The Intelligent Investor: Northern Pacific Railway example
Without reading the source, from your description it seems that the author believes that this particular company was undervalued in the marketplace. It seems that investors were blinded by a small dividend, without considering the actual value of the company they were owners of. Remember that a shareholder has the right to their proportion of the company's net value, and that amount will be distributed both (a) in the form of dividends and (b) on liquidation of the company.  Theoretically, EPS is an indication of how much value an investor's single share has increased by in the year [of course this is not accurate, because accounting income does not directly correlate with company value increase, but it is a good indicator]. This means in this example that each share had a return of $10, of which the investors only received $1. The remainder sat in the company for further investment. Considering that liquidation may never happen, particularly within the time-frame that a particular investor wants to hold a share, some investors may undervalue share return that does not come in the form of a dividend. This may or may not be legitimate, because if the company reinvests its profits in poorer performing projects, the investors would have been better off getting the dividend immediately. However some value does need to be given to the non-dividend ownership of the company. It seems the author believes that investors failing to consider value of the non-dividend part of the corporation's shares in question led to an undervaluation of the company's shares in the market. "The company was paying ""only"" $1 a share in dividends, compared to $10 a share in earnings. That is a so-called payout ratio of 10%, which is low. A more normal payout ratio would be 40%, something like $4 a share. If a $13 stock had a $4 dividend, the dividend yield would be about 30%, which would be ""too high,"" meaning that the price would go up to drive down the resulting yield. Even $1 a share on a $13 stock is a high dividend of about 7%, allowing for appreciation to say, the $20-$25 range. Graham was a great believer in the theory that management should pay out ""most"" of its earnings in dividends. He believed that by holding dividends so far below earnings, the company was either being ""stingy,"" or signalling that the $10 a share of earnings was unsustainable. Either of these would be bad for the stock. For instance, if $1 a share in dividends actually represented a 40% payout ratio, it would signal management's belief that they could normally earn only $2.50 a year instead of $10." Two of the main ways that investors benefit financially from a stock are dividends and increases in the price of the stock.  In the example as described, the benefits came primarily from dividends, leaving less benefits to be realized in terms of an increase in the value of the company. Another way to put that is that the company paid its profits to shareholders in the form of a dividend, instead of accumulating that as an increase in the value of the company.  The company could have chosen to take those profits and reinvest them in growing the business, which would lead to lower dividends but (hopefully) an increase in the valuation of the stock, but they chose to pay dividends instead.  This still rewards the investors, but  share prices stay low.
"I would change that statement to ""very few people can CONSISTENTLY beat the market "". Successful strategies will get piled into and reduce returns. Markets will pick up inefficiencies, but at the same time they do exists. Tons of interesting reading especially in regards to value. Is there a risk premium that we don't know for value? Or is it a market behavior thing?" "Answering this question is weird, because it is not really precise in what you mean. Do you want all stocks in the US? Do you want a selection of stocks according to parameters?  Do you just want a cool looking graph? However, your possible misuse of the word derivative piqued my interest. Your reference to  gold and silver seems to indicate that you do not know what a derivative actually is. Or what it would do in a portfolio.  