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Commentary:
Lessons For Investors
January 2001
Dennis C. Butler, President
Centre Street Cambridge Corporation
Private Investment Counsel
See also:
General Index
of all guest columns written by Dennis C. Butler, CFA
The year 2000 capped an extraordinary period in financial market history: an unprecedented five-year string of U.S. stock index gains exceeding 20% per year succeeded by a year in which one of the major indexes -- the NASDAQ -- dropped by over 50% (a rare event), with markets around the world following the American example to steep negative results. To a large extent the boom/bust cycle of this period was a fiction of the market indexes, and the so-called New Era (to employ a term that seems to have fallen from favor) a shallow facade, for behind it all was an intense focus on one business sector -- technology -- whose prospects were viewed as limitless and whose gyrations swayed the averages. Stocks did not really rise 85% in 1999, as the NASDAQ index led so many to believe (a few managed such gains), nor did they drop 50% in 2000 (some did). Stocks outside the technology sphere generally declined during those years. Nevertheless, the tech euphoria, while it lasted, made many a reputation for investment prowess, just as it sullied the repute of those not inclined to occupy that "space." But, as Iago declares in Othello, reputation is "oft got without merit and lost without deserving." The tech crash of 2000 reversed this sad trend, we are happy to say.
Meanwhile, 2000 turned out to be the best year in several for investors, first as technology speculators drained interest and funds from the rest of the market early in the year, and later as the aftermath of the speculative binge dragged down the broader list of stocks during the last several months. Investment bargains became available in numbers not seen since the early 1990s, at least for market participants who had not dissipated their capital chasing dot-coms.
Lessons For Investors
This New Year the financial press seems keen to offer conservative investment advice; perhaps the fact that readers have been dealing with the first down market in a decade -- indeed, the worst decline in nearly a quarter century by some measures -- has something to do with it. In any case, the leading financial journal recently extolled the virtues of dullness in the form of diversified funds, which don’t offer the bottle-rocket excitement so many people have come to expect, but neither do such funds threaten the demoralizing drops some investors have had to get used to. The journal in question had previously published a piece discussing the mistakes that were made in the midst of the tech mania earlier in the year. In still another article appearing at year-end, individual readers confessed to their sins and proffered the lessons learned from their experiences over the last couple of years. All of this makes us wonder why these media couldn’t find the space to write about such mistakes while they were being made. After all, the financial press must be the repository of (or at least have access to) an abundance of market history and wisdom. Certainly it was not all that difficult to recognize the rampant speculation occurring over the last few years. Instead, we get advice about conservative funds not when it is needed, which is in the midst of the speculative cycle, but after the funds have appreciated and probably at the precise time we should be looking elsewhere for attractive opportunities.
One of the most interesting things about being in the investment business is the opportunity it affords to observe the behavior of human beings under conditions of uncertainty, and when the stakes are high. It seems that even when certainty is lacking, it is desperately sought; thus we devise mental "models" to explain market phenomena and guide our actions. Some models work satisfactorily for a while, and the longer their explanatory power persists, the more difficult it is to dislodge them as conditions change. Well into the 1980s, for example, market participants were haunted by fears of a resumption of the inflation that reigned in the late 1970s. In the latter half of the 1990s the model reflected a very different experience with financial markets: rising values. Hence, its message was more positive, and aggressive: equities always do better than other assets, it was claimed, so they must be owned. It is, of course, a relatively small step from this sentiment to the belief that equities can be purchased at any price, a dangerous assumption, but one that fit the experience of many investors, hence the step was taken. "Buying the dips," indexing -- policies fundamentally founded in market expectations and not financial analysis -- indicated a willingness to own equities, regardless of the cost.
Just as the inflation model eventually proved passe, so, too, it seems, has the must-own theory of equity investment reached the limits of its usefulness, as the favorable market trend that supported it has run its course. Equity ownership has suddenly become associated with the pain of declining net worth, rather than the pleasure of seemingly effortless profit. This may explain the financial press’ new-found interest in more conservative investment methodologies. It also illustrates the media’s failure to come to grips with the core weakness of its message. The real lesson for investors to be drawn from the past year’s events is that all market- based guides to investment are ultimately doomed to fail at some point as conditions change. What is unchanging is that equities represent ownership of businesses: approaching them from that perspective ensures consistency in investing throughout the ups and downs of the market.
