GADR: All Stocks, All The Time? (2/3)
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Bettie and Big Blue
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Suppose that in 1987, a single mom of moderate means, Bettie,
begins investing to finance the future education of her young
daughter, Amaryllis. Bettie has no time to do investment
research. But, she is sure that computers are the growth
industry of the future; she knows that IBM is the biggest
computer company; and she knows that the company she works for
won't buy anything but IBM equipment.
While watching Wall Street Week, Bettie learns about how to buy
common stocks commission-free, through a dividend reinvestment
program (DRIP). The fact that in early 1987 every single
panelist on WSW is bullish on IBM confirms her intuition about
the stock. So, commencing in January, she starts a DRIP with
IBM. Every month $100 is automatically transferred from her
checking account to a special trust account, where shares of IBM,
including fractional shares, are purchased monthly and credited
to Bettie.
To keep the calculations simple, I've assumed that the monthly
price Bettie paid equals the average of IBM's high and low price
for that calendar year. I've also assumed that quarterly
dividends were reinvested at that same average price for the
whole year.
As Berney indicated, the high point for IBM shares for the coming
decade was reached in August of 1987, just 7 months after Bettie
began accumulating IBM shares. Vast sums were lost over the next
6 years as institutions and individuals bailed out of IBM, which
had been, until then, the Market's "bellweather stock". Though
the DJIA did quite nicely overall during this period, IBM
declined an astonishing 77% -- a magnitude almost on a par with
that of the Dow's decline during the worst span of the Great
Depression.
However, unlike much of Wall Street, Bettie did not lose a cent.
In fact, she didn't even lose a minute's sleep. There wasn't
much time to follow Big Blue's travails, or even watch WSW, since
she was already occupied with work and parenting. She just
continued with her program of automatically buying and holding
$100 of shares of IBM every month.
Though there are several more years before she begins college,
Amaryllis has already let her mother know that she has a
particular college in mind.
Examining her latest quarterly statement, our single mom figures
she will have about 330 shares of IBM at the end of the year. At
IBM's recent price of 182, this amounts to over $60,000. The
cash Bettie has laid out totals $14,400, so her profit is more
than $45,000. And, the cash was not even expended all at once --
it was allocated in monthly increments of $100 over a period of
12 years. Bettie's average annual return on the sums invested is
roughly 22%.
No Model Portfolio Theory. No alpha, beta, gamma, delta, or
epsilon. Not even vega. No worrying about which of IBM's
special charges against earnings will have future cash
consequences and which are merely reflections of abstract
accounting concepts. No pondering the cash flow significance of
purchased in-process research and development. No worrying about
what the long-term return on risk-free bonds will be in a
disinflating world economy or what an appropriate risk premium
should be for a boom and bust industry with constantly falling
prices. No timing, pricing, allocating, or apportioning. No
selling, no watching and waiting, no "on the one hand, but on the
other hand ..." None of the kind of stuff we go through every
day.
It was completely automatic -- automatic transfer of bank account
funds, automatic purchase of shares, automatic reinvestment of
dividends. Figuratively speaking, Bettie was investing
blindfolded with her hands tied behind her back -- and still made
22% per year for 12 years.
Did Buffett do better than Bettie over this period by "pricing"
his way out of the Market before the crash of 1987 and pricing
his way back in afterwards? Yes. Did Wayne do better than
Bettie? Well, as a long time shareholder of Berkshire Hathaway,
he probably did. Did all but a handful of professional money
managers underperform Bettie from 1987 through 1998? You
bet.
And, dollar-cost-averaging works in reverse as well. When
college for Amaryllis is just 2 or 3 years off, Bettie can begin
selling shares of IBM monthly, via her DRIP account, for a tiny
commission. The fraction of her portfolio she sells every month
can be apportioned so that she is selling shares right up to the
time Amaryllis is ready to pay the tuition on her 4th year of
college. The monthly proceeds of these sales, along with her
usual $100, can be used to buy CD's. By selling in this way,
Bettie need not worry about timing or pricing. She merely sells
a fixed number of shares automatically every month. In some
months Mr. Market will pay less, and in some months he will pay
more. On average, Bettie will receive a good sales price, just
as on average she received a good purchase price when she was in
her accumulation phase.
Harvey and Sam
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Harvey's is another hypothetical case, this one having to do
with Wal-Mart. Harvey graduated from High school in Pine Bluff,
Arkansas back in 1991. After graduation, he began working
full-time at an auto-and-truck service station. His high school
sweetheart, Frieda, got a job at the nearby Wal-Mart. Working at
Wal-Mart was not for Jay -- he would never have been able to
conform to all the rules Wal-Mart employees have to follow. And,
he didn't particularly care for shopping at all, unless it was
for tools, which he could get at Sears. But he knew that
Wal-Mart founder Sam Walton had become the richest man in
America, at that time. So, Harvey decided that rather than be
Sam's employee or his customer, he was going to become Sam's
partner. He would buy stock in Wal-Mart, just like Frieda was
already doing.
Harvey didn't know anything about stock brokers, except that he
didn't particularly trust them. And, unlike Bettie, he didn't
even watch Wall Street Week, as he preferred going to the Tractor
Pull at the Pine Bluff racetrack on Friday evenings. So, he made
a number of phone calls to Wal-Mart and explained that he wanted
to buy stock in the company, but that he only had $100 to invest.