The straightforward way to ""see"" an efficient frontier is to do the following. For a set of stocks (in this case six ""randomly"" selected ones):      library(quantmod)  library(fPortfolio)  library(PerformanceAnalytics)     getSymbols(c(""STZ"", ""RAI"", ""AMZN"", ""MSFT"", ""TWX"", ""RHT""), from = ""2012-06-01"", to = ""2017-06-01"")     returns &lt;- NULL  tickerlist &lt;- c(""STZ"", ""RAI"", ""AMZN"", ""MSFT"", ""TWX"", ""RHT"")  for (ticker in tickerlist){   returns &lt;- cbind(returns, monthlyReturn(Ad(eval(as.symbol(ticker)))))  }  colnames(returns) &lt;- tickerlist  returns &lt;- as.timeSeries(returns)    frontier &lt;- portfolioFrontier(returns)  png(""frontier.png"", width = 800, height = 600)  plot(frontier, which = ""all"")  dev.off()    minvariancePortfolio(returns, constraints = ""LongOnly"")    Portfolio Weights:    STZ    RAI   AMZN   MSFT    TWX    RHT   0.1140 0.3912 0.0000 0.1421 0.1476 0.2051     Covariance Risk Budgets:    STZ    RAI   AMZN   MSFT    TWX    RHT   0.1140 0.3912 0.0000 0.1421 0.1476 0.2051     Target Returns and Risks:   mean    Cov   CVaR    VaR   0.0232 0.0354 0.0455 0.0360    https://imgur.com/QIxDdEI  The minimum variance portfolio of these six assets has a mean return is 0.0232 and variance is 0.0360. AMZN does not get any weight in the portfolio.  It kind of means that the other assets span it and it does not provide any additional diversification benefit.   Let us add two ETFs that track gold and silver to the mix, and see how little difference it makes:    getSymbols(c(""GLD"", ""SLV""), from = ""2012-06-01"", to = ""2017-06-01"")    returns &lt;- NULL  tickerlist &lt;- c(""STZ"", ""RAI"", ""AMZN"", ""MSFT"", ""TWX"", ""RHT"", ""GLD"", ""SLV"")  for (ticker in tickerlist){   returns &lt;- cbind(returns, monthlyReturn(Ad(eval(as.symbol(ticker)))))  }  colnames(returns) &lt;- tickerlist  returns &lt;- as.timeSeries(returns)   frontier &lt;- portfolioFrontier(returns)    png(""weights.png"", width = 800, height = 600)  weightsPlot(frontier)  dev.off()    # Optimal weights  out &lt;- minvariancePortfolio(returns, constraints = ""LongOnly"")  wghts &lt;- getWeights(out)  portret1 &lt;- returns%*%wghts  portret1 &lt;- cbind(monthprc, portret1)[,3]  colnames(portret1) &lt;- ""Optimal portfolio""    # Equal weights  wghts &lt;- rep(1/8, 8)  portret2 &lt;- returns%*%wghts  portret2 &lt;- cbind(monthprc, portret2)[,3]  colnames(portret2) &lt;- ""Equal weights portfolio""   png(""performance_both.png"", width = 800, height = 600)  par(mfrow=c(2,2))  chart.CumReturns(portret1, ylim = c(0, 2))  chart.CumReturns(portret2, ylim = c(0, 2))  chart.Drawdown(portret1, main = ""Drawdown"", ylim = c(-0.06, 0))  chart.Drawdown(portret2, main = ""Drawdown"", ylim = c(-0.06, 0))  dev.off()   https://imgur.com/sBHGz7s   Adding gold changes the minimum variance mean return to 0.0116 and the variance stays about the same 0.0332. You can see how the weights change at different return and variance profiles in the picture.  The takeaway is that adding gold decreases the return but does not do a lot for the risk of the portfolio.  You also notice that silver does not get included in the minimum variance efficient portfolio (and neither does AMZN).  https://imgur.com/rXPbXau  We can also compare the optimal weights to an equally weighted portfolio and see that the latter would have performed better but had much  larger drawdowns. Which is because it has a higher volatility, which might be undesirable.  ---  Everything below here is false, but illustrative.  So what about the derivative part? Let us assume you bought an out of the money call option with a strike of 50 on MSFT at the beginning of the  time series and held it to the end.  We need to decide on the the annualized cost-of-carry rate, the annualized rate of interest, the time to maturity is measured in years, the annualized  volatility of the underlying security is proxied by the historical volatility.   library(fOptions)   monthprc &lt;- Ad(MSFT)[endpoints(MSFT, ""months"")]  T &lt;- length(monthprc) # 60 months, 5 years  vol &lt;- sd(returns$MSFT)*sqrt(12) # annualized volatility    optprc &lt;- matrix(NA, 60, 1)  for (t in 1:60) {   s &lt;- as.numeric(monthprc[t])   optval &lt;- GBSOption(TypeFlag = ""c"", S = s, X = 50, Time = (T - t) / 12, r = 0.001, b = 0.001, sigma = vol)   optprc[t] &lt;- optval@price  }    monthprc &lt;- cbind(monthprc, optprc)  colnames(monthprc) &lt;- c(""MSFT"", ""MSFTCall50"")    MSFTCall50rets &lt;- monthlyReturn(monthprc[,2])  colnames(MSFTCall50rets) &lt;- ""MSFTCall50rets""    returns &lt;- merge(returns, MSFTCall50rets)    wghts &lt;- rep(1/9, 9)    portret3 &lt;- returns%*%wghts  portret3 &lt;- cbind(monthprc, portret3)[,3]  colnames(portret3) &lt;- ""Equal weights derivative portfolio""    png(""performance_deriv.png"", width = 800, height = 600)  par(mfrow=c(2,2))  chart.CumReturns(portret2, ylim = c(0, 4.5))  chart.CumReturns(portret3, ylim = c(0, 4.5))  chart.Drawdown(portret2, main = ""Drawdown"", ylim = c(-0.09, 0))  chart.Drawdown(portret3, main = ""Drawdown"", ylim = c(-0.09, 0))  dev.off()  https://imgur.com/SZ1xrYx   Even though we have a massively profitable instrument in the derivative. The portfolio analysis does not include it  because of the high volatility. However, if we just use equal weighting and essentially take a massive position in  the out of the money call (which would not be possible in real life), we get huge drawdowns and volatility, but  the returns are almost two fold. But nobody will sell you a five year call.  