock market.
The three dimensions of height, length and width describe material objects in space. The fourth dimension is time, which is non-spatial but real. Time measures change or movement. Life and matter in motion require the four dimensions of space-time for adequate description. The importance of understanding time, beginning with famous maxims to live by, is next.
Famous Maxims To Live By
The famed sayings of the Greek philosophers Socrates (469-399 B.C.) and Aristotle (384-322 B.C.) reveal time’s importance by connecting time to memorable maxims to live by. Socrates says, “Know thyself. The unexamined life is not worth living.”
Socrates instructs us not to live life in a fog and simply go along as circumstances direct. Instead, he instructs us to question who we are and what we want in life. We should reflect on what we love, what productive endeavors we are good at and what achievements make us happy. This is significant because a person’s selfhood is their beliefs and values that are the source for our actions—and actions are the means for our happiness. Live the dream!
Aristotle continues Socrates celebrated maxim by explaining the importance of planning in life’s pursuit of happiness. Aristotle says, “The unplanned life is not worth examining.”
Planning is a course of action or scheme, determined in advance to achieve or realize a goal. Planning establishes how to achieve goals in life. Planning requires the experience of knowing whom we are and where we are in life, where we want to go, and the foresight to develop a workable program of action, represented by an interconnected network of activities or events, to achieve our goal or end.
An unplanned life has no bearings or no direction since these individuals do not know how they are going to get from where they are to where they want to go in life. An unplanned life is often a hodgepodge of unconnected events. Thus, life’s disarray makes a close examination impractical.
Time is vitally important to planning. Only the use of time and dates,
i.e., scheduling, adequately defines a plan. Scheduling is allocating resources to activities and assigning dates to the plan based on resource constraints. Assign an allotted amount of resources and time to each activity or event on the plan to achieve intermediate goals that lead to your objective. Decide on different sub-plans and intermediate objectives and specify schedule dates for completion. Scheduling is the means to accomplish your plan’s goal or end, and to identify which activities are on the critical path leading to a successful conclusion. Scheduling is essential for planning life’s pursuits. Therefore, both planning and scheduling are indispensable. The Astute Investor says, “The unscheduled life is not worth planning.”
Individuals find it too easy to procrastinate without set dates to compare against and check. A plan without a schedule is only a wish list since monitoring is impossible, and it may drift because the plan has no reference points. Without dates, comparing the plan with the present is unworkable and quickly becomes outmoded or even irrelevant. Without a schedule, the plan is meaningless since the activities or events may not happen in our lifetime. Time is fundamental in developing a plan and schedule, in knowing thyself, achieving happiness and is essential in life, next.
Time Is Life
Time is central to life as well as for planning purposes. Benjamin Franklin (1706-1790), the brilliant American politician, United States founder and author and publisher of Poor Richard’s Almanac, best recognized the importance of time’s effect on life and to one’s pursuit of happiness. Benjamin Franklin says, “Dost thou love life? Then do not squander time; for that’s the stuff life is made of.”
Saving material possessions in life for later use, such as money, land or food is possible. However, stockpiling time in one’s life is different, it is impossible. Live life while we are here, in the moment. Therefore, we can say, “Time is life.” The importance of understanding the essential concept of time concerning money and the stock market is next.
Time Is Money
“Remember that time is money,” is the famous advice Benjamin Franklin gives to a young tradesperson. Those who pay a mortgage or apartment rent on the first of every month know about and have a keen appreciation that time is money. Every month on the first, the mortgage or rent money is due without fail.
For those working by the hour or billing by the hour, time is money. Lawyers frequently bill their clients by the hour. Paying employees such as engineers and accountants a salary may occur once a month on a set date. In these employment instances, time is money.
Bonds have a similar relationship, paying interest or principal due regularly, i.e., monthly, quarterly, semi-annually or annually. Alternatively, for Zeros (covered in the next chapter) paying the principal and interest does not occur until the end of the contract is due. For contractual payment of bond interest on predetermined dates, time is money.
The relationship between time and money changes in the stock market, however. Thinking that time is money is not worldly enough for stock market participants. Simply believing that “time is money” is not accurate enough for investment success, next.
Timing Is Money
In the complicated and sophisticated stock market, time is not money—“timing is money.” The difference is significant. Time moves from being regular with specific dates for payment—as with the contractual obligations for payroll, interest, rent, or mortgage payments—to being irregular for value-based payments.
Professional comedians, publishers, actors, managers, symphony conductors, athletes, ballet dancers, sales personnel, opera singers and stock traders all recognize the importance of timing to being successful in their fields of work. A young comedian receives this advice, “Pause and give the audience a chance, without timing the jokes won’t work.”
