Retro Investing: The Eisenhower Era by James A. Maccaro This article was originally published as a "Trader's Notebook" feature of Traders.com, and is copyrighted 2006 by Technical Analysis, Inc., which reserves all rights. It has been published on wallstreetcosmos.com with the permission of the original publisher. As the 1950’s began, most people were reluctant to invest in the stock market. Memories of the crash of 1929 and the Great Depression of the 1930’s were still fresh. The popular view of the stock market was that it was only for the rich or for gamblers. Indeed, several opinion polls taken in the late 1940’s and the early 50’s showed that less than ten percent of Americans could even name a brokerage firm. However, as the 1950’s progressed and the economy grew at a fast rate, confidence returned and many middle class people began to rethink their aversion to stocks. To encourage this process, brokerage houses got into the habit of hiring financial journalists to serve as public spokesmen for the firm and as cheerleaders for the stock market. A good example of this is Henry Gellermann, a German immigrant (born and educated in Munich) who came to the United States in 1929 as a newspaper reporter specializing in financial matters. He had the bad luck to arrive shortly before the crash occurred but was able to find work as an American correspondent for several European newspapers. He subsequently became a U.S. citizen, wrote for numerous American publications and served in World War II with military intelligence. After the war, he was hired by Bache & Company, to serve as their public face. In 1957, Gellermann wrote How to Make Money Make Money, with an introduction by an editor of The Wall Street Journal. The book was successful and went through many printings, although it and its author are now obscure (if not nearly forgotten). The heart of the book is a superb description of the securities markets in the United States and Canada as they existed at mid-century. However, in keeping with his day job in public relations for an investment firm, Gellermann took a very cheerful view of the stock brokerage industry. His sentiment clearly was that the Wall Street establishment was beyond reproach, and that what was good for them was good for America. In addition to its overview of the financial system, the book also offers interesting stock market advice. Gellermann asserted that “when you come right down to it, there’s just one good measure of the value of a stock: What the market says it’s worth.” He added, “if you think the market price is low in relationship to underlying value, that’s too bad,” further stating “you can assemble all the facts, use all the analytical techniques in the world to determine the ‘real’ value of a company’s securities. If the answer you arrive at disagrees with the answer you get in the market, your wrong -- as of that moment.” Of course, Gellermann noted, the market might eventually agree with your assessment, and the stock would therefore be worth buying, but he stressed that there are no guarantees and he discouraged the idea of looking for bargains. He explained, “ … the market is not always interested in facts, or can painfully ignore them.” In effect, he argued that a stock might be undervalued at present but there is no reason to believe that it will not continue to be undervalued into the future. This approach is the mirror image of Warren Buffett’s strategy, honed by his study under Benjamin Graham (the founder of fundamental analysis) and his years of experience. Buffett, in fact, stresses that the market is frequently wrong and that the key to long term investing is to take advantage of this fact. He compares the stock market to a bi-polar individual. On some days, “Mr. Market” (to use Buffett’s phrase) is in a manic mood and is eager to overpay for a stock, but on other days he is inordinately depressed and, lacking any confidence in the future, is anxious to dump securities at any price. In Buffett’s view, when there is a divergence between a stock’s price and its intrinsic value, the stock market is wrong (creating a potential opportunity for investors), but in Gellermann’s view, the fault lies with you, not the market. Gellermann’s position was given academic respectability a generation latter with the creation of the efficient market/random-walk theory, which holds that because stock prices reflect all available information, they correctly reflect the value of the shares and, consequently, any attempt to “beat the market” is futile. Of course, the price of a stock can vary significantly, even over brief periods. Efficient market proponents dismiss these price movements as merely random events, similar to someone randomly walking back and forth in an unpredictable manner. Investors were warned by Gellermann to not overpay for shares. “There is such a thing … to use one of Wall Street’s pithier adages … as buying not only the future but the hereafter,” he warned. To value a stock, Gellerman relied primarily on its dividend yield. This ultra-conservative approach made sense to people of Gellerman’s generation because it took nearly three decades for the Dow-Jones indexes to reach their pre- 1929 crash highs, which discouraged faith in capital gains. A low dividend yield indicated to Gellermann that the stock was priced for “the hereafter,” but a high dividend yield could indicate that the market does not have faith in its continuance. Therefore, it can be said that Gellerman was looking for a “Goldilocks” dividend, one that was not too low but also not too high. There is a lot to be said for the warning that an inordinately high dividend yield suggests that the market does not have confidence in its continuance. For example, very recently General Motor’s dividend yield was flirting with 9%, when the board of directors cut the payout in half. While Gellerman gave first priority to the dividend yield, he also acknowledged the price-to-earnings ratio, book value and leverage (i.e., the level of debt) as factors to consider. On the question of diversification, Gellerman urged individual investors to, in his words, “put all your eggs in one basket.” He opposed diversification, noting that “John D. Rockefeller, Sr., managed to amass a tidy number of millions in spite of the fact that he certainly put the lion’s share of his savings into Standard Oil stock.” Today, the same can be said of modern tycoons, such as Warren Buffett and Bill Gates. Article is Continued After Sponsor's Message To support his case, Gellerman used a hypothetical portfolio of ten stocks as an example. He asserted that in such a portfolio, some stocks will advance but others will decline, thereby canceling-out the gains. Ironically, a bit more than 30 years latter, Peter Lynch used the same hypothetical in order to buttress his belief in a diversified portfolio. He asserted that with a typical portfolio of about ten stocks, most would give average returns and some would disappoint, but a few would exceed expectations and the losers would be more than compensated for by the winners. Lynch noted that a stock that increases ten-fold (a “ten-bagger”) could easily counteract a few losers and still provide for a portfolio with excellent returns and that the chances of having such stocks increases with the number of companies in the portfolio. Gellerman advised that individual investors limit their stock holdings to three or four “carefully chosen” stocks. He further advised that a stock should be sold if changing circumstances or new information warrant a new and lower assessment of its value. However, if the price declines while its prospects are still good, Gellerman recommended that additional shares should be purchased. “The greater will be your eventual profit -- if you’ve selected a good, sound stock and don’t lose your nerve when the time comes that you can buy another 100 shares for only $2,500 even though the first 100 you purchased cost you $5,500.” This approach is in keeping with Warren Buffett’s style of investing and seems to contradict Gellerman’s declaration that “if you think the market price is low in relationship to underlying value, that’s too bad.” I think that Gellerman underestimated the typical private investor when he declared, “you’ll find that managing a three- stock portfolio or a four stock portfolio will take all the time and thought you can give to it.” Of course, if the wrong stocks are picked, it does not matter how many are in the portfolio. The stock market has changed tremendously since How to Make Money Make Money was published. At that time, for example, the New York Stock Exchange was open from 9:30 to 3:30, and the Dow-Jones indexes (which included the railroad index instead of the transportation index) was calculated only five time per day, at 11:00, noon, 1:00, 2:00 and at the close, and the results were not released on the “ticker” until 12 minutes latter! Much has changed, but Gellermann’s observations and positions still have value. Suggested Reading: Henry Gellerman, How to Make Money Make Money, Thomas Y. Crowell & Co., 1957. Peter Lynch, One Up on Wall Street. Simon & Schuster, 1988, revised 2000. James Maccaro, “Warren Buffett,” Stocks & Commodities, 2002 Bonus Issue. Burton G. Malkiel, A Random Walk Down Wall Street. W. W. Norton & Co., 1973, revised 2004. |
Wall Street Cosmos
Research Report: Retro Investing (The Eisenhower Era)