A random Walk Down Wall Street: The Time-Tested Strategy for Successful Investing

Does This Mean That Markets Are
Inefficient?
This chapter’s review of the Internet and housing bubbles
seems inconsistent with the view that our stock and real
estate markets are rational and efficient. The lesson, however,
is not that markets occasionally can be irrational and that we
should therefore abandon the firm-foundation theory of the
pricing of financial assets. Rather, the clear conclusion is that,
in every case, the market did correct itself. The market
eventually corrects any irrationality—albeit in its own slow,
inexorable fashion. Anomalies can crop up, markets can get
irrationally optimistic, and often they attract unwary
investors. But, eventually, true value is recognized by the
market, and this is the main lesson investors must heed.
I am also persuaded by the wisdom of Benjamin Graham,
author of 
Security Analysis
, who wrote that in the final
analysis the stock market is not a voting mechanism but a
weighing mechanism. Valuation metrics have not changed.
Eventually, every stock can only be worth the present value
of the cash flow it is able to earn for the benefit of investors.

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In the final analysis, true value will win out. The important
investment question is how you can estimate true value.
More about this in chapter 5, where we will take a closer look
at how professionals attempt to determine what a stock is
truly worth.
Markets can be highly efficient even if they make errors.
Some are doozies, as when Internet stocks in the early 2000s
appeared to discount not only the future but the hereafter.
How could it be otherwise? Stock valuations depend upon
estimations of the earning power of companies many years
into the future. Such forecasts are invariably incorrect.
Moreover, investment risk is never clearly perceived, so the
appropriate rate at which the future should be discounted is
never certain. Thus, market prices must always be wrong to
some extent. But at any particular time, it is not obvious to
anyone whether they are too high or too low. The evidence I
will present next shows that professional investors are not
able to adjust their portfolios so that they hold only
“undervalued” stocks and avoid “overvalued” ones. The fact
that the best and the brightest on Wall Street cannot
consistently distinguish correct valuations from incorrect
ones shows how hard it is to beat the market. There is no

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evidence that anyone can generate excess returns by making
consistently correct bets against the collective wisdom of the
market. Markets are not always or even usually correct. But
NO ONE PERSON OR INSTITUTION CONSISTENTLY
KNOWS MORE THAN THE MARKET.
Nor does the unprecedented bubble and bust in house
prices during the first decade of the 2000s drive a stake
through the heart of the efficient-market hypothesis. If
individuals are given an opportunity to buy houses with no
money down, it can be the height of rationality to be willing
to pay an inflated price. If the house continues to escalate in
value, the buyer will profit. If the bubble bursts and the
house price declines, the buyer walks away and leaves the
lender (and perhaps ultimately the government) with the loss.
Yes, the incentives were perverse. And in retrospect,
regulation was lax and some government policies were ill
considered. But in no sense was this sorry episode and the
deep recession that followed caused by a blind faith in the
efficient-market hypothesis.

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