Since an investor has no control over daily stock price movements in the market, he or she has to take advantage of circumstances the stock market presents as they occur. This requires good timing and recognizing opportunity.
Knowing whom you are, where you want to go, what you want, and when are all-important concepts, readily applicable in investing. Planning and scheduling of one’s life is dependent upon one’s beliefs and values, plus desires that result in decisions, leading to actions (more on the Life And Happiness Model in chapter 12). Accomplish your investment goal by using correct timing over the planning horizon specified.
The strategy that investors use to accomplish a specific goal over a set planning horizon using the securities market depends upon the timing available to investors. The Stock Market Taxonomy section at the end of this chapter and in chapter 11, categorizes different strategies.
Current research beliefs in investing focus on the random walk process. Daily stock price movements for a company’s stock are a random process in the research literature, which is the foundation of the random walk theory discussed next.
Random Walk Theory For Stock Prices
The random walk theory is a result of an investigation into stock price movements in 1953 by Maurice Kendall of the English Royal Statistical Society. His research study purpose is to identify stock price cycles. But, unexpectedly, Kendall does not detect cycles in most of the data he investigates. Each daily price series for the company’s stock studied act like a random walk process—no cycles were in evidence.
Consequently, day-to-day company stock price movements are seemingly independent from one another and are as random as the flipping of a coin. Learn the investment research literature incorrectly assumes that stock prices move in a random walk process, much like a pure gambling game.
A corporation’s stock price movement description, in the financial research literature, is of one aimlessly wandering through time. As if someone drew by chance a plus or minus number and added that number onto the previous day’s closing price. Burton G. Malkiel explains the phrase given to this seemingly aimless wandering of corporate stock prices is the random walk process. The game of American roulette is a true random walk process, next.
American Roulette
Understand a true random walk process by looking at the American roulette game of chance. An American roulette wheel has thirty-eight numbered slots on its perimeter. One through thirty-six numbers evenly divided into red and black colors. A zero and a double zero are present which are green. Spinning the wheel in one direction, a white ball rolls in the opposite direction. The white ball eventually clatters to rest on one of the equally divided thirty-eight slots with a probability of one divided by thirty-eight, or 2.63157 percent.
When playing a fair American roulette game, the numbers that result after each spin of the wheel and roll of the ball are each independent from one another and display no serial correlation. Consequently, the numbers that come up in a fair American roulette game are a random walk process.
In a random walk process, knowing the last winning number in the American roulette game has no predictive power on the next winning number. Each spin of an American roulette wheel is a stand-alone process with the numbers produced symbolizing what is occurring from that random physical event of spinning the wheel and rolling the ball.
Even if the number seven has not appeared in the last 4,000 spins of the wheel and roll of the ball in American roulette, the likelihood of a seven-coming up on the next spin is still 2.63157 percent. The probability on the next spin does not increase merely because the number seven is “due to hit.” Thus, the fair American roulette game is a true random walk process with no predictive ability whatsoever based on the outcomes of past numbers. Therefore, looking at its past data is immaterial to what will happen in the future. A random walk process describes stock price movements, next.
Stock Prices And The Random Walk Theory
Stock prices, in the investment research literature, move in a random walk process. The random walk process supports the random walk theory (RWT) and says a stock’s price moves up or down in a random pattern. Therefore, you cannot predict stock prices. Because prices in the marketplace respond quickly to available information, and because that information arrives randomly, daily stock prices move in a random walk process.
Random walk theorists study day-to-day corporate stock prices and say that knowing what happens to a corporation’s stock price today will have no predictive power over its price tomorrow. If stock prices are up today, there is no way to know from prices alone if stock prices will be up or down tomorrow. Random walk theorists compare stock prices to an intoxicated partygoer who staggers around on the dance floor. One does not know what direction the inebriated stock-price reveler will step in next.
It is a least tacitly put forth by stating that stock price movement is a random walk process, like the comparison with American roulette gambling, that good luck is a logical strategy for investing in the stock market. After reading The Astute Investor, investors will instead agree that it is correct knowledge, beliefs and proper strategy that are most important for investment success. Not simply dumb luck, such as throwing darts at a newspaper listing of common stock for a suitable selection of investment choices.
A person’s correct beliefs, as in life, are paramount to successful investing. Gaining the correct knowledge offered in The Astute Investor is demanding work. Nevertheless, it is worthwhile, as the acquired confidence helps investors feel they are not simply relying on luck and adrift on a random windswept turbulent sea with no valid signposts in sight. The first indication that a random walk process is not adequate to model the stock market comes through an investigation of historical market averages.