Somewhat OT : The ultimate pyramid scheme?
Updated: 12-Dec-99
A Brief History of the Market
[BRIEFING.COM - Robert V. Green] Recently it occurred to us that the history of the Stock
Market can be divided into several unique phases, based upon the prevailing investment concept
of the time. Here is a brief history of the basic driving forces behind the market.
PHASE 1 Buy Stocks That Continually Increase Dividends
PHASE 1, 1760 -1960s The original concept behind stocks was that you became part owner of
the business. Therefore, you were entitled to part of the cash flow generated by the business, paid
as a "dividend."
This basic idea was the principle behind stocks for the first two hundred years of the US stock
market, up until the 1960's.
Or course stocks paid dividends. Who would want to own a business that never paid you any
money?
The risks associated with receiving your share of the profits were high, because business has
always been hard to guarantee.
Many people focused on the risks of stocks. In fact, the great capitalist Andrew Mellon is credited
with the quote "Gentleman prefer bonds" because the risk of default was lower than the risk of a
falling dividend.
Therefore, the principle driving force in Phase 1 was: Buy stocks that continually increase their
dividend. (There are even people still alive today who remember when this was the dominant
theme on Wall Street.)
Management was guided by the following principle: run a good business, make a profit, pay your
shareholders every quarter. Good management was defined by how much they could increase the
dividend.
PHASE 2 Buy Stocks That Continually Increase Earnings
PHASE 2 1960s - 1990s: Somewhere in the last thirty to forty years, the emphasis shifted from
finding stocks that "increase dividends" to finding ones that "increase earnings."
The idea was that, eventually, companies with rising earnings would someday raise their
dividend. Searching for rising earnings was simply a way to jumping in ahead of a rise in the
dividend, and therefore, "getting in" before everyone else.
Management of companies shifted their emphasis. Because earnings per share became more
important than dividend payouts, companies were managed to increase earnings per share.
What's wrong with that? Earnings per share is not always the same as increasing business.
When this shift occurred, in the mid-sixties, it gave birth to the conglomerate mania. Companies
with high price/earnings ratios began acquiring companies with low price/earnings ratios.
Because the acquirer issued fewer shares (per earnings dollar) to purchase the lower valued
company, the earnings per share of the combined companies would increase, even if the total
absolute earnings of the combined companies did not increase. Earnings-per-share increased,
but there wasn't any additional money.
The conglomerate craze finally came to an end when it simply became too hard to manage giant
companies in dozens of industries. Then the absolute earnings began to decline, more than new
acquisitions could cover up, with disastrous results for the stock price. (But that's another
story...)
Nevertheless, the focus during Phase 2 was: Buy stocks that continually increase earnings.
Growth investors, a term invented in this phase, focused on earnings growth. The P/E ratio
became the dominant ratio, with PEG (Price/Earnings-to-Growth) more popular near the end of
the era.
Phase 2 ended when the internet stocks came along.
PHASE 3 Buy Stocks That Continually Increase Revenues
PHASE 3 1995 - October 1999: Then, sometime along the way, the emphasis shifted again, to
finding stocks with rising revenues. Particularly technology stocks. Particularly internet stocks.
The idea was that explosive growth would make the company HUGE! This was the driving force
behind most internet stocks. Losses were unimportant, because it would all be justified, sometime
in the future.
Management, therefore, shifted direction of their companies towards increasing revenues.
Acquisitions of companies with revenues is now becoming more widespread. Starting new
businesses, long before the principle line of business is profitable, is common.
Priceline and Amazon.com are examples. Both are rushing into new lines of business, long before
they have made their core business profitable. Such a thing would have been punished in earlier
phases of the stock market. Today, they are rewarded.
Price/Sales became the dominant ratio in this era.
But we wonder if even this phase is starting to dwindle. Certainly the last month has been
puzzling.
PHASE 4 Buy Stocks That Continually Increase In Price
PHASE 4 October 1999 - ? : And now of course, we have reached the point where you should
simply buy a stock with rising prices.
Although we mean this somewhat tongue-in-cheek, there is also "truth-in-jest."
After all, that's what is working right now. Pure momentum is driving the highest flyers in the
market. The people making the most money are the ones who are best at spotting momentum
early. But the real game is getting out early.
What more is there to say about it? Dividends, earnings, revenue. They've all been replaced as
the driving force.
After all, 289 stocks have doubled in the last four weeks. Nearly half, 128 of them, have negative
revenue growth rates! But they have rising stock prices.
Phase 4 probably scares a lot of people. But phase 3 scared people too. Phase 2 probably scared
anyone who grew up in the phase 1 mentality.
How management will adjust to this new era is unclear.
How long Phase 4 will last is also unclear.
The Unsung Hero of Wall Street
Someone, somewhere, is an unsung hero of Wall Street.
This is the person who initially convinced people that buying a technology stock, which will
never pay a dividend, was a good thing. On this person's shoulders lies much of the great growth
of the bull market of the last 19 years.
That unsung hero is the one who made it possible for companies to reinvest earnings in new
technologies, instead of paying a dividend.
He/she also made it possible for phases 2, 3, and 4 to come into existence.
But most critically, this unknown person is the one who convinced investors that the goal of
holding a stock was not to be an owner of a business, but to get your reward from selling to
someone else.
Here's to hoping that there is always a ever increasing supply of people willing to pay a higher
price. |