Others can correct any mistakes or misunderstandings in the above. It hopefully gives a starting point.  Read more at:   https://en.wikipedia.org/wiki/Modern_portfolio_theory https://en.wikipedia.org/wiki/Option_(finance)  The imgur album:  https://imgur.com/a/LoBEY" For the mechanices/terms of stock investing, I recommend Learn to Earn by Peter Lynch. I also like The Little Book of Common Sense Investing by John Bogle. It explains why indexing is the best choice for most people. For stock picking, a good intro is The Little Book of Value Investing by Chris Brown. And then there is The Intelligent Investor by Ben Graham. IMO, this is the bible of investing. My plan is that one day I can become free of the modern day monetary burdens that most adults carry with them and I can enjoy a short life without these troubles on my mind. If your objective is to achieve financial independence, and to be able to retire early from the workforce, that's a path that has been explored before. So there's plenty of sources that you might want to check.  The good news is that you don't need to be an expert on security analysis or go through dozens of text books to invest wisely and enjoy the market returns. This is the Bogleheads philosophy. It's widely accepted by people in academia, and thoroughly tested. Look into it further if you want to see the rationale behind, but, to sum it up: It doesn't matter how expert you are. The idea of beating the market, that an index fund tracks, is about 'outsmarting' the rest of investors. That would be difficult, even if it was a matter of skill, but when it comes to predicting random events we're all equally clueless.  *Total Expense Ratio: It gives an idea of how expensive is a given fund in terms of fees. Actively managed funds have higher TER than indexed ones. This doesn't mean there aren't index funds with, unexplainable, high TER out there. The most significant capability that an investor must have is the knowledge on the way to look for the high dividend stocks. Through accumulating good information relating to towards the stocks that you are finding is the better way of getting the perfect and profitable investments. It is really important to learn what makes a particular stock better and superior compared to other.   Traders are essential to start a complete analysis and investigation before getting their money on any business projects. Obviously, investors certainly want to have an investment that could guarantee an effective expense for a very reasonable cost the moment of getting it. The chances of crucial to invest in a market that you might be aware and qualified about. So, creating a comparison and compare in one business to a different is totally essential so as to find the high dividend stock. The quant aspect '''''. This is the kind of math I was wondering if it existed, but now it sounds like it is much more  complex in reality then optimizing by evaluating different cost of capital. Thank you for sharing A classic text on growth stock picking is Common Stock and Uncommon Profits By Philip Fisher, with a 15 point checklist.  Here is a summary of the list that you can check out. I'm not in the business but I've always thought that Catalyst + industry context = market beating returns.  Meaning that if you know what an event means faster than everyone else you can make money.  Though I don't know how you'd express that in a report.  An example that comes to mind is when Japan announced they were forming a consortium, the largest in the world, to make LCD panel glass.  After that I got the heck of GLW though the stock price kept going up at the time.  It is like no one understood the implications. "First, note that a share represents a % of ownership of a company. In addition to the right to vote in the management of the company [by voting on the board of directors, who hires the CEO, who hires the VPs, etc...], this gives you the right to all future value of the company after paying off expenses and debts. You will receive this money in two forms: dividends approved by the board of directors, and the final liquidation value if the company closes shop. There are many ways to attempt to determine the value of a company, but the basic theory is that the company is worth a cashflow stream equal to all future dividends + the liquidation value. So, the market's ""goal"" is to attempt to determine what that future cash