Wall Street "R" Us
What is Wall Street anyway? What makes Wall Street so different and special from the rest of our society?
The truth is rather than being different from, Wall Street is a reflection of our society as a whole, an out-sized exhibition of who we are, a strong distillation of the hopes, dreams, fears, and worries that drive all of us, whiskey to the beer of ordinary life. What counts on Wall Street -- money and net worth -- is the same as what counts on Main Street, only more so.
And just like on Main Street or inside the Beltway, on Wall Street if a claim is asserted often enough, it becomes true. Simply, we human beings tend to believe that if a thing is said a lot, it must be true. It's a basic human trait, that which is repeated often becomes conventional wisdom, common sense, a received idea, consensus reality.
On Wall Street, as new concepts arrive that promise wealth -- or disaster -- or new stocks or products swim into view with the same promise, its denizens become excited. Many such concepts, stocks, and products become important solely because they are held in value by a lot of people; they become famous for being famous.
And precisely who do we mean by 'Wall Street?' Certainly not only the folks who actually work along these few short blocks, for these days those who invest in our public markets work not only all over Manhattan but throughout the nation and the world. At the outer edge of Wall Street, its citizens comprise all those countless millions of folks who invest in financial instruments of every kind here and abroad and the army of people, the vast majority of whom are outside Manhattan, who handle investors' money, analyze industries and companies, and sell to investors, i. e., traders, brokers, reporters, commentators, salesmen, and mutual-fund managers. In other words, in addition to the pros, you, and me, the public markets are populated by everybody else you and I know, most of whom have at least some money in a mutual fund if not a portfolio of securities.
In the old days, gossip was limited to word of mouth within a village. These days, though separated by vast distances, we're connected through fiber optics and satellite. The ceaseless gossip that passes along the electronic web means every trend is magnified thousands of times, often until it becomes a mania driven by a frenzied mob or a collapse into a desperate panic.
An extreme example of such mob psychology is the notorious Dutch tulip mania. In Europe in the mid-16th century tulip bulbs were not only prized but rare, as only a few had been imported from Turkey. The placid burghers of Holland were particularly struck by tulips' beauty, and the rarest specimens came to sell for thousands of florins. By 1643, every level of Dutch society, from the very rich to the poor, had its own tulip field. Tuppenwoerde, or tulip madness, turned into windhandel, trading air. An "Admiral Tromp," bought for 500 florins, might be traded with some extra florins for a "General Bol," which a speculator would hope to sell in a week for 1,000 florins. Soon puts and calls were bought and sold in tulip bulbs. Tulip madness rose to such a fever that most other commercial activity in Holland slowed. Burghers with heretofore sound judgement mortgaged their lands and homes to sink their net worth into tulips. When the nutty prices finally cracked and plummeted, the economic life of Holland collapsed.
Mob psychology has not changed today. What happened 250 years ago inside the tiny compass of Holland occurs today across the planet in the simultaneous rise and fall of public markets of Singapore, London, Sydney, New York, and Tokyo. As early as the late 19th century, a French writer named Gustave LeBon noticed these features of public markets. Even though investors are unknown to each other and separated by vast distances, LeBon noted they are still linked, still part of a crowd, by the prices of the investments they hold in common. Something about being part of this odd "crowd" tends to diminish the higher faculties of its members, and the crowd’s more primitive emotions, especially fear and greed, come to the fore. Let a stock soar in value and greed consumes the primitive mind of the crowd, egging on its members to buy more; let the same stock fall steadily, and rather than the stock becoming a better buy, the fear-driven crowd sells and sells, dumping the stock beyond all reason to a fraction of its real-world value.
Tulip-mania is an extreme example, but history abounds in such extremes. As recently as 1981, Kuwaitis could pay for stock with post-dated checks. Fueled by a blizzard of worthless checks put up by greed-crazed Kuwaitis, its market rose hundreds of percent, from a capitalization of $15 billion to about $100 billion. A simple passport clerk in his late 20s was able to pass $14 billion of worthless checks. When the frenzy was punctured, the authorities found that $90 billion worth of bad checks had passed hands, and many prominent Nejdi Sunni families were wiped out.
