Fad Investing 101

Investment fads have been around since trading began in New York City under the buttonwood tree two hundred years ago.

Professor Graham of Columbia University may have been one of the early creators of an investment fad after the Crash of 1929. In his influencial book, Security Analysis, common stocks were said to be worth no more than the present value of future dividends. His theory of future yield became popular in the thirties and one of the established methods of evaluating stocks, but the style lost its ascendancy with the advent of another stock phenomenon.

Sam Steadman, at Loeb Rhodes, and T.Rowe.Price, an investment manager in Baltimore, developed the concept of growth stocks. Their perception of stock values soon overtook Graham's theory of discounted dividend value to become the dominant theme in Wall Street. Yield was discarded for growth.

This formula, as it evolved later suggested that a proper P/E for a stock was equal to its estimated earnings growth rate. IBM was said to be worth twenty times earnings because its earnings were projected to grow at twenty percent per year. As the growth stock paradigm reached its zenith, stocks with the fastest projected earnings growth became known as the 'nifty fifty', a select group of fast growing stocks selling at silly multiples. By 1973, a market correction put a stop to that nonsense with a fall of fifty percent for the Industrial Averages. Stock prices fell to mouth watering levels.

It was time for a new fad.

The contrarian view was introduced helping to supplant earlier formulas. The contrarian proponents claimed that warm public endorsement of industries or big companies was usually wrong. The most widely acclaimed stocks often became overpriced and were to be avoided. Wise investors should seek neglected industries from the daily list of stocks hitting new lows. Companies that had been subject to bad publicity were of special interest; journalistic exaggeration invariably lowered their stock price. Companies under a cloud were more often an investment opportunity than an inappropriate speculation.

The equity cult was still alive and well, but investor preference supported a more cynical evaluation.

Simultaneously, another investment style was gaining popular support.

Index investing took hold as fewer and fewer managers outperformed the popular averages. The stock market was said to be too efficient, and forecasting business conditions and corporate earnings, too perilous a task. Moreover, few large money managers outperformed the S.& P. 500.

Thus indexing became acceptable to conservative and cynical investors, despite the fact there was little reward for Wall Street.

Perhaps to mend that shortcoming, creative minds found another theory to attract investors.

The information age had arrived. Technology had not only increased the speed with which it delivered data, but it also created innovative ways that these electronic streams of data could be manipulated. Broadband and the Internet joined to create hundreds of investment opportunities. As industry adapted to supply chain management, and its promise of fast delivery and reduced inventories, higher earnings for early participants seemed assured. Trading of stocks, commodities and derivative instruments were executed faster and at less cost. The telephone and computer industries were redesigned to become more efficient.

And everything transmitted now travelled at the speed of light.

The dot com era was upon us, and its stimulus quickened the step of hesitant investors. It was time for renewed optimism and irrational price gains.

The high tech phenomenon came and went in record time. In little more than a decade it had spent itself, like a Florida hurricane, depriving investors of a significant portion of their accumulated wealth as it passed.

Before the pain of losses from the nosebleed heights of the high tech market had subsided, the newest stock market phase evolved. Memory of serious losses in preceding years didn't seem to matter.

High tech investing has been given new life with a book called Running Money, by Andy Kessler.

Mr. Kessler believed he has discovered a new choice for the intelligent investor, a very profitable new arena to study. He believed producers of intellectual property with high margins were a special breed of future winners. No longer were the low margin manufacturer in America an appropriate investment media. You can forget about industrial stocks, metal bending and book value/share. Kessler asserted that companies with high margins and no real assets represent a new economic opportunity.

More and more, he says, America is exporting high tech, high margin intellectual property to foreign manufacturers who build low margin products according to our instructions, our designs, which we in turn import. More significantly, these imported products have a large American profit imbedded in them. An ever broadening spectrum of intellectual properties with copyrighted, high profit margins are being sent abroad to low labor cost nations and turned into finished products for export. We send our designs and instructions to a Taiwan foundry to manufacture a chip, or a newly developed drug is sent to Puerto Rico and becomes a treatment for leucemia victims; or a Hollywood digital movie is produced for foreign and domestic theatres, shown to global audiences. All of these products and hundreds more like them, are sold to Americans as well as foreigners with substantial American profits imbedded in each. And those that we consume are paid for with low yielding US Treasury bills.

For Kessler, it's a perfect world:
"We think, they sweat"; America the beautiful, the birthplace of future fortunes.

Maybe that's why the dividend model of Professor Graham is obsolete and we have all come to accept a yield free universe, so highly recommended by Warren Buffett at Berkshire Hathaway.

In this era of new companies with brilliant designs and designers, the next investment craze has to be high margin intellectual property, American growth stocks with no assets, no dividends, just rising profits, accumulating in Bermuda, thinking.

Are these stocks suitable investments under Professor Graham's theory of equity valuation?

Or are they just another fad?
Richard E. McConnell November 1, 2004