Capital Ideas — Chapter 7: The Search for High P.Q.

1. 1. Eugene Fama, a third-generation Italian-American from Boston, consolidated knowledge about stock price behavior into a comprehensive theory explaining why prices appear to fluctuate randomly.
2. 2. Fama's job with Harry Ernst involved finding buy-and-sell signals based on price momentum, but the rules only worked on old data, not new data.
3. 3. Fama was urged by his Tufts professors to attend the University of Chicago for graduate school because he was 'more intellectual than the typical Harvard type.'
4. 4. Fama taught the first graduate course at Chicago on Harry Markowitz's portfolio theory, despite Markowitz's work being virtually unknown in the finance department.
5. 5. The Fisher-Lorie study (1964) measured total returns of all NYSE common stocks from 1926 to 1960, finding that $1,000 invested in 1926 grew to nearly $30,000 by 1960—a 9% annual return.
6. 6. Edgar Lawrence Smith's 1924 study showed that stocks beat bonds hands down over long periods, influencing the bull market of the 1920s.
7. 7. Fisher and Lorie asserted that an investor who selected stocks at random would, on average, end up with the same wealth as one who earned the market's average return.
8. 8. Fama's 1965 article 'The Behavior of Stock Market Prices' concluded that stock prices are not predictable, and he challenged chartists to subject their theories to rigorous tests.
9. 9. Fama argued that even skilled security analysts cannot consistently outperform random selection because the market is efficient: prices adjust 'instantaneously' to new information.
10. 10. Fama coined the terms 'efficient market' and 'market efficiency' to describe a market where prices immediately reflect all available information, making trends unlikely.
11. 11. Michael Jensen's 1969 study of 115 mutual funds over 1955-1964 found that, after adjusting for risk, the average fund underperformed a buy-and-hold strategy by 15%.
12. 12. Warren Buffett's analogy of 215 million coin-tossers shows that a small number of consistent winners can emerge by chance, not skill.