While tulip-mania and the Kuwaiti madness sound bizarre, they illustrate an important point. The key trait to grasp about all public markets is that they are all too often in the grip of a mass psychosis, or mob mania, sometimes regarding an entire market, and sometimes regarding only one stock. In the early 90s the craze was for bio-tech stocks; today it’s for Internet stocks; and back in the seventies it was for the Nifty Fifty.
A possible recent example of utter folly is Amazon.com, a company that's never earned a penny of profits. While the company doubtless has some intrinsic net value, it is somewhat expensive at its current market capitalization of $6.2 billion. As Paul Isaac recently pointed out in Grant's Interest Rate Observer, even if Amazon came to sell every book in America in four years' time ($26 billion in revenues) and earn all the profits (at 3 percent net margins, which would be $780 million) of the entire retail book market -- a dubious proposition I expect you'll agree -- Amazon.com's stock would still today be selling at a PE of about 16 with virtually no room to grow.
In fact, the most aggressive forecast, by Credit First Swiss, is for Amazon to have a 15 percent -- not 100 percent -- market share of the U. S. book market by 2002, which will require an 80 percent compound annual growth rate over the next four years. If you believe a company will have little trouble accomplishing this feat, trust me, you should reexamine your investment style. Other Internet stocks are similarly divorced from commercial reality.
Actually, it takes a long time for the benefits of a new technology such as the Internet to become profitable. We needed decades to learn how to employ electricity to our commercial benefit. Similarly, the first years of development of personal computers produced few commercial successes.
The savvy investor always must distinguish the huge difference between a company's stock and the company itself. For most companies, the two have a reasonable relationship; many stocks sell for about what they're worth. At times, however, the stock and the company become disconnected. As time creeps on, even though the stock's price doesn't advance, some companies get better at what they do: they hire the right president, they produce just the right product for their market, they buy their chief competitor. At the same time, some companies go downhill: A centi-millionaire now and full of Napoleonic hubris, the founder stashes a bimbo in a company penthouse and loses his focus to the ensuing domestic strife, a once-fine product ages and the company milks it instead of investing in its successor, or in its hubris the company ignores the hot upstart in its market who is snatching its sales. While some companies are gradually getting better at what they do, 'Wall Street' -- that is, all of us -- may still believe it's a dog. And while the business of a company is gradually getting worse, Wall Street may still be excitedly touting it, like a tulip-bulb merchant extolling the virtues of a mixed bag of yellows, reds, and whites.
Like Amazon.com, all too often the selling price of the stocks of real companies get ahead of themselves. A good example is RCA back in the 1920s. Just as people today recognize the value in the Internet, back then people recognized the value of commercial radio, and RCA's stock soared beyond all reason. Indeed, investors were right, radio was a valuable service, and indeed, they had even picked the right vehicle. However, RCA's stock peaked in the 1920s and never regained its 1920s' value. Likewise, AOL and Amazon.com may never again sell for more than they bring today.
Back in the 1960s computer leasing was yet another idea whose time had come. Today, driven under by Moore's Law (that chip capacity will double every 18 months) there are no computer leasing firms left.
Hard as it may be to believe today, in the late 1970s and early 1980s, when stocks were far, far cheaper, conventional wisdom had it that stocks were a terrible place in which to invest. Bank CDs were thought by the prudent to be by far a wiser investment. Our best business magazines ran cover stories announcing the 'Death of Equities.' To prove the point, from 1966 to 1982, over 16 long years, the Dow moved from 1000 to 800 and not adjusted for some pretty hefty inflation, either. Back then it was thought that anyone who put money into stocks was hopelessly foolish.
Another example: For 300 years a few hundred of the British elite invested in Lloyd's of London. Being such an "underwriting member" of Lloyd’s became a mystical experience to investors world-wide, the admittance to a secret society that opened the gates of wealth and allowed its members to rub shoulders with peers of the British realm. By the mid-1980s, clever Lloyd’s agents had used this cachet to sell 33,000 wealthy people around the world on the advantages of investing in Lloyd’s, each of whom was told in grave tones that he would be dealt with by Lloyd’s and its working professionals "in utmost good faith," which was defined as the investors’ being furnished with whole truth regarding the risks that he was taking.
