and theorists who peddle harebrained formulas or “secret”
methods for making huge and quick profits on the stock
market. There has been a spate of
How to Get Rich
Overnight
books in recent years. Seasoned financiers and
investors laugh at them—or rather, they feel only pity for
the gullible individuals who follow the “advice” contained in
such tomes. The May 1962 Wa
ll Street collapse pulled
down many of these “blinkered” speculators, so its history
should be worth examining.
In order to achieve any understanding of that collapse, it
is helpful to first quickly trace the course of the market
over the preceding 12 years. The easiest way to do this is by
following the Dow-Jones industrial average.
At the 1950 low, the Dow-Jones industrial average stood
at 161.60. It climbed to 293.79 by the end of 1952, dropped
to 255.49 in mid-1953, then climbed steadily to 521.04 in
1956, from which level it drifted down to around 420 at the
end of 1957.
From 420 in 1957, the Dow-Jones average rose to well
over 650 in 1959, made some up-and-down zigzags and hit
a late-1960 low of 566.05. From that base, it shot up to a
then all-time peak of 734
.91 on December 13, 1961.
As the market moved upward through 1961, some Wall
Street veterans dusted off the oft-quoted pre-1929 crash
saying that the stock market was discounting not only the
future, but the hereafter as well.
Many years ago, the per-share price
vs.
per-share
earnings ratio was widely—though unofficially—adopted as
a reliable rule-of-thumb indicator of stock values. “Ten
times earnings” was long considered the maximum
permissible price one could pay for a stock and still
reasonably expect to make a profit.
Then, in the late 1920s, GM-Du Pont’s John J. Raskob—
whose outlook was judged quite bullish—ventured the opin-
ion that certain stocks might be worth as much as 15 times
their per-share earnings. After the 1929 crash, ratios were,
of course, very much lower and, even as late as 1950, the
price-earnings ratios of the stocks listed in the Dow-Jones
industrial index averaged out to about 6:1.
Views on the price-earnings ratio underwent
considerable revision in recent years. Some knowledgeable
investors allowed that in a rapidly burgeoning economy,
stocks of especially healthy companies might reasonably
sell for as much as 20 times their per-share earnings. Other
professional investors argued persuasively that when
healthy companies had tangible assets with net, per-share
replacement or liquidation values in excess of per-share
prices, the importance of the price-earnings ratio would
logically dwindle.
But few seasoned investors approved such situations as
developed in 1960-1962, when fr
enzied buying drove prices
so high that some issues were selling for more than 100
times their per-share earnings. In more than a few
instances during the 1960-1962 period, staggering prices
were paid for the stocks of companies that had only
negligible assets, questionable potentials—and that hadn’t
shown much in the way of profits for a considerable time.
It has been suggested that the boom that began in 1960
was caused by people buying stocks as a hedge against
inflation. If this is true, the insane inflation of certain
common-stock prices was an extremely odd way to go about
it. But the hedge theory appears even less valid when one
remembers that buyers consistently ignored many fine
stocks that, by any standards of measurement, were
underpriced
and concentrated on certain issues,
continuing to buy them after their prices had soared out of
sight. All evidence inclines the observer to believe that the
great mass of non-professional buyers was obeying a sort of
herd instinct, following the crowd to snap up the popular
issues without much regard for facts. Many people were
doing their investment thinking—if it can properly be
called that—with their emotions rather than with their
heads. They looked for lightning-fast growth in stocks that
were already priced higher than the limits of any genuine
value levels to which they could conceivably grow in the
foreseeable future.
It is an old Wall Street saw that the stock market will
always find a reason for whatever it does—after having
done it. Innumerable theories have been advanced to
explain why the market broke on May 28, 1962. The blame
has been placed on everything from “selling waves by
foreign speculators” to the Kennedy Administration’s
reaction to the aborted steel industry price increase—in
fact, on everything but the most obvious reasons.
The factors that bring on financial panics are many and
varied. For example, in 1869, the cause was an attempted
corner on gold. In 1873 and 1907, bank failures started the
trouble. In 1929, the stock market was vastly overpriced,
and the general state of American business and the rate of
America’s economic expansion were such as to justify little
or none of the stock buying that carried prices to the
towering peaks from which they inevitably had to fall.
Despite all the efforts that ha
ve been expended to draw a
close parallel between the 1929 crash and the 1962 price
break, the two have practically nothing in common.
True, some segments of the stock market were grossly
overpriced in 1960-1962; far too many stocks were priced
far too high. But the nation’s business outlook was
generally good in 1962, and the economy was expanding at
a merry clip. There were no hidden, deep-down structural
flaws in the economy such as there had been in 1929.
There were other great differences. In 1929, stock specu-
lation was done mainly on borrowed money; shares were
purchased on the most slender of margins. Thus, when
prices collapsed, credit collapsed, too.
Then, of course, there is the most important difference of
all, the one the calamity howlers conveniently forgot. May
28, 1962, was not a crash. It was an adjustment—albeit a
somewhat violent one.
As I’ve said, some stocks were selling for more than 100
times their earnings during the height of the 1960-1962
boom. Now, it would be rather difficult for a company to
expand enough to justify stock prices that were 100 times
the company’s per-share earnings. Even assuming that
every penny of the company’s earnings were paid out in
dividends to common-stockholders, the stockholders would
still be receiving only a one-percent return on their
investment. But if all earnings were distributed in
dividends, there would be no money left for the company to
spend on expansion. That, of course, would effectively
eliminate any possibility of capital growth. Yet, even with
these glaringly self-evident truths staring them in the face,
people bought overpriced stocks.
