During the technology boom, 3Com sold a small portion of its Palm subsidiary while retaining most of the shares. The market valued that remaining stake above the value of the entire parent company. The prices implied that everything else 3Com owned had a large negative value.
The inconsistency challenges the claim that markets always get prices right. Burton Malkiel's case for owning a broad market fund can accommodate it. Seeing a mistake and turning it into a dependable profit are different achievements. The second requires a trade you can execute, finance and hold long enough to beat a simpler investment after expenses.
The opportunity must survive the trade
In principle, you could buy an underpriced claim and sell an overpriced related one. Selling something you do not own usually requires a short sale. You borrow shares, sell them, and hope to repurchase them more cheaply before returning them. Suitable shares may be unavailable to borrow. You also have ongoing obligations, including compensating the lender for dividends.
Even an available trade can exhaust your resources. A gap may widen or persist while your financing runs out. You can be right about the eventual correction and unable to stay invested until it happens. These are general limits to correcting prices; recognizing the Palm inconsistency alone tells us little about the return available to an ordinary investor.
When an opportunity depends on public news, competing traders may buy before you finish reading it. If they expect higher profits, their purchases can raise the price immediately. Unexpected news then produces unpredictable changes without requiring perfectly rational investors. Private information can give someone an advantage; Malkiel rejects the claim that even insiders know nothing useful. A reader with limited time and public reports faces a different competition.
Prices do sometimes trend as information spreads slowly or people imitate one another. Malkiel acknowledges this momentum. But trends can reverse sharply, and frequent trades bring costs and taxes. Searching past charts can also uncover patterns created by chance. A convincing rule needs evidence from periods beyond those used to discover it, measured against a suitable alternative after costs. The chart-rule tests he cites fail to establish dependable superior results after trading costs.
How would you recognize the expert?
Careful business research faces its own difficulties. Facts can be wrong, earnings forecasts can fail, and prices may not converge to estimated value. An analyst's employer may also earn fees arranging a company's securities sales, giving it reasons to welcome optimistic recommendations. Research can be valuable while these obstacles still prevent a dependable advantage for its buyer.
An index tracks the performance of a specified collection of securities. A fund making money has not demonstrated skill if a suitable index did better. The index should represent the kinds of securities and risks the fund holds; otherwise, taking different risks can look like better judgment. The long-run studies Malkiel cites find typical active funds lagging broad indexes. Timing the market adds another burden. Selling before a decline still leaves the decision about when to return, and waiting too long can miss a sharp recovery.
A winning record needs scrutiny too. Across many managers, chance produces impressive streaks. Some managers have skill, but past success often fails to persist, and you must choose before knowing who wins. The historical record can conceal failures altogether. Malkiel follows three hundred fifty-eight equity funds operating in nineteen seventy. Only seventy-eight remained in twenty seventeen. Mergers commonly buried poor records. Looking only at survivors leaves out much of what happened to investors choosing from the original population.
Finding that manager is a demanding task for someone with a job and other obligations. A polished forecast cannot answer it. The evidence needs to establish an advantage you could have obtained in advance, at a price that left you better off.
An advantage that does not require perfect prices
Investors collectively own the market and receive its return before costs. A passive fund holding the same broad mix receives the corresponding gross return. Active investors can beat one another, but their combined holdings cannot earn more than the market they hold. The group spending more on management and trading keeps less afterward.
An index fund follows that collection instead of continually choosing supposed bargains. Broad, inexpensive versions let you participate without paying someone to make those repeated judgments. Their holdings include future winners before you know which companies they will be, alongside many other businesses. The fund still charges expenses and can fall sharply with the market. Lower costs preserve more of a return; they cannot guarantee that return is positive.
Passive investors nevertheless rely on research by others. Malkiel tests this dependence with a thought experiment. Suppose everybody indexes and nobody responds when a company discovers a valuable drug. Its unchanged share price now offers a reason for someone to investigate and buy. Neglected opportunities would reward active research again. His argument leaves unresolved precisely how many active investors a market needs.
Large index providers also concentrate shareholder voting power. Malkiel disputes the claim that ownership across rival companies necessarily weakens competition. Favoring one industry's profits, he argues, can harm other businesses in the same portfolio. That defense remains contested.
A saver need not prove every price correct. The decision is whether paid expertise can add enough return to cover its cost. In an imperfect market, inexpensive participation can still be the stronger choice.
Three things to keep
A visible pricing mistake need not offer a trade you can profitably sustain.
Judge expertise against a relevant alternative after costs, including records that disappeared.
Low costs do not eliminate market losses or concerns about concentrated shareholder power.