flow stream is, and what the risk related to it is. Depending on who you talk to, a typical stock market has some degree of 'market efficiency'. Market efficiency is basically a comment about how quickly the market reacts to news. In a regulated marketplace with a high degree of information available, market efficiency should be quite high. This basically means that stock markets in developed countries have enough traders and enough news reporting that as soon as something public is known about a company, there are many, many people who take that information and attempt to predict the impact on future earnings of the company. For example, if Starbucks announces earnings that were 10% less than estimated previously, the market will quickly respond with people buying Starbucks shares lowering their price on the assumption that the total value of the Starbucks company has decreased. Most of this trading analysis is done by institutional investors. It isn't simply office workers selling shares on their break in the coffee room, it's mostly people in the finance industry who specialize in various areas for their firms, and work to quickly react to news like this. Is the market perfectly efficient? No. The psychology of trading [ie: people panicking, or reacting based on emotion instead of logic], as well as any inadequacy of information, means that not all news is perfectly acted upon immediately. However, my personal opinion is that for large markets, the market is roughly efficient enough that you can assume that you won't be able to read the newspaper and analyze stock news in a way better than the institutional investors. If a market is generally efficient, then it would be very difficult for a group of people to manipulate it, because someone else would quickly take advantage of that. For example, you suggest that some people might collectively 'short AMZN' [a company worth half a trillion dollars, so your nefarious group would need to have $5 Billion of capital just to trade 1% of the company]. If someone did that, the rest of the market would happily buy up AMZN at reduced prices, and the people who shorted it would be left holding the bag. However, when you deal with smaller items, some more likely market manipulation can occur. For example, when trading penny stocks, there are people who attempt to manipulate the stock price and then make a profitable trade afterwards. This takes advantage of the low amount of information available for tiny companies, as well as the limited number of institutional investors who pay attention to them. Effectively it attempts to manipulate people who are not very sophisticated. So, some manipulation can occur in markets with limited information, but for the most part prices are determined by the 'market consensus' on what the future profits of a company will be.  Additional example of what a share really is: Imagine your neighbor has a treasure chest on his driveway: He gathers the neighborhood together, and asks if anyone wants to buy a % of the value he will get from opening the treasure chest. Perhaps it's a glass treasure chest, and you can mostly see inside it. You see that it is mostly gold and silver, and you weigh the chest and can see that it's about 100 lbs all together. So in your head, you take the price of gold and silver, and estimate how much gold is in the chest, and how much silver is there. You estimate that the chest has roughly $1,000,000 of value inside. So, you offer to buy 10% of the chest, for $90k [you don't want to pay exactly 10% of the value of the company, because you aren't completely sure of the value; you are taking on some risk, so you want to be compensated for that risk].  Now assume all your neighbors value the chest themselves, and they come up with the same approximate value as you. So your neighbor hands out little certificates to 10 of you, and they each say ""this person has a right to 10% of the value of the treasure chest"". He then calls for a vote from all the new 'shareholders', and asks if you want to get the money back as soon as he sells the chest, or if you want him to buy a ship and try and find more chests. It seems you're all impatient, because you all vote to fully pay out the money as soon as he has it. So your neighbor collects his $900k [$90k for each 10% share, * 10], and heads to the goldsmith to sell the chest. But before he gets there, a news report comes out that the price of gold has gone up. Because you own a share of something based on the price of gold, you know that your 10% treasure chest investment has increased in value. You now believe that your 10% is worth $105k. You put a flyer up around the neighborhood, saying you will sell your share for $105k. Because other flyers are going up to sell for about $103-$106k, it seems your valuation was mostly consistent with the market.  