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Forerunners of Modern Financial Economics

A Random Walk in the History of Economic Thought, 1900–1950

Donald R. Stabile

The economists who began using statistics to analyze financial markets in the 1950s have been credited with revolutionizing the scholarship of investing and with inaugurating modern financial economics. By examining the work of economists who used statistics to analyze financial markets before 1950, Donald Stabile provides evidence about the forerunners of modern financial economics.
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Chapter 7: Statistics and the Theory of Value Investing

Donald R. Stabile


Value investing had always formed a part of any intelligent investment decision. Investors considering whether to buy a stock would at least look at the fundamental factors that would influence its value in terms of a firm’s prospects for future earnings. In the 1920s, however, investors had gone overboard in the earnings they anticipated from firms. What they needed was guidance from a set of well-defined principles for how to measure the value a stock could be expected to hold in the future in a way that counter-balanced their optimism. During the 1920s, investment analysts had produced guidelines for evaluating a business by looking at its books, business prospects, and the underlying economic environment. It even included some rules of thumb, such as R.W. Schabacker’s advice that an investor should never put money in a stock with a price/earnings ratio above ten (Schabacker 1930, pp. 409–10). This rule did not tell investors how to value the stock based on future earnings, however. Nor did it indicate what risks were involved in estimating future dividends. This chapter will describe how in the 1930s, Benjamin Graham and David Dodd, John Maynard Keynes, and John Burr Williams supplied investors who chose to read their books for theories and advice about finding the value of a stock in terms of its economic fundamentals. It will consider their attitude toward statistics and indicate where statistical analysis might have helped them. The starting point is with a book on investment that has now become a...

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