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| November 15, 2005 |
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| Talk to the McColl School of Business
Charlotte, North Carolina |
| Good Morning. When I was a 20 year old undergraduate I sat in the stacks of Cornell University reading John Maynard Keynes’ General Theory of Employment, Interest and Money, because I wanted to know something of the original flavor of this one work I’d heard so much about. I was besotted instantly and within a fortnight I had consumed every major work he wrote. Worse yet, I had started using words like “fortnight” and “besotted”. Keynes was instantly addicting. In a moment I will tell you why he should be of interest to you, but first let me tell you how important and celebrated he was. From 1917 to 1946, nobody in the world of thought mattered more. Maynard Keynes led the British Treasury team that financed the impossibly onerous First World War effort, then he resigned from the Treasury in disgust over the economic terms imposed on Germany in the Treaty of Versailles, wrote a book brutally condemning the Treaty, and proved horrifyingly prescient over the next twenty years as the totalitarian outcome he predicted arrived as though on a train schedule. He was holding down the most celebrated lecture post Cambridge University had ever known, and what a name he was making for himself in the City of London, trading for himself, his college, and two insurance schemes. He was once forced to take delivery of a wheat trade, thought likely to break him, and he calmly proposed to the Cambridge dons that they vacate King’s College Chapel to let him store his wheat. This didn’t fly, but imagine the cheek in trying it on. In the event he asserted the wheat wasn’t in good delivered form, demanded cleaning, and the cleaning process took long enough that prices recovered and he made a tidy profit. His personal life made the newspapers, and he married the prime ballerina of the Bolshoi. When the Depression hit, shaking—no, very nearly destroying society’s belief in markets, market outcomes, or the private ownership of the means of production, he wrote this book. It was written in 1935, at great speed, and delivered to President Roosevelt chapter by chapter in galley proofs as fast as it could be taken to Washington. It says that markets are subject to breakdowns, but that they can be made to work by enlightened government action, and that action was sufficiently predictable that Society could live with the inevitable bumps in the road. The Depression was just one hell of a speed bump. This was heady stuff at the time, and for me reading it 40 years later. But think of the subtle corollary point; if markets and cycles could be scientifically predicted by government, surely they could be better predicted by private agents and those private men could operate in any market they chose for their own greater comparative advantage. From this thought, to visions of sugarplums dancing in my head, was but an instant. Besides, Keynes was rich, and his Chapter 12 of this book, which tells you how to trade shares and commodities, is the wittiest and wisest 17 pages on markets I have ever read. Surely we can all do this, and with computers, why can’t we do it better than Keynes? Here is why he matters to you. 90% and more of the financial press, and 100% of CNBC and its ilk, fancy themselves little Keyneses. That half of them have never heard of him, and the other half bollix up his name, was completely predictable to Keynes. He wrote, “Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist.” He would find it delicious irony that he today is the “defunctee” they ape. I didn’t know the most delicious part of the irony until 15 years after we began Levy, Harkins and for this I must let Robert Skidelsky, Keynes’ brilliant biographer, tell the story. This is from pages 524 and 525 of his “Keynes: The Economist as Savior”. “In 1929 he had lost practically all his money; in 1931 he even tried to sell his two best pictures, his Matisse and his Seurat, but found no buyers……Keynes personal investment philosophy changed with his economic theory……In the 1920’s Keynes saw himself as a scientific gambler. He speculated on currencies and commodities. His aim was to play the cycle. This was the height of his “barometric” enthusiasm, when he believed it was possible, by forecasting short term rhythms, to beat the market. The gambling instinct was never quite extinguished.” But Skidelsky goes on, “By the 1930’s (Keynes) was prone to dismiss this kind of activity as a mugs game. ‘I was the principle inventor of credit cycle investment’, Lord Skidelsky quotes Lord Keynes, “and I have not seen a single case of a success having been made of it”. “Credit cycling meant valuing shares relative to money, …or as he put it, valuing them by last week’s results, rather than by their long term prospects.” By 1938, Keynes was going so far as, “I feel no shame still owning a share when the bottom of the market comes. I should say that it is from time to time the duty of a serious investor to accept the depreciation of his holdings with equanimity and without reproaching himself. Any other policy is anti-social, destructive of confidence, and incompatible with the workings of the economic system.” Skidelsky writes, “(Keynes’) new philosophy can be summed up as fidelity to a few carefully chosen stocks; his “pets”, as he called them.” Yes, and I could wring the old boy’s neck. He had gone completely from a swashbuckling trader to a Grahamite long-termer and to the best of my knowledge he never said any of this publicly; what I have read to you all comes from private correspondence Skidelsky has so faithfully tracked down, and from reconciling Keynes’ financial accounts. He also made more than 20 times his money in the 1930’s with his little secret. If I had known