It was balderdash. The market insiders promptly dumped inter-market policies on these star-struck newcomers, put them into dubious syndicates, and underwrote business that benefited nobody except plummy insiders. By the late 1980s, these peers-elect had not only seen no profits but were forced to pay billions of dollars of losses, as they had backed up their "investments" with irrevocable bank letters of credit. The result? Thousands of investors were bankrupted, more thousands were impoverished, while despite massive investigations by the British, American, Canadian, and Australian authorities and billions of dollars of lawsuits, Lloyd’s insiders got off scot-free.
How did Lloyd’s get away with scamming some of the most sophisticated investors in the world, a number of whom were savvy U. S. insurance professionals? Simple, indeed, like most Ponzi schemes. Investors sold each other in a climate of getting in on a sure-fire good thing. While the books at Lloyd’s were more or less open to inspection by investors, who would bother to conduct such an old-fashioned, time-consuming exercise?
Well, say some, for me it’s different; I have a savvy broker who’s in the know. However, I reply that brokers are as blind and foolish as the rest of us, and perhaps more so. They are so well plugged into today’s passions of "the Street" that they can’t see value until it’s pointed out to them. Were there any brokers who advised selling IBM back in 1986 and 1987?
The important lesson for successful investors to learn about Wall Street is to think independently of the herd. Thus, if everybody is saying to buy or hold onto IBM for dear life, consider selling it. If in fact everybody’s bought IBM, who’s left to do more buying? None of this is to say to rush blindly into selling such a situation short, but it does mean it’s time for doing some homework.
If Amazon.com is all the rage, what is the discipline to use to find such a stock before it skyrockets, which is when successful investors buy.
An investor can take a hard look around himself and stick to what he knows.
He might be a hairdresser who knows a lot about hair products.
She might be a real-estate broker who knows local property values.
He might be a small-town banker who knows the movements and trends of retail businesses in his small town.
She might live in Georgia and make herself into an expert about various industries native to her home state.
He might be a fishing enthusiast who knows a solid new line of fishing gear when he sees one.
He might be an auto mechanic and spy a great new fuel-injection system that’s come on the market. He puts one in his car and a few others into those of his customers. The new system works well, saves money on fuel, and makes the old nags get up and go. He studies articles about the new system in trade magazines, to which he subscribes in order to keep up. He obtains the official financial statements of the manufacturer, and when he finds the accounting jargon of 10-Ks (annual reports) and 10-Qs (quarterly reports) that have been filed with the SEC more than he can fathom, he asks his accountant to explain the terms to him. When he goes to his industry’s annual trade show, he drops by the manufacturer’s booth and asks pertinent questions of the system’s sales manager. He calls half a dozen of his buddies who own repair shops and hears that his own good luck with the system has been repeated. His accountant has led him to see that the stock is not overvalued; in fact he finds that not one Wall Street analyst follows the stock.
He has now done what no broker will have done (a broker’s job is to sell stocks and earn commissions, not understand their underlying companies), as well as precious few fund managers. He’s conduced what’s come to be called due diligence--that is, he’s done his homework.
Convinced now that he knows something others don’t, the mechanic buys what he can afford of the stock and socks it away until others discover later what he has discovered sooner. If he’s done his homework correctly, if he’s bought the stock cheaply enough, in time others will learn the benefits of owning the company and then the real fun begins.
What’s the prime difference between our auto mechanic and a Wall Street broker?
The auto mechanic is living in the real world, while the Wall Street broker knows little more than his industry’s gossip.
Just the fact that the mechanic has read the 10-Qs and 10-Ks puts him ahead of 99% of all other investors—including professional fund managers, brokers, and traders.
Ask yourself: Of the stocks you own, have you read all the companies’ reports religiously? For all its faults, the SEC puts companies through a tough drill to get them to disclose everything negative about themselves—and 99% of a company’s investors can’t be bothered to read the text!
