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TRADER'S NOTEBOOK


Retro Investing With An Eisenhower-Era Approach

06/19/06 03:19:13 PM PST
by James Maccaro

Here's something for those with a nostalgic bent.

As the 1950s began, most people were reluctant to invest in the stock market. Memories of the crash of 1929 and the Great Depression of the 1930s were still fresh. The common view of the stock market was that it was only for the rich or for gamblers. Indeed, several opinion polls taken in the late 1940s and the early 1950s showed that fewer than 10% of Americans surveyed could even name a brokerage firm. However, as the 1950s progressed and the economy grew at a fast clip, consumer confidence returned and the middle class began to rethink their aversion to stocks. To encourage this process, brokerage houses got into the habit of hiring financial journalists to serve as public spokesmen for the firm and as cheerleaders for the stock market.

One such example is Henry Gellermann, a German immigrant (born and educated in Munich) who came to the United States in 1929 as a newspaper reporter specializing in financial matters. He had the bad luck to arrive shortly before the crash but was able to find work as an American correspondent for several European newspapers. He subsequently became a US citizen, wrote for numerous American publications and served in World War II with military intelligence. After the war, he was hired by Bache & Co. to serve as their public face.

THE MARKET AT MID-CENTURY
In 1957, Gellermann wrote How To Make Money Make Money, with an introduction by an editor of The Wall Street Journal. The book was successful and went through many printings, although it and its author are now obscure (if not nearly forgotten).

The heart of the book is a superb description of the securities markets in the US and Canada as they existed at mid-20th century. In keeping with his day job in public relations for an investment firm, Gellermann took a cheerful view of the stock brokerage industry. His sentiment clearly was that the Wall Street establishment was beyond reproach, and that what was good for them was good for the country. In addition to its overview of the financial system, the book also offers interesting stock market advice.

Gellermann asserted that "when you come right down to it, there's just one good measure of the value of a stock: What the market says it's worth." He added, "If you think the market price is low in relationship to underlying value, that's too bad," further stating: "You can assemble all the facts, use all the analytical techniques in the world to determine the %91real' value of a company's securities. If the answer you arrive at disagrees with the answer you get in the market, you're wrong -- as of that moment."

Of course, he noted, the market might eventually agree with your assessment, and the stock would therefore be worth buying, but he stressed that there were no guarantees and he discouraged the idea of looking for bargains. As he explained, " ... The market is not always interested in facts, or can painfully ignore them." Gellermann argued that a stock might be undervalued at present, but there was no reason to believe that it would not continue to be undervalued into the future.

"MR. MARKET" CAN BE MANIC
This approach is the mirror image of Warren Buffett's strategy, honed by his study under Benjamin Graham (the founder of fundamental analysis) and years of experience. Buffett, in fact, stresses that the market is frequently wrong and that the key to long-term investing is to take advantage of this fact. He compares the stock market to a bipolar individual. On some days, "Mr. Market" (to use Buffett's phrase) is in a manic mood and is eager to overpay for a stock, but other days he is inordinately depressed and, lacking any confidence in the future, is anxious to dump securities at any price.

In Buffett's view, when there is a divergence between a stock's price and its intrinsic value, the stock market is wrong (creating a potential opportunity for investors), but in Gellermann's view, the fault lies with you, not the market.

Gellermann's position was given academic respectability a generation later with the creation of the efficient market/random walk theory, which holds that because stock prices reflect all available information, they correctly reflect the value of the shares and, consequently, any attempt to "beat the market" is futile. Of course, the price of a stock can vary significantly, even over brief periods. Efficient market proponents dismiss these price movements as mere random events, similar to someone walking back and forth in an unpredictable manner.

Investors were warned by Gellermann to not overpay for shares. "There is such a thing ... to use one of Wall Street's pithier adages ... as buying not only the future but the hereafter," he warned.

To value a stock, Gellermann relied primarily on its dividend yield. This ultra-conservative approach made sense to those of Gellermann's generation because it took nearly three decades for the Dow Jones indexes to reach their pre-1929 crash highs, which discouraged faith in capital gains.