Such were the difficult situations that developed—and
that caused the stock market to fall. Experienced investors
should have been able to read the warning signals loud and
clear long before the May 28 break took place.
As I stated previously, the Dow-Jones industrial average
shot to its all-time high of 734.91 on December 13, 1961.
The downward movement began immediately afterward
and continued through December 1961 and January 1962.
There was a brief recovery that continued until March,
when the Dow-Jones average edged up over 720, but the
graph line shows the recovery was an uncertain, faltering
one. The downward trend was resumed in March—and the
graph line from then on makes a steep descent that is
broken by only a few spasmodic upward jogs.
The May 28, 1962, price break had its beginnings in
December 1961. The downward adjustment was evidently
needed and unavoidable. That it culminated in the sharp
price plunge of May 28 was due to the emotional reaction—
verging on panic—shown by inexperienced investors who
were unable to realize that what was happening
had
to
happen and, what was worse, who understood almost
nothing of what was going on around them. To paraphrase
Abraham Lincoln,
all
stock market investors cannot fool
themselves
all
of the time. The awakening had to come—
and it did.
The anatomy of a stock market boom-and-bust such as
the country experienced in 1962 is not too difficult to
analyze. The seeds of any bust are inherent in any boom
that outstrips the pace of whatever solid factors gave it its
impetus in the first place.
An old and rather corny comedy line has it that the only
part of an automobile that cannot be made foolproof by a
safety device is the nut that holds the wheel. By much the
same token, there are no safeguards that can protect the
emotional investor from himself.
Having bid the market up irrationally, these emotional
investors became terrified and unloaded their holdings just
as irrationally. Unfortunately, an emotionally inspired sell-
ing wave snowballs and carries with it the prices of all
issues, even those that should
be going up rather than
down.
Withal, I believe it is absolutely essential for the
American public to bear in mind that:
1.
The nation’s economy was relatively sound on Friday
afternoon, May 25, 1962, when the New York Stock Ex-
change closed for the weekend.
2.
The U.S. economy was just as sound on the following
Monday morning, when the stock exchange reopened.
3.
The economy was basically no less sound when
trading ended on that hectic Monday. Few—if any—
industrial orders were canceled. Few—if any—jobs were
lost. Few—if any— business establishments were forced to
close their doors. Few —if any—investors, large or small,
were completely wiped out as so many had been in 1929.
I realize that all this is scant comfort to those who lost
money when stock prices fell on May 28. It can only be
hoped that they will profit
from the painful lesson.
The wise investor will recognize that many stocks being
offered on the market are still considerably
underpriced.
For example, there are many issues selling for as little as
one-third or even one-fourth the net, per-share liquidation
values of the issuing company’s assets. To understand what
this can mean to the stockholder, consider the case of the
Honolulu Oil Company.
A few years ago, the directors and stockholders of the
Honolulu Oil Company decided
for reasons of their own to
dissolve the company. One comp
any in which I hold a sub-
stantial interest and another oil company learned of this
decision and together signified their desire to buy Honolulu
Oil’s assets.
The stockholders of Honolulu
Oil had their choice of two
ways in which they could sell their company’s assets. First,
they could sell their stock to the two buying companies. Or,
alternatively, they could hold their stock, sell the actual
assets and distribute the proceeds among themselves before
formally dissolving their company.
Honolulu Oil’s shareholders chose the latter method.
The company’s stock was selling at around $30 per share—
but, so valuable were its tangible assets, that the price the
buying companies paid for them worked out to about $100
per share. This, of course, was the sum each Honolulu
stockholder received for each share he held when the
company was dissolved. In other words, the cash value of
Honolulu Oil’s assets was more than three times as much
as the total value of its issued stock.
Naturally, shareholders can reap this particular type of
windfall profit only when the company concerned is
dissolved. But it should be plain to see how much added
safety there is in investing in a company that has tangible
assets with a net liquidation value greater than the value
of its stock. If, as an exampl
e, the net liquidation value is
three times that of the stock, then, in effect, each dollar of
the stockholder’s investment is secured by three dollars’
worth of realizable assets.
There are more such companies than one might imagine.
They can be found in various industries, but I am most
familiar with companies in the petroleum industry and,
more particularly, with thos
e engaged in the business of
producing oil.
Several oil stocks issued by sound, thriving companies
are selling at prices well within any reasonable price-
earnings ratio limits. Some of these oil companies also have
tangible assets worth three, four and even more times the
total value of their issued stock. It might be of interest to
consider just one reason why this is so. Producing oil
companies normally carry their oil and gas leases at cost on
their balance sheets. A lease for which a company paid, say,
$25,000 is carried at that figure even though it covers a
property on which the proven crude-oil reserves in place
are, as is entirely possible, 50,000,000 barrels. On the
books, the lease is shown as an asset worth $25,000, even
though any other producing oil company would gladly pay
several million dollars to take it over. The implications of
this bit of accounting intelligence will not be lost on the
alert investor. Similar situations exist in many other
industries, and the astute investor will find them and profit
from them.
My own confidence in the stock market has not been
shaken by the May 28 price break nor by later drops. I am
still a heavy investor in common stocks. I’m still banking—
to the tune of many millions of dollars—on the healthy
climate of the American economy and the bright future of
American business.
This, in essence, is the on
ly advice and counsel a
successful, experienced investor can give to anyone who
wishes to reap the benefits of a boom and to avoid the
losses of a bust.