Making it momentary as a sound, Swift as a shadow, short as any dream;
Brief as the lightning in the collied night that in a spleen unfolds both heaven and earth,
And ere a man hath power to say, Behold!, The jaws of darkness do devour it up.”
We have often enough in past letters scolded the “New Era” mentality that adores stocks at every price. Considering how near to a religious belief this has become, and with every channel in your television now threatening to go to 24 hour stock coverage, further demurrals from us really come to seem like bad manners. Also, and we blush to write this, we now own more stocks and hold fewer bonds than we have in many years. So the question becomes have we succumbed to the mania too? We think not, and while we might be at risk of an unpleasant quarter or two, we are in fact working in a vineyard quite some distance from the crowd.
One of the oddest traits of this remarkable bull market is how little the enthusiasm for stocks has spilled over into a love of the underlying businesses. In fact, in best-selling books like Wharton Professor Jeremy Siegal’s “Stocks for the Long Term”, actual commerce is held not to matter to investment success at all. The Professor loves stocks, around the world, and at all times, because they are stocks, not because they have anything to do with an underlying firm. Since, as J.M. Keynes observed, “Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist”, the prevalent academic notion has been taken up around Wall Street. For many months now poor data for business conditions as a whole are absolutely relished. At the firm level, confessions of gigantic errors of past investment judgments that lead to plant closures and layoffs are swooned over rapturously. This is foolishness. The sum of all the shares in a business is still only worth what the underlying business is worth, and a well managed business is worth more than a series of well crafted press releases detailing past error. We are going to tell you about three very attractive businesses now, with stock prices to match.
You own shares of John Deere & Co. now, and we want to make it even more at the right price. The people of Asia are coming to enjoy eating three meals a day, and adding meat to their diets at a charmingly unhealthy clip. This alone increases grain consumption by double-digit rates. But food isn’t grown in Asia the way it is in America, oftentimes hundreds or thousands of miles from where it is consumed. In China, over 50% of all grain is grown within 30 miles of where it is consumed, and hundreds of Asian cities are expanding in radius by a kilometer a year, taking farmland out of production that has been producing grains for centuries. This is a formula for shortage at a time when the world’s carryover stocks in grains are at all-time lows. Indeed, in Europe last month, for the first time in two decades, a tax was placed on wheat exports, to keep more of their crop at home, but placing a greater strain on the rest of the world’s supplies. Yet the financial world blithely goes on assuming there are EEC butter mountains and milk lakes ready for the tapping at a moment’s notice, which in fact has not been true for more than a year now.
These shortages could not come at a more opportune time for Deere, which has recently prevailed in a long and bitter struggle over its unions, allowing it to rationalize its employment practices, with all the attendant profitability that entails. And, as more than one of our clients has observed, naming another farm equipment maker is a real challenge, the consolidation in their business has been so long and complete. That it sells at ten times earnings is testimony to just how complacent the financial world is in the face of looming shortages of basic products.
Gannett is the anti-Internet investment. At the risk of being made roadkill on the Information Superhighway, we can’t help noticing that Americans don’t actually read from the Stanford University Scientific Database once they learn how to get in it. They read the Lafayette, Indiana “Journal and Courier” and the De Moines, Iowa “Register” for the high school football accounts or to guess who got into trouble on this week’s thinly veiled police blotter. Gannett publishes 80 of these sorts of newspapers daily and 50 more weekly across the American heartland. It is a terrifically profitable business, faithfully earning about a 25% return on adjusted book value, mostly because local businesses need local papers to advertise in. And, when small business is feeling big for its britches, Gannett owns 20 local radio and television stations too.
Gannett does have one technological marvel up its sleeve, and that is “USA Today”. Printed in over 30 plants nationwide, its editors regularly get to read the first two editions of every major East Coast paper before closing their own bulldog edition, and then routinely beat the others to your local newsstand. Widely derided as “McPaper” for its shallow coverage of news at its inception a decade ago, it is now solidly profitable. Best of all, it has been improving in seriousness and depth of coverage at a time when the self-styled “newspaper of record”, The New York Times, has been decaying. Readers notice. In the first nine months USA Today was the only major daily with a substantial increase in readership. Selling even now at less than a market multiple, Gannett is a tribute to how seriously Wall Street can take its own hastily concocted prophesies over a hundred years actual experience.