Eventually someone driving by sees your flyer, and offers you $104k for your shares. You agree, because you want the cash now and don't want to wait for the treasure chest to be sold. Now, when the treasure chest gets sold to the goldsmith, assume it sells for $1,060,000 [turns out you underestimated the value of the company]. The person who bought your 10% share will get $106k [he gained $2k]. Your neighbor who found the chest got $900k [because he sold the shares earlier, when the value of the chest was less clear], and you got $104k, which for you was a gain of $14k above what you paid for it. This is basically what happens with shares. Buy owning a portion of the company, you have a right to get a dividend of future earnings. But, it could take a long time for you to get those earnings, and they might not be exactly what you expect. So some people do buy and sell shares to try and earn money, but the reason they are able to do that is because the shares are inherently worth something - they are worth a small % of the company and its earnings." Also a layman, and I didnt read the article because it did the whole 'screw you for blocking my ads' thing. But judging from the title, I'd guess someone bought a massive amount of call options for VIX, the stock that tracks volatility in the market. Whenever the market crashes or goes through difficult times, the VIX fund prospers. The 'by october' part makes me think it was call options that he purchased: basically he paid a premium for each share (a fraction of the shares cost) for the right to buy that share at today's price, from now until october. So if the share increases in value, for each call option he has, he can buy one share at todays price, and sell it at the price it is that day. Options can catapult your profit into the next dimension but if the share decreases in value or even stays the same price, he loses everything. Vicious redditors, please correct the mistakes ive made here with utmost discrimination "Check out Professor Damodaran's website: http://pages.stern.nyu.edu/~adamodar/ . Tons of good stuff there to get you started. If you want more depth, he's written what is widely considered the bible on the subject of valuation: ""Investment Valuation"". DCF is very well suited to stock analysis. One doesn't need to know, or forecast the future stock price to use it. In fact, it's the opposite. Business fundamentals are forecasted to estimate the sum total of future cash flows from the company, discounted back to the present. Divide that by shares outstanding, and you have the value of the stock. The key is to remember that DCF calculations are very sensitive to inputs. Be conservative in your estimates of future revenue growth, earnings margins, and capital investment. I usually develop three forecasts: pessimistic, neutral, optimistic. This delivers a range of value instead of a false-precision single number. This may seem odd: I find the DCF invaluable, but for the process, not so much the result. The input sensitivity requires careful work, and while a range of value is useful, the real benefit comes from being required to answer the questions to build the forecast. It provides a framework to analyze a business. You're just trying to properly fill in the boxes, estimate the unguessable. To do so, you pore through the financials. Skimming, reading with a purpose. In the end you come away with a fairly deep understanding of the business, how they make money, why they'll continue to make money, etc." The stock market's principal justification is matching investors with investment opportunities.  That's only reasonably feasible with long-term investments.  High frequency traders are not interested in investments, they are interested in buying cheap and selling expensive.  Holding reasonably robust shares for longer binds their capital which is one reason the faster-paced business of dealing with options is popular instead.  So their main manner of operation is leeching off actually occuring investments by letting the investors pay more than the recipients of the investments receive. By now, the majority of stock market business is indirect and tries guessing where the money goes rather than where the business goes. For one thing, this leads to the stock market's evaluations being largely inflated over the actual underlying committed deals happening.  And as the commitment to an investment becomes rare, the market becomes more volatile and instable: it's money running in circles. Fast trading is about running in front of where the money goes, anticipating the market.  