A low dividend yield indicated to Gellermann that the stock was priced for "the hereafter," but a high dividend yield could indicate that the market does not have faith in its continuance. Therefore, it can be said that Gellermann was looking for a "Goldilocks" dividend, one that was not too low but also not too high.

There is much to be said for the warning that an inordinately high dividend yield suggests that the market does not have confidence in its continuance. For example, very recently, General Motors' dividend yield was flirting with 9% when the board of directors cut the payout in half.

While Gellermann gave first priority to the dividend yield, he also acknowledged the price/earnings ratio, book value, and leverage (the level of debt) as factors to consider.

On diversification, Gellermann urged individual investors to, in his words, "put all your eggs in one basket." He opposed diversification, noting that "John D. Rockefeller, Sr., managed to amass a tidy number of millions in spite of the fact that he certainly put the lion's share of his savings into Standard Oil stock." Today, the same can be said about modern-day tycoons, such as Warren Buffett and Bill Gates.

To support his case, Gellermann used a hypothetical portfolio of 10 stocks as an example. He asserted that in such a portfolio, some stocks will advance but others will decline, thereby canceling out the gains. Ironically, more than 30 years later, Peter Lynch used the same hypothesis in order to buttress his belief in a diversified portfolio. He asserted that with a typical portfolio of about 10 stocks, most would give average returns and some would disappoint, but a few would exceed expectations and the losers would be more than compensated for by the winners. Lynch noted that a stock that increases 10-fold (a "10-bagger") could easily counteract a few losers and still provide for a portfolio with excellent returns and that the chances of having such stocks increases with the number of companies in the portfolio.

Further, Gellermann advised that individual investors limit their stock holdings to three or four "carefully chosen" stocks. He further suggested that a stock should be sold if changing circumstances or new information warrant a new and lower assessment of its value. However, if the price declines while its prospects are still good, he recommended that additional shares should be purchased. "The greater will be your eventual profit -- if you've selected a good, sound stock and don't lose your nerve when the time comes that you can buy another 100 shares for only $2,500 even though the first 100 you purchased cost you $5,500." This approach is in keeping with Warren Buffett's style of investing and seems to contradict Gellermann's own declaration that "if you think the market price is low in relationship to underlying value, that's too bad."

Gellermann may have underestimated the typical private investor when he declared, "You'll find that managing a three-stock portfolio or a four-stock portfolio will take all the time and thought you can give to it." Of course, if the wrong stocks are picked, it does not matter how many are in the portfolio.

SOME THINGS NEVER CHANGE
The stock market has changed tremendously since How To Make Money Make Money was published. At that time, for example, the New York Stock Exchange was open from 9:30 am to 3:30 pm, and the Dow Jones indexes (which included the railroad index instead of the transportation index) was calculated only five times per day, at 11:00, noon, 1:00, 2:00 and at the close, and the results were not released on the ticker until 12 minutes later. Much has changed, but Gellermann's observations and positions still have value.

RELATED READING
Gellermann, Henry [1957]. How To Make Money Make Money, Thomas Y. Crowell & Co.
Lynch, Peter [1988, revised 2000]. One Up On Wall Street, Simon & Schuster.
Maccaro, James [2002]. "Warren Buffett," Technical Analysis of STOCKS & COMMODITIES, Volume 19: Bonus Issue.
Malkiel, Burton G. [1973, revised 2004]. A Random Walk Down Wall Street, W.W. Norton & Co.



James Maccaro

James Maccaro is an attorney and freelance writer. He has written articles for Newsday, Ideas on Liberty, The Massachusetts Law Review, and other magazines. His law journal articles have been cited in several legal decisions, including by the US Court of Appeals for the DC Circuit and by the US Supreme Court. James A. Maccaro is an attorney and freelance writer. He has written articles for Newsday, Ideas on Liberty, The Massachusetts Law Review, and other magazines. His law journal articles have been cited in several legal decisions, including by the US Court of Appeals for the DC Circuit and by the US Supreme Court. He may be reached at jam@juno.com.

Address: 154-61 22nd AVE
Whitestone, NY 11357
E-mail address: jam@juno.com


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