Stock Valuation from the Sixties through the Nineties
Malkiel notes that there were a number of speculative trends from the 1960s to 1990s, and that they all mended up in the same way. Every few years, the stock market has another bubble or speculative mania which soon crashes and levels off, such as overvalued food stocks in the 1980s or the Nifty Fifty blue chips in the 1970s, but in both cases the speculative phase ended and stocks returned to their normal values. By the 1990s, institutions accounted for more than 90% of the trading volume on the NYSE, and yet professional investors participated in several distinct speculative movements from the 1960s through the 1990s. In each case, professional institutions bid actively for stocks not because they felt such stocks were undervalued under the firm foundation principles, but because they anticipated that some greater fools would take the shares off their hands at even more inflated prices (Yan, p. 5).
The Soaring Sixties
1. The New "New Era": The growth-stock/New-issue craze:
a. Growth was the magic work in those days, taking on an almost mystical significance. More new issues were offered in the 1959-62 period than at any previous time in history. It was called the "tronics boom," because the stock offering often included some garbled version of the word "electronics" in their title, even if the companies had nothing to do with the electronics industry.
b. Jack Dreyfus commented on the mania as follows: a shoelace making firm changed the name from Shoelaces, Inc. To Electronics and Silicon Furth-Burners. In today's market, the words "electronics" and "silicon" are worth 15 times earnings. However, the real play comes from the word "furth-burners," which no one understands.
c. The SEC uncovered many evidence of fraudulence and market manipulation in this period. Many underwriters allocated large portions of hot issues to insiders of the firms such as partners, relatives, officers, and other securities dealers to whom a favor was owed. The tronics boom came back to earth in 1962.
2. Synergy Generates Energy: The Conglomerate Boom.
a. Part of the genius of the financial market is that if a product is demanded, it is produced. The product that all investors desired was expected growth in earnings per share. By the mid-1960s, creative entrepreneurs had discovered that growth meant synergism, which is the quality of having 2 plus 2 equal 5.
b. In fact, the major impetus for the conglomerate wave of the 1960s was the acquisition process itself could be made to produce growth in earnings per share. The trick is the ability of the acquiring firm to swap its high-multiple stock for the stock of another firm with a lower multiple. The targeting firm can only "sell" its earnings at multiple of 10, say. But when these earnings are packaged with the acquiring firm, the total earnings could be sold at a multiple of 20.
c. As a result of such manipulations, corporations are now required to report their earnings on a "fully diluted" basis, to account for the new common shares that must be set aside for potential conversions. The music slowed drastically for the conglomerates on January 19, 1968. On that day, the granddaddy of the conglomerates, Litton Industries, announced that earnings for the second quarter of that year would be substantially less than had been forecast. In the selling wave that followed, conglomerate stocks declined by roughly 40% before a feeble recovery set in.
d. The aftermath of this speculative phase revealed two factors. First, conglomerates were mortal and were not always able to control their far-flung empires. Second, the government and the accounting profession expressed real concern about the pace of mergers and about possible abuses. Few mutual or pension funds were without large holdings of conglomerate stocks. They were hurt badly.
During the 1980s and 1990s de-conglomeration came into fashion. Many of the old conglomerates began to shed their unrelated, poor-performing acquisitions to boost their earnings.
3. Performance comes to the market: the bubble in Concept stocks
a. With conglomerates shattering about them, the managers of investment funds found another magic word: performance in the late 1960s. The commandments for fund managers were simple: Concentrate your holdings in a relatively few stocks and don't hesitate to switch the portfolio around if a more desirable investment appears. And because near-term performance was important it would be best to buy stocks with an exciting concept and a compelling and believable story (Yan, p. 6).
b. Cortess Randall was the founder of National Student Marketing (NSM). His concept was a youth company for the youth market. Blocks of NSM were bought by 21 institutional investors. Its highest price was 35.25. However, in 1970, its lowest price was 7/8.
II. The Sour Seventies
1. In the 1970s, Wall Street's pros vowed to return to "sound principles." Concepts were out and investing in blue-chip companies was in. They were called the "Nifty Fifty," also "one decision" stocks. You made a decision to buy them, once, and your portfolio-management problems were over.
2. Hard as it is to believe, the institutions had started to speculate in blue chips. In 1972, P/E for Sony is 92, for Polaroid is 90, for McDonald's is 83. Institutional managers blithely ignored the fact that no sizable company could ever grow fast enough to justify an earnings multiples of 80 or 90.
3. The end was inevitable. The Nifty Fifty were taken out and shot one by one.
III. The Roaring Eighties
1. The Triumphant Return of New issues: the high-technology, new-issue boom of the first half of 1983 was an almost perfect replica of the 1960s episodes, with the names altered to include the new fields of biotechnology and microelectronics. The total value of new issuers in 1983 was greater than the cumulative total of new issues for the entire preceding decade.
2. Concepts Conquer Again: the Biotechnology Bubble: valuation levels of biotechnology stocks reached an absurd level. In 1980s, some biotech stocks sold at 50 times sales.
3. From the mid-1980s to the late 1980s, most biotechnology stocks lost three-quarters of their market value.
IV. The Nervy Nineties
1. One of the largest booms and busts of the late twentieth century involved the Japanese real estate and stock markets. From 1955 to 1990, the value of Japanese real estate increased more than 75 times. By 1990, Japan's property was appraised to be worth 5 times as much as all American property.
2. Stock prices increased 100-fold from 1955 to 1990. At their peak in Dec 1989, Japanese stocks had a total market value of about $4 trillion, almost 1.5 times the value of all U.S. equities and close to 45% of the world's equity market capitalization.
Stocks sold at more than 60 times earnings, almost 5 times book value, and more than 200 times dividends (Yan, p. 7).
3. The financial laws of gravity know no geographic boundaries. The Nikkei index reached a high of almost 40,000 on the last trading day of the decade of the 1980s. By mid-August 192, the index had declined to 14,309, a drop of about 63%. In contrast, the DJIA fell 95% from Dec 1929 to its low in the summer of 1932.
Chapter 4: The Biggest Bubble of All: Surfing on the Internet
One of the greatest speculative bubbles, at least before the 2008-09 crash, was the Dot.com and New Economy bubble of the 1990s, which crashed in the early 2000s. It was no different from the railroad manias of the 19th Century, the South Sea Bubble of 1720, and the IPO, electronics and conglomerate mania of the 1960s. All of these had their heyday, and those who bought early and sold before the crash made money, but there was a reason that Wall Street kept the speculative high-tech stocks in a separate market, since many of these Internet companies would be here today and gone tomorrow, with only a few survivors. Despite the constant speculative mania, Malkiel still believes in the efficient markets theory and that they will always weed out frauds, scams, corruption and inefficiency.
Chapter 4. The Biggest Bubble of All: Surfing on the Internet
1. The NASDAQ Index, an index essentially representing high-tech New Economy companies, more than triples from late 1998 to March 2000. The P/E ratios of the stocks in the index that had earnings soared to over 100.
2. Amazon sold at prices that made its total market cap larger than the total market values of all the publicly owned booksellers such as Barnes & Noble. Priceline sold at a total market cap that exceeded the cap of the major carriers United, Delta, and American Airlines combined.
3. Cooper, Dimitrov and Rau found that 63 companies that changed their names to include some Web orientation enjoyed a 125% greater increase in price during 10 day Cooper, Dimitrov and Rau found that 63 companies that changed their names to include some Web orientation enjoyed a 125% greater increase…