this it might have saved me many a care-worn night, trading currency futures in Asia. If we all had known it maybe some part of the blather that passes for commentary might be stifled. So what is to be done if we openly acknowledge that we don’t know what markets will do next, we never know, and it is to our great advantage to know that we don’t know, when the other guy thinks he does? If we are not to set ourselves up as little Maynards, indeed, the Maynard who never was, how are we to add value to the investment scene, and even more importantly, reap swinging big fees? You might start by reading this book, Benjamin Graham’s “Intelligent Investor”. Graham is another investment genius who is quoted about one hundred times more often than he is read. Proof of this comes if you know that 120,000 people sat for the CFA exam last year, in one of its three levels. And, according to Graham’s indispensable biographer Janet Lowe, approximately 4,500 copies of this book sell every year. How can that be? The CFA degree is highly technical, time consuming and challenging, requires great dedication. Graham is an easy read, and the concepts can be taken in in at most two afternoons. You would think that the booksellers would unload 40,000 copies a year just to the CFAers, but this is not the case. There are other people in the room who are value investors, the type spawned by Benjamin Graham and David Dodd’s thought process, and I must give them a chance, but let me share just one insight that Edwin Levy and I have been able to make that is Grahamsian in its way. I read the Value Line Investment Survey every Friday night. It is indispensable. It reviews in detail 10 years of financial history for about 1,350 companies. They are grouped by industry, so that you can regularly see how competitors are fairing against each other, and it is published in 13 week cycles, meaning every quarter each company is reviewed once. Since it goes back ten years, you get to see all those “one time events” again, and it is remarkable how very frequently “one time” misallocations of capital happen. Since, as my friend George Wyper likes to say, allocating capital is the most important decision managements make, it is even more remarkable how lightly Wall Street treats this phenomena. We don’t live in the world of do-overs; why do they? But never mind that for this moment. What I observed over fifteen years ago now was that the great majority of listed companies in the Value Line Survey don’t make any money. They have reported profits, GAAP profits, their statements are signed by accountants, and I am not alleging some Enron like scheming. I mean they don’t make any money in the way you and I use the term. Imagine we conduct a Grahamite thought experiment, we pretend we own a business together, just you and I, we lop off some zeroes from its financial statements, and we ask ourselves, “How much of the reported profits of this business could we pay ourselves, spend on completely unrelated items, like school fees, or mortgage payments, or diamond rings for girlfriends, without imperiling the business?” I admit we would sacrifice growth if we acted this way, but what I am getting at is would we have an asset to come back to if we spent the bulk of the profits over say a 3 to 5 year period? The great majority of listed companies….automakers, airlines, phone companies, cable TV concerns, most technology firms, particularly semiconductor chipmakers, railroads, mining companies, even most oil companies, need to spend all of their reported profits plus their depreciation and sometimes a bit more than that, just to stay in business and ahead of inflation. They will so rapidly lose competitive advantage if they do not spend to survive we won’t have an asset left in three or four years if we do not put up this money. Here is an even more provocative assertion. It is easy to see the difference between a cash consuming and a cash producing business. Seasoned investment professionals rarely ever get this wrong, and they do not disagree much amongst each other. This panel, which is liable to dispute anything at the drop of a hat, I predict would have an 80% plus agreement rate if we did this for all 1,350 Value Line companies. Wyper and I do in fact periodically do this, and we rarely disagree. Now keep in the back of your mind the nature of stock averages. Suppose all you brought to the investment process was the ability to tell a good business, a cash generating business, from a bad one. You knew a little something about what to pay for this, meaning you compared the cash generated by the business to the 10 year Treasury rate, and you were confident the stock would flow a lot more cash than the bond over some reasonable 5 to 10 year time frame. You tried to stick with companies with some sort of moat around the business, they were hard to compete with for some reason, and the managers understood the importance of daily digging, because this is America, and if you have got a great business people will find out about it and try to emulate you. But this is it, this is all the “investing” you do. No sweeping Weltanschauung, no secular trend plays, no wrangling over economic outlooks, no reaction to any 8:30 in the morning statistic released. None of it…..Ever. No matter what the circumstance we don’t know about that stuff. If you can imagine this, you are about exactly describing the lives of Ed Levy, Jim Lebenthal, and me. This is what we do, this is the mid-course change we made, from Keynes to Graham, and it is lucrative and fun. You can do it too. If you just exclude the chaff from the wheat, and care nothing for the short term, you can get returns significantly better, both statistically and financially, --maybe even romantically, better than the S&P or Dow Jones average. To repeat myself, you can do this too, and it is fun and lucrative. Back |