HUMBLING
LESSONS FROM PARTIES PAST
By BURTON G. MALKIEL
By BURTON G. MALKIEL
•The
‘Elec-tronic” boom of 60s, the
Nifty 50s boom of 70s, the Biotech boom of 80s and the Technology Bubble of
90s.
•
•BENJAMIN
GRAHAM, co-author of "Security Analysis," the 1934 bible of value
investing, long ago put his finger on the most dangerous words in an investor's
vocabulary: "This time is different."
•
•Pricing
in the stock market today suggests that things really are different.
•Growth stocks, especially
those associated with the information revolution, have soared to
dizzying heights while the stocks of
companies associated with the older economy have tended to languish.
•
•Well
over half the stocks on the New York Stock Exchange and Nasdaq are selling at lower
prices today than they did on Jan. 1, 1999.
•
•It
is not unusual today for new Internet issues
to begin trading at substantial multiples of their offering prices.
•And
after the initial public offerings, day traders rapidly exchange
Internet shares as if they were Pokémon cards for adults.
•
•As
we enter the new millennium, how can we account
for the unusual structure of stock prices?
•Does
history provide any clues to sensible strategies for today's investors?
•
•To
be sure, we are living through an information
revolution that
is at least as important as the Industrial Revolution of the late 19th century.
•And
much of the current performance in the stock market can be traced
to the optimism associated with "new economy" companies - those that stand to
benefit most from the Internet.
•
•The
information revolution will profoundly change the way we learn, shop and
communicate.
•But the rules of
valuation have not changed.
•Stocks
are only worth the present value of the
cash flows they are able to generate for the benefit of their shareholders.
•
•It
is well to remember that investments in
transforming technologies have not always rewarded investors.
•Electric power companies, railroads, airlines and
television and radio manufacturers transformed our country, but most of the early
investors lost their shirts.
•Similarly,
many early automakers ended up as road kill, even if the future
of that industry was brilliant.
•
•Warren
E. Buffett, chief executive of Berkshire Hathaway and a disciple of Graham, has
sensibly pointed out that the key to investing is not
how much an industry will change society, but rather the nature of a company's competitive
advantage, "and
above all the durability of
that advantage."
•
•Yet
the Internet must rely for its success on razor-thin margins, and it will continue
to be characterized by ease of entry.
•
•A
drug company can develop a new medication and be given a 17-year
patent that can be exploited
to produce above-average profits.
•No such sustainable advantage will adhere to the dot-com
universe of companies.
•
•Moreover,
the "old economy" companies may not be nearly as
geriatric as is commonly supposed.
•We
still need trucks to transport the goods of e-commerce, as
well as steel to build the trucks, gasoline
to make them run and
warehouses to store the goods.
•
•Precedents of recent decades offer many valuable
lessons to today's investors.
•Consider
the "tronics boom" of
1960-61, a so-called new era in which the stocks of electronics
companies making
products like transistors and optical scanners soared.
•
•It
was called the tronics
boom because stock
offerings often included some garbled version of the word
"electronics" in their titles, just as "'dot-com" adorns
the names of today's favorites.
•
•More
new issues were offered than at any previous time in history.
•But
the tronics boom came down to
earth in 1962,
and many of the stocks quickly lost 90 percent of their value.
•
•Another
parallel to today's market was seen in the 1970's, when just 50
large-capitalization growth stocks, known as the Nifty 50, drew almost all the attention of individual
and institutional investors.
•They
were called "one decision" stocks because the only
decision necessary was whether to buy; like family heirlooms, they were never to be
sold.
•
•In
the early part of that decade, price-to-earnings multiples of Nifty 50 stocks
like I.B.M., Polaroid and Hewlett Packard rose to 65 or more while the overall
market's multiple was 17.
•
•The
Nifty
50 craze ended like all others; investors eventually made a second decision -- to sell
-- and some
premier growth stocks fell from favor for the next 20 years.
•
•The
biotechnology boom of the early 1980's was an almost perfect
replica of the microelectronics boom of the 1960's.
•Hungry
investors gobbled up new issues to get into the industry on the ground floor.
•
•P/E ratios gave way to price-to-sales ratios, then to ratios
of potential sales for products that were only a glint in some scientist's eye.
•Stock prices surged.
•
•Again,
as sanity returned to the market and more realistic estimates of potential
profits were made, many biotechnology
companies lost
almost all of their value by
the early 1990's.
•
•The
lessons here are clear. Occasionally, groups of stocks
associated with new technologies get caught in a speculative bubble, and it appears that
the sky is the limit.
•But
in each case, the laws of financial gravity prevail and market
prices eventually correct.
•
•The
same is likely to be true of the dazzling stocks in today's market.
•Few of the Internet darlings will ever justify their current
valuations, and many investors
will find their expectations unfulfilled.
•
•Even supposedly conservative index-fund investors may be surprised to know that very significant
shares of their portfolios
are invested in information technology companies whose P/E
and price-to-sales ratios vastly exceed even the sky-high
multiples
reached during those past periods of market speculation.
•
•At
the very least, investors might well start the year by examining
their portfolios,
to see if their asset allocations are appropriate for their stage in life and their tolerance
for risk.
•
•Burton
G. Malkiel is an economics
professor at Princeton University and the author of “A Random Walk Down Wall
Street" (W.W. Norton).
•
•http://www.alphashares.com/OpEd_Humbling_Lessons.pdf
•