Watching Grass Grow
Despite its reputation for glamor and excitement (a view shaped by promoters, media hype and Wall Street’s marketing machine), serious investing is mostly hard, plodding work, with many hours spent reading reports and analyzing financial statements. Most of the action seen on television -- people on phones shouting at each other across trading rooms, or the bustle of activity on exchange floors -- really isn’t investing, nor is it all that interesting. Neither does investing usually entail stocks rocketing two or three hundred percent in a single day, such as occurred frequently with newly-public technology companies during the past few years. Fortunately, the genuine article doesn’t have to produce an adrenaline rush to be successful. To illustrate what we mean, we created the following table which lists the average daily gains (including weekends and holidays) over varying periods of time for several successful stocks. The anonymously-named ABC and XYZ represent two of Centre Street’s commitments; their price histories are shown since purchase. GE (General Electric) is an example of a "market stock" whose price trends tend to reflect those of the overall market; we begin with its price on January 1, 1982, the year when the great bull market of the 1980s and 1990s began. MSFT (Microsoft) is an example of a highly-successful technology company, a favorite of "growth" investors. Microsoft’s price on April 1, 1986 was selected -- a date shortly after its initial public offering. BRK (Berkshire Hathaway) was chosen for several reasons: its history is widely known as it is the investment vehicle of the noted investor Warren Buffett, and its shares have never split during Buffett’s tenure which began on May 10, 1965 (making for easy calcula tions). Since different time periods and beginning prices are involved, the records are not really comparable to each other, so the next to last column showing daily changes as a percent of beginning price helps to place the gains in perspective. The table serves to illustrate our point: even excellent investments can produce results in excruciatingly small increments. Also note that truly exceptional ones, such as Berkshire and Microsoft, can produce great wealth.
* Adjusted for Stock Splits.
Stock BeginningDate BeginningPrice (BP)* Price12/31/00 $ PriceChange TotalDays $ ChangePer Day Change As % BP AnnualizedReturns** ABC 7/1/94 $15.50 $49.56 $34.06 2,375 $0.014 0.09% 19.56% XYZ 8/1/94 $8.00 $67.63 $59.63 2,344 $0.025 0.32% 39.43% GE 1/1/82 $1.19 $47.94 $46.75 6,939 $0.007 0.57% 21.45% MSFT 4/1/86 $0.19 $43.38 $43.19 5,389 $0.008 4.20% 44.41% BRK 5/10/65 $18.00 $71,000.00 $71,082.00 13,019 $5.452 30.29% 26.13%
** Excluding Dividends.Gains of one or two cents per day may sound pretty paltry to the get-rich-quick crowd, but they add up if you let them. Too often investors are inclined, even encouraged, to sell their holdings for silly reasons, such as a fear that the market will decline or a broker’s admonition to take profits and move on to "something better." A few of the stocks in the table have been through several more or less severe (and unpredicted) market downturns -- even wars and political turmoil -- and have still produced outstanding long-term results. While it is certainly possible that any one of them could have been switched to some other selection that may have done better for a while, it is unlikely that such a policy, with its tax implications and trading costs, would have improved upon a simple buy and hold procedure. Numbers such as these reinforce our view that to be successful in investing, one should buy businesses one is certain one wants to own, at prices that make sense, and keep them.
Dennis C. Butler, CFA, is president of Centre Street Cambridge Corporation, investment counsel. He has been a practitioner in the investment field for over 23 years and has been published in Barron's. He holds an MBA from Wharton and a BA in History from Brown University. His quarterly newsletter can be found at www.businessforum.com/cscc.html. To correspond with him directly and /or to obtain a reprint of his featured articles, "Gold Coffin?" in Barron's (March 23, 1998, Volume LXXVIII, No. 12, page 62) or "What Speculation?" in Barron's (September 15, 1997, Volume LXXVII, No. 37, page 58), he may be contacted at:
Telephone: 617.441.9695
Email: cscc@world.std.com
URL: www.businessforum.com/cscc.html
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Revised: April 25, 2001 TAF
© Copyright 2001 Dennis C. Butler, All Rights Reserved