For the first nine months of 2000 our average account was down -9.24%.
We wrote in our April letter to you that the notion that there were “new economy” stocks that were exempt from traditional yardsticks of valuation was idiocy masquerading as insight. What we did not know was that in just six months time most of these shares would be selling for 20% or less of their springtime prices. Sometimes bubbles burst, sometimes they deflate more gradually; it’s an unstable process. Fortunately, the process is about at an end, as the distance between here and zero for every dot.com stock closes in on insignificance. The absence of such rank speculation is a blessing not to be underestimated.
War in the middle East, on the other hand, is unexpected and not easily yielding to rational analysis. What do the Palestinians want? The question is so unsettling because it doesn’t seem to have an answer. The conflict does, however, hold the price of oil hostage, and that is plainly spooking the investment world. Oil price hikes are very large tax increases, with all the dampening tendencies on the economy that implies. But, they are impossible for the Federal Reserve to negate with monetary policy, since decreasing interest rates in the face of an accelerating inflation rate is anathema to central banks. Coming as this does in October, the month for stock market gremlins, has convinced a great many stockholders they have seen this movie before and didn’t enjoy it last time. We are not so fearful in general, and we are particularly pleased with the investments we are in specifically.
Oscar Wilde observed, “History never repeats itself, historians repeat themselves; there is a world of a difference.” When it comes to October meltdowns we suppose if everyone believes in it, it makes it a little more likely to happen, but that’s as far as our analysis takes us. If your time horizon is no longer than a month, you don’t belong in the stock market in the first place. Which brings us to the more important point: After you have sold, you are left owning bonds yielding between 5 ¾ and 6%. This is one of the most unappealing investments imaginable, and we say this despite freely acknowledging the economy is slowing. If you mean to invest “for keeps”, and not as a trader, or even a patient trader, signing up for a six percent monetary gain strikes us as poisonous to prosperity. Inflation is much worse than officially published, and we are past caring about the government’s basket of goods, designed to describe life in a trailer park without food and energy. You don’t live in that world, and you have hired us to keep you out of it. In our world, prices are rising rapidly, perhaps at twice the Consumer Price Index rate, and we wish to exclude nothing from the calculation. As our friend Jim Grant so aptly frames the rationalizing from Washington, “Inflation ex inflation is always zero.” Selling stocks means buying bonds, and we would far prefer to add to our naturally indexed REIT portfolio, than sign up for any bond portfolio we can currently imagine.
It never seems so in the short run, but it is almost always better to immunize yourself from the effects of inflation than to hedge against short term price swings in the stock market. For example, in the last part of the quarter we have been buying shares in Dun and Bradstreet, which is really just a way for us to get at their spin-off, Moody’s. Inflation is lumpy, and it is hard to guess where it is going to spring up next. Moody’s rates bonds, and wherever inflation springs up next, bonds get issued by the score. There are only two companies that do this and count, and the other one’s not public. Moreover, Moody’s fits in with our theme of buying great businesses at good prices, in that it has always been highly profitable, and a “bad” year doesn’t threaten us with anything much worse than dull performance. It has taken us many years to fully appreciate who benefits from inflation and who is harmed, and our Moody’s investment is the fruit of clearer thinking.
No quarter can pass without our mentioning our two favorite stocks, which by happy chance are our two biggest holdings. In several meetings with the management of Echostar, we were struck again how a conversation with Charlie Ergen is like reading next year’s newspapers. Charlie has an achievable vision of how we are all going to watch television tailored to our own tastes, delivered on our own schedules. You don’t realize how inconvenient TV is until Echostar describes to you what it will look like in the near future. And no one can over-emphasize the impact of television in American life. In another time, George Elliot wrote, “To get an idea of our fellow countrymen’s miseries, we have only to take a look at their pleasures.” The average American watches 51 hours of television in a week. To put that in focus, there are only 168 hours in a week. The TV habit may very well be deplorable, but there is no denying the strength of its grasp on American life. Own the pipe into Americas TV’s, and you are the toll taker of the world.
We want to repeat and underline one thing more about Echostar before we move on. The company is profitable today if its accounting is normalized to amortize the cost of getting a new customer over that customers’ tenure, rather than expensing now the costs of adding him to the system, which is their current practice. At year-end, Echostar will have a customer base big enough to throw off almost $2 a share in normalized earnings, while growing at 80% a year. The stock is $40 per share; this is the wrong price.
The quarter was otherwise noteworthy to your net worth because it saw the auction of European radio spectrum that will allow rapid internet access through cell phones. The phones, of course, will change their look entirely, and no one knows at the moment whether the final appliance will look more like a phone, a laptop, a Palm pilot or Dick Tracy’s watch. We do know that the European governments sold these air rights for an astonishing sum of money. If the worldwide telephone buyers are to ever justify these truly staggering license fees, they have got to get these systems built in a hurry. That’s where Qualcomm comes in. There is only one standard that can currently deliver high speed internet access, and you own a part of it. Another standard is promised that will be an off-shoot of the extant European GSM standard. But, do the telephone companies want to pay interest bills, and let their competitors get a head start, waiting around for a new standard out of blind loyalty to their suppliers’ best interests? This is what is at stake in our Qualcomm investment, particularly if we are correct that cellular phones will come to resemble land lines, and data transference will be many times more important than voice. In the short term, which flavor of CDMA gets chosen by whom always dominates trading. The battleground that matters is the developed world, not China or Korea, and our patience in sitting through big price swings in the stock will be well re-paid if Qualcomm wins where it counts. So long as the telcos all pay us royalties, we don’t really care where the next order comes from. This stock is expensive, and we are mindful of that, but there are so few other ways of profiting from the wireless revolution, and the growth rate is so extraordinary, that we are unwilling to be shut out.
It is commonplace in the investment business that the letters get shorter as the performance gets better. Let’s hope the year end letter reads like a Western Union telegram. “Made money. Stop. Send more.”
Sincerely yours,
Edwin A. Levy
Michael J. Harkins