But if there is no actual market to anticipate, only people running before the imagination of other people running before money, the net payout converges to zero as the ratio of serious actual investments in tangible targets declines. By and large, high frequency trading converges to a Ponzi scheme, and you try being among the winners of such a scheme.  But there are a whole lot of people competing here, and essentially the net payoff is close to zero due to the large volumes in circulation as opposed to what ends up in actual tangible investments. It's a completely different game with different rules riding on the original idea of a stock market.  So you have to figure out what your money should be doing according to your plans. crank out expensive shares when markets are frothy Corporations go public (sell their shares for the first time) in market conditions that have a lot of liquidity (a lot of people buying shares) and when they have to make the fewest concessions to appease an investing public. When people are greedy and looking to make money without using too much due diligence. Think Netscape's IPO in 1995 or Snapchat's IPO in 2017. They also issue more shares after already being public in similar circumstances. Think Tesla's 1 billion dollar dilution in 2017. Dilution results in the 1 share owning less of the company. So in a less euphoric investing environment, share prices go down in response to dilution. See Viggle's stock for an example, if you can find a chart. issue debt Non-financial companies create bonds and sell bonds. Why is that surprising to you? Cash is cash. This is called corporate bonds or corporate debt. You can buy Apple bonds right now if you want from the same brokers that let you buy stocks. mutual fund investor Bernstein is making a cynical assessment of the markets which carries a lot of truth. Dumping shares on your mom's 401k is a running gag amongst some financial professionals. Basically mutual fund investors are typically the least well researched or most gullible market participants to sell to, influenced by brand name more than company fundamentals, who will balk at the concept of reading a prospectus. Financial professionals and CFOs have more information than their investors and can gain extended advantages because of this. Just take the emotions out of it and make objective assessments. In fact markets are not efficient and participants are not rational. That is why we have booms and busts in markets. Emotions and psychology play a role when investors and/or traders make decisions, sometimes causing them to behave in unpredictable or irrational ways. That is why stocks can be undervalued or overvalued compared to their true value.  Also, different market participants may put a different true value on a stock (depending on their methods of analysis and the information they use to base their analysis on). This is why there are always many opportunities to profit (or lose your money) in liquid markets. Doing your research, homework, or analysis can be related to fundamental analysis, technical analysis, or a combination of the two. For example, you could use fundamental analysis to determine what to buy and then use technical analysis to determine when to buy. To me, doing your homework means to get yourself educated, to have a plan, to do your analysis (both FA and TA), to invest or trade according to your plan and to have a risk management strategy in place. Most people are too lazy to do their homework so will pay someone else to do it for them or they will just speculate (on the latest hot tip) and lose most of their money. Something that introduces the vocabulary and treats the reader like an intelligent individual? It's a bit overkill for 'retirement', but Yale has a free online course in Financial Markets. It's very light on math, but does a good job establishing jargon and its history. It covers most of the things you'd buy or sell in financial markets, and is presented by Nobel Prize winner Robert Schiller. This particular series was filmed in 2007, so it also offers a good historical perspective of the start of the subprime collapse. There's a number of high profile guest speakers as well. I would encourage you to think critically about their speeches though. If you research what's happened to them after that lecture, it's quite entertaining: one IPO'd a 'private equity' firm that underperformed the market as a whole, another hedge fund manager bought an airline with a partner firm that was arrested for running a ponzi scheme six months later.  The reading list in the syllabus make a pretty good introduction to the field, but keep in mind they're for institutional investors not your 401(k).