He was eventually connected to the Wal-Mart Investor Relations
Department in Bentonville. They mailed him the forms for
registering in their DRIP. Harvey bought his first share of
Wal-Mart from Frieda, and she helped him fill out the DRIP
enrollment forms. He made his first monthly contribution in
January of 1992.
The following year, Sam Walton seemed to lose his Midas touch.
Sales kept rising, but the newly parsimonious shoppers of the
1990's, and the plethora of retail stores from coast-to-coast,
were whittling away at Sam's profit margins. Then, old age
finally brought about Sam's retirement. Not long afterwards,
Wal-Mart reported its first quarter of declining earnings in 25
years. For the next three years profits were basically flat.
The stock's price fell 44% over this span.
In the meantime, Frieda got admitted to an out-of-state college.
Harvey and Frieda agreed that their relationship would continue
as before, whenever Frieda was back in Pine Bluff. But, both of
them knew that it wouldn't. Eventually, Frieda married someone
she met at school. Even so, Harvey and Frieda remained friends.
Though Harvey had lost Frieda, he was determined to win at
investing. He figured that if he hung in with investing the way
he would doggedly look for a short circuit in a truck's
electrical system, that he would make his money back. From
knowing Frieda, Harvey knew that Wal-Mart stores had a lot of
customers, and that, managerially speaking, Wal-Mart ran a very
tight ship. If Wall Street didn't agree, as judged by the
stock's 3-year downward slide, Harvey figured that was just one
more thing for Wall Street to be wrong about.
So, Harvey stayed the course with his investment strategy of
making $100 monthly purchases of Wall-Mart stock. Around the end
of 1995, after the Fed had rapidly tightened short-term rates,
the nation seemed to be headed for recession. Manufacturing
output was in decline, as was manufacturing employment. Consumer
debt and consumer bankruptcies were at cyclical highs, and
rising. Though all but forgotten now, this apparent prelude to
recession was not a favorable environment for discount retailing.
A dozen or so large retail chains went into bankruptcy,
affecting around 3000 stores. This meant that the surviving
chains were competing against some 3000 stores that were dumping
inventory at going-out-of-business prices, while being protected
by the bankruptcy courts from having to pay creditors.
And then, a funny thing happened. Going into a decent, though by
no means exceptional, holiday season, retailing stocks began to
move sharply upwards -- based upon little more than optimism that
the worst was over. On the strength of its holiday season sales,
K-mart, the Wal-Mart of decades past, was able to get the
financing to pull back from near bankruptcy. K-mart's success at
avoiding disaster in early 1996 seemed to confirm the growing
optimism about retailing. And at Wal-Mart, same store sales and
profits, as well as margins, began to rise again, as they have
ever since.
Looking at his most recent DRIP statement, Harvey figures he'll
own 250 shares of Wal-Mart by the end of 1998. At WMT's recent
price of 81, Harvey's shares are worth $20,250 -- a compound
annual growth rate of almost 25%. Harvey still doesn't watch
Wall Street Week. And, he has never even heard of GADR. He just
keeps making his $100 monthly purchases of Wal-Mart. But, being
pleased with the results so far, he's thinking about raising his
monthly purchases to $200.
What Does This Have To Do With Graham?
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Some readers may be wondering what this has to do with
Graham. Indeed, IBM was one of Graham's favorite examples of the
kind of stock the intelligent investor should not buy.
Graham was generally skeptical about the profit potential of
hi-tech stocks, or growth stocks of any sort, because of too much
competition, too rapid product cycles, and P/E's that are usually
too high.
Further, though Graham thought highly of dollar-cost-averaging,
he recommended that new investors (like Bettie and Harvey) avoid
beginning a program of dollar-cost-averaging when prices were
high. Graham feared that a subsequent decline in prices would
cause the new investor to sell. Feeling burned by the
experience, the new investor might never again invest in stocks.
Hence his use of the qualifying phrase "begun at reasonable
prices" in the footnote to the passage from p. 95 of The
Intelligent Investor, quoted above.
Interestingly, many small investors who are saving for retirement
through 401(k)'s and similar retirement plans seem to be
accepting with equanimity significant short-term declines in
their portfolio value. Indeed, rather than selling on the dips,
a substantial number of small investors are buying on the dips.
It is an open question, though, whether they would continue to do
so were there a general market decline of the magnitude and
duration of IBM's travails from 1987 through 1993.
What Else Does This Have To Do With Graham?
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- In addition to dollar-cost-averaging, Graham recommended that
conservative investors (ones seeking safety of principal and
freedom from bother) confine themselves to "leading companies in
important industries". Whatever Graham's reservations about IBM,
he would have agreed that IBM is a leading company in an
important industry. Indeed, if one examines prosaic criteria
such as sales and profits, it could be argued that IBM is
the leading company in the important industry.
And, Wal-Mart replaced Woolworth (now Venator) on the DJIA
because Wal-Mart has become the nation's leading retailer. Since
2/3 of U.S. economic activity is consumer generated, retailing is
surely an important industry.
[cont'd in next posting] |
