Is This the Bottom? – Part 2 July 1, 2002February 21, 2017 The first thing to say is: I don’t know. Obviously. (Friday, I had one of my gloomy market assessments that at least one of you has learned to take as a contrary indicator – whenever I do one of those, the market bounces, at least temporarily.) No, wait: the first thing to say is: See ‘My Big Fat Greek Wedding.’ It’s a romantic comedy not quite as good as ‘Moonstruck’ – what ever could be? – but in very much that wonderful mold. And the next thing to say is that I had my second-ever root canal last week. Piece of cake. Didn’t even need even one of the pain pills they gave me for afterward. This reminded me of the column I wrote almost precisely five years ago on the occasion of my first root canal. I reprint it here because (a) you have teeth, too (well, most of you) and (b) hindsight is fun . . . and it sort of leads back to the point. June, 11, 1997 Gee, it’s great to be alive. You’re thinking that’s because the market is 7500 on the Dow, give or take, and — like the odometer that finally turns all its little dials to 00000.0 when you go those last 170 yards beyond 99,999.9 . . . delicious . . . the market is going to 0,000 just as the calendar is going to ,000 — it’s all coming together, in other words, neat and well organized, like the strands of a complicated plot. But no, this is not what has me excited, although it certainly is fun to see one’s net worth inching up almost every day. Likewise, I’m happy to see the crime rate, welfare rolls and unemployment rates coming down, the AIDS virus yielding to science, the days getting longer and longer (if it keeps up this way through Thanksgiving, we’ll have nothing but sunlight), cigarette advertising under attack, decimal stock-market pricing on its way (it will shave transaction costs) — all that. But the immediate cause of my good cheer is my root canal. I have wonderful news. It turns out — in the hands of a really good endodontist, anyway — root canals are just no big deal. All my life I have dreaded the possibility that one day I might need one. But having managed to avoid it until last week, I lucked out. I skipped the century or so when it was a procedure just this side of agony. Technology saved me, and just in time. Seriously: this is one fewer thing for you to worry about. If you ever need one, take the time to find someone who specializes in root canals and then figure it will be only a little less convenient and comfortable than going for a haircut. Tomorrow I’ll get back to money. But aren’t you relieved? Soon, I’ve read, they may be zapping tooth decay without need of drilling. Ah, brave new world. It’s stuff like this that makes you think the market’s not so overpriced after all. (And talk like that that makes you think it is.) Wait a second. You mean I thought it was overpriced at 7500 five years ago? And Alan Greenspan and Bob Rubin thought it was overpriced at 6500 six months before that? Didn’t we/they know that the Dow was headed to nearly 12,000? And that the NASDAQ would triple? Well, no, we did not. Bubbles tend to expand way beyond what any sane observer imagines they could, just as busts, all too often, let out far more air than most sane observers think they should. Historically, the stock market goes to extremes in both directions. This is possible because people ignore value at both extremes. I have a friend with almost all his assets tied up in AOL stock who promised me, when I begged him to diversify, that he would sell when it got back up to 50. It was then 44, down from a peak of 81. Yes, even at 44 it was selling at 100 times earnings, but no matter – surely it would go back to 50. At 39, he said, ’45 is the new 50.’ He would sell when it got back to 45. Couldn’t bear to sell at 39. ‘Sell!’ I begged him. ‘Diversify!’ And so it went, all the way down to 14 last week. If this is how you make financial decisions – through a sort of superstitious numerology, as if you were playing craps, rather than an assessment of value – you would be much better off not calling the shots yourself. (At 14, I think AOL may be fairly priced here. I’m no expert. But I’d be surprised if it’s absurdly undervalued. So its bear market may or may not have ended.) Joel Williams: ‘I am really disappointed to see stuff on your site about ‘value’ in the stock market. There is no such thing as value. There is only price. If you can show statistically that some of these alleged measures of value can be correlated with changes in price, then there may be some basis for using the term. But any causal effect is rather weak, so far as I can see. Consider Comstock Capital Value Fund (DRCVX), managed by Charles Minter, for example. In 1998, he decided that the market was ‘over-valued’ and began shorting stuff. By traditional measures, he may have been right, but so what? In the third quarter, he actually made some money, but thereafter, for the next 2 years since 10/9/1998, the fund tanked big time, losing about 50%. But he was firm in his belief, and the fund turned around. Since 10/9/2000 the fund the fund is up over 60%, but is still not back to its 10/9/1998 high, even with distributions reinvested. Was he ‘right’ in 1998? Who cares! The purpose of being long or short stuff is to make money, and he has failed miserably. The point is that Mr. Minter just ‘knew’ that the market was over valued, and eventually he was right – just like the stopped clock that is right once or twice a day (depending on whether it tells military time). Sure, he saw the ‘bubble,’ but failed to profit from it. Currently the fund is entirely short – Mr. Minter still thinks that things are ‘over-valued.’ I wonder what will happen next.’ ☞ I wonder, too. And I agree with Joel, up to a point. Sure, the ultimate goal is not to be right, it’s to be rich. I’ve lost a lot of money being right, too. (Almost invariably, this happens when I’ve tried shorting overvalued stocks and find that, like Minter, I placed my bet too soon. Yes, many of them eventually collapse; but often it’s just too expensive or heart-stopping to watch them go ever higher before they do.) But sure there’s such a thing as value when it comes to buying a business enterprise (or a small share in one), even if it can be very difficult to assess. And I would argue that stock prices, while they may wildly overshoot ‘true value’ in both directions, tend over time to follow it. Like a drunk trying to walk a straight line. He may veer sharply this way and that – may even fall into the gutter before righting himself – yet in a general way he tends to stick to that line. What is a company with no debt, no expenses to speak of, no operations, and $100 million worth of cash and real estate worth? I would argue: about $100 million. If it’s divided into 10 million shares, you might reasonably pay $10 each. You’d feel foolish paying $12 and might get pretty excited at $6. Why? In both cases it’s because of value. Now take the same company and assume that, independent of the cash and real estate, it also has a business that makes forklifts. That business throws off $20 million a year in profit – $2 a share – and, in your estimation, is no more likely to grow than to shrink, but should be able to keep up with inflation. Now what’s it worth? You have the $10 or so in assets, but also a magic wallet that fills up with $2 each year – real dollars not diminished by inflation. Would anyone pay $150 for a share in that company? To get a paltry $2 a year in profits? And to own, in addition, $10 a share worth of real estate and cash? It makes no sense when, with the same $15,000 that you might have paid for 100 shares at $150 a share, you could pre-pay a portion of your 6.5% mortgage. With the stock, you’d have your theoretical $200 share in annual profits (100 shares earning $2 each). With the mortgage pre-payment, you’d be saving $975. So why buy the stock? But what if the stock were selling for $7 instead of $150? Then, wouldn’t you grab it? The exact same company, but two very propositions – one terrible, one great – depending on where the stock is. The problem, of course, is that – even when the accounting is honest – it’s difficult or impossible to know what a company will earn in the future (or even, in most cases, the true value of its assets and the true weight of its liabilities and contingent liabilities). So ascertaining value is not easy. But that doesn’t mean it doesn’t matter. As Ben Graham wrote (thanks John Hook for reminding me of this), ‘value will out.’ Maybe not today or tomorrow. But, almost invariably, an overvalued stock will eventually fall and an undervalued stock will eventually rise. The values are a lot better today than they were a couple of years ago. They may get better still. Tomorrow: Is There a Real Estate Bubble?