So remember: If you hear it all the time, then most of the time it’s wrong. I refuse to invest on tips. Most so-called sure things have come through a daisy chain of others, and the information arrives at best garbled, at worst wrong. Remember the old children’s game of telephone, the one in which the first of a dozen children is given a simple message to whisper along a row? Invariably the message becomes garbled. The same thing happens with information about stocks. Ninety percent of the time the "inside info" that you’re told is wrong or deliberately distorted. Even if it’s the president of a company who gives me the "straight skinny," I know I’m going to lose half my money—and if it’s the chairman of the company who slips me the inside dope, I know I’m going to lose all my money.
The big lesson? Do your own homework. Remember that every day for every stock bought on Wall Street someone is a seller. One of the two is wrong, which means that every day half the people trading on Wall Street are dead wrong.
Making money is not based on luck. To succeed you have to figure out your own approach, one that makes sense to you and that fits your personality, what you know, and how much time you have to devote to the markets. You might invest in auto products or those for hair care. You might be a trader who can’t stand to be in a situation more than 30 minutes. You have to figure out who you are, what you can stand, and how to achieve your very own competitive edge yourself. Your competitive edge will rarely be a broker. Your broker has only one person in mind to help, and that’s himself. Of course it’s human nature to take the easy way, to find Charley Savvy who seems to have the inside dope on investing. Charley’s inside dope is 99% industry gossip, not solid research on value. Like most people in his industry, he feels he doesn’t need to read all those boring 10-Ks and 10-Qs. That’s an immense amount of work and his customers are quite willing—indeed eager--to trade off the easy gossip he peddles. It’s much more fun to chat with others "on the Street" about companies than to do backbreaking hours of research.
How might the attentive investor have fared with my notions?
An alert investor would have noticed back when money-market accounts first started in the seventies that his Merrill Lynch account was written through Bank One. These accounts were so convenient and popular that it wasn’t hard to see that Bank One was likely to pull ahead of its competitors. Investors who bought the stock then saw a huge profit.
Back in the 1950s everybody knew that Japan was a joke as a place to manufacture anything. However, alert investors saw that Honda was producing motorcycles that were taking the U.S. by storm, and that the company was attracting many customers with its clever ads stating "You meet the nicest people on a Honda." Those who investigated and bought Japan were in for a wild bullish ride for decades.
Alert women in the 1950s would have noticed how many of their friends were coming to use Tampax. Those who bought its stock caught a rising star for many years.
In the 1970s the country had a crying need for nursery schools, day-care centers, whatever you want to call them. Those who bought such stocks saw their investment rise several hundred times.
In the same period a student could have noticed in the 1970s that the government had decided to make student loans through a government-backed company called Sally Mae. Investors in it have done wonderfully well.
The same thing happened to nursing homes, private hospitals, and garbage companies. I know it’s hard to believe now, but at one time garbage was principally handled by the government and the mob, both at rates far more expensive than what private enterprise charged. (Hmmm . . . could the government and the mob have anything in common? . . . . )
While Wall Street has a reputation for cutthroat, shady dealing, such knavery happens at all levels of society. Group-think, the inability to think for oneself, is a far greater danger to investors. In fact, Wall Street is one of the few places where the written contract isn’t used much. Trillions of dollars pass hands annually on the word of investors and brokers, most of it over the telephone. You won't last long on Wall Street if your spoken word is not your bond.
If a stranger came to your door and asked you to hand over your life’s savings, you’d probably kick him out. However, many people read an ad in the newspaper, and without much thought send off their life savings. These are folks who spend days -- weeks -- carefully planning their next vacation, looking into the quality of the airlines they'll fly on, what food their hotels serve, how pleasant are the rooms, what there is to do at night, how good the prices are for shopping, and what the weather patterns have been like for the past 20 years. All this is homework, due diligence, if you will. But for an investment that will mean a far better education for their child when he goes to college, easier retirement years, and how hard they will have to work after another 10 years, they drift with the herd, spending no more time picking their broker or stocks than they spend deciding what TV program to watch or movie to attend.
To do well, an investor must train himself to think for himself. If he follows the conventional wisdom of Wall Street, he risks being left with worthless certificates, a bag of tulip bulbs—or worse.
As investors we must abolish the notion that Wall Street will be either our savior or our enemy. The soundest wisdom is that of Pogo: "We have met the enemy and he is us."
Updates are available at www.jimrogers.com.