You also own offshore oil rigs, in almost every form they come: Global Marine, Reading and Bates, Rowan Drilling, and Schlumberger. From the end of the second World War to 1982, drilling for oil in the ocean’s depths was considered a fairly stable growth industry. It requires an amazing amount of technical know-how to drill at great depth, it is a business America has always dominated, and geologists believe there is perhaps twice as much oil left to be discovered underwater as there is on land. Nonetheless, investor over-enthusiasm can ruin almost any good thing when enough money is poured at a business, and offshore drillers have spent almost fifteen years working off the great speculative excess of the early 1980’s.
Today, by contrast, there are 553 offshore rigs working around the world and exactly one on order. That’s up from none for the two previous years, and the company building the rig (Rowan Drilling) intends it for its own account. Knowing that these rigs toil in the most inhospitable places on earth (the Bering Sea off Alaska, the North Sea, the South China Sea), the world’s present implied depreciation life of 553 years for a rig is deeply hilarious and illustrative of the wild swings in sentiment sobersided capitalists are prone to. For purposes of comparison, in 1983 there were 240 rigs on order, and today’s best guess of total rig building capacity is five or six worldwide. Rates for these rigs, which only started climbing six months ago, have a long way to go.
A sharp-eyed client called recently to point out there was a pronounced theme to our investment outlook. Agriculture, oil, newspapers and gold all benefit from a return to inflationary times. While we are doing our best to diversify around it, there is no denying to you what we actually think. Inflation is returning and the world is woefully unprepared for it. This sentiment is sharply at odds with the consensus of some of the best minds in finance, and it gives us pause. Still, we think the surging commodity indices are for real, and it is noteworthy how far back on the back pages price increases are still printed. For a decade and more managers have been hailed for plant closings, layoffs and just in time inventory schemes that leave no margin for supplier error. It was a great strategy for the eighties, and all winning strategies get carried to excess. Surpluses of stuff are thin on the ground, and still a staple of Wall Street’s dreams. What is more, the rapid rise in commodities prices this last half year has come in the face of a decidedly sluggish economy. What if it prospers?
Small inflations become big ones when the monetary authorities are clearly unprepared and unwilling to raise rates aggressively in the face of rising prices. Alan Greenspan and the other members of the Federal Reserve Board may have put themselves in an awkward spot by tolerating, and indeed in Congressional testimony actively encouraging, the astonishing mutual fund boom. Will the Fed raise rates if there are runs on mutual funds, or will it find its hands tied? Won’t we tolerate just a little inflation if that will calm the markets? Central bankers like William McChesney Martin used to believe curbing speculation, “Removing the punch bowl just as the party got good”, as Martin put it, was a crucial part of the job. Mr. Greenspan is America’s host.
1995 proved to be an especially good year in that we far exceeded our long-stated goals. At a time when a “momentum” craze has infected the country, making everyone an above average investment manager, it’s worth re-stating what we try to do here. Our goal is to beat inflation by six to eight percent a year, without sacrificing our principle that lowest risk is found in greatest intrinsic value. We have managed to do that for almost seventeen years, and we marvel at the people who now believe it is so easy to do.
Your portfolio has less than a market multiple even after the appreciation of last year. That means we have paid essentially nothing for a sort of call option on inflation that may yet prove very valuable. Since we like the companies too, it’s a nice way to start the New Year.
Wishing you and yours all health and happiness in 1996, we are,
Sincerely yours,
Edwin A. Levy
Michael J. Harkins
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In 1995 our average account gained +27.0% from all sources, inclusive of all fees.
The statistics below are also from 1995:
*GNP Price Deflator…………………………………………..+1.7
*Consumer Price Index………………………………………..+2.8
Average Treasury Bill Rate…………………………………....+6.1
Standards and Poor 500 Appreciation………………………..+34.1
Dow Jones Industrial Appreciation…………………………..+33.4
New York Composite Appreciation………………………….+31.3
Nasdaq Composite Appreciation……………………………..+39.9
*Bear, Stearns Estimate
Note: The figures above represent the composite performance of all fully discretionary, balanced accounts. These figures exclude accounts managed for less than 6 months, accounts using short selling and accounts consisting only of fixed income investments, to more accurately reflect the past performance of fully discretionary, balanced accounts. However, past performance is no guarantee of future results.