The Sanity of Institutions
Growth, Tronics and Synergy
Growth companies such as IBM and Texas Instruments sold at price-earnings multiples of more than 80. Questioning the propriety of such valuations became almost heretical.
Companies plastered “tronics” in their name. The tronics boom came back to earth in 1962.
Synergy Generates Energy: The Conglomerate Boom
- Baker Co. & Electronik Co. have 200k shares outstandings, and $5 earnings per share per year.
- Baker has a price-earnings multiple of 10. Each share is $50.
- Electronik has a price-earnings multiple of 20. Each share is $100.
- In their combination, 3 Baker shares ($150) are converted to 2 Electronik shares ($200).
- (Baker + Electronik) has 333,333 shares outstanding and $2m annual earnings.
- The conglomerate has $6 earnings per share per year! The stock rises to $120.
- Rinse and repeat.
Buzzwords: market matrices, core technology fulcrums, modular building blocks, nucleus theory of growth.
Conglomerate names: shipbuilding -> marine systems, zinc mining -> space minerals division, steel fab plant -> materials technology division.
When Litton Industries, the congolemerate granddaddy, reported missed 2nd quarter earnings, the music slowed. FTC also announced investigations into mergers. Also, congolemerates couldn’t always control their far-flung empires.
Performance Comes to the Market: The Bubble in Concept Stocks
It’s easier to sell a mutual fund with stocks that appreciated faster than those in competitors’ portfolios. Concept companies offered a compelling story that the market could recognize now, to boost near-term performance.
Because near-term performance was especially important (investment services began to publish monthly records of mutual-fund performance), it was best to buy stocks with an exciting concept and a compelling and believable story that the market would recognize now
But even if the story was not totally believable, as long as the investment manager was convinced that the average opinion would think that the average opinion would believe the story, that’s all that was needed, e.g. Cortes W. Randell’s company to service the needs of young people.
| Security | High Price 1968–69 | Price-Earnings Multiple at High | Number of Institutional Holders | Year-End 1969 Low Price | 1970 Percentage Decline |
|---|---|---|---|---|---|
| National Student Marketing | \(35 \frac{1}{4}\) | 117 | 31 | \( \frac{7}{8} \) | 98 |
| Performance Systems (fast food franchise) | 23 | \(\infty\) | 13 | \(\frac{1}{8}\) | 99 |
Concept companies also had too rapid expansion, too much debt, loss of management control, etc.
The Nifty Fifty
The Nifty Fifty: IBM, Xerox, Avon Products, Kodak, McDonald’s, Polaroid, and Disney.
They were “big capitalization” stocks, i.e. an institution could buy a good-sized position without disturbing the market.
These stokcs were considered growers and buy-and-forget. No one questioned the plausibility of a sizable company growing fast enough to justify earnings multiple of +80.
The Japanese Yen for Land and Stocks
By 1990, all Japanese property was ~$20 trillion - 5x all of American property. They justified it with high population density and regulations on habitable land.
Japanese stock market value responded by growing to 1.5x America’s. Kabuto-cho (Japan’s Wall Street):
- Are price-earnings inflated?
- “Nah, depreciation charges are overstated.”
- “Furthermore, we’re not even considering partially owned affiliated firms!”
- Adjusted earnings multiples were still too high (internationally and historically)
- Profitability was decreasing. Strong Yen => fewer exports.
- Aren’t 0.5% yields too low?
- “Nah, that’s because of the interest rates.”
- Well, interest rates began to rise in 1989.
- But stock prices are 5x the value of assets…
- “But look at how the company land is appreciating!”
- But companies found affordable land abroad.
- Also, rental income was rising far more slowly than land values.