Appendix

John Templeton’s Advice to Investors

In addition to letters to clients of his investment firm, John Templeton wrote many words of advice to investors, as well as being quoted regularly in books and newspaper articles about his views on the art of successful investment. In this section we reproduce his best-known and most pertinent observations. Perhaps his most famous piece of advice came in the form of a series of maxims, or aphorisms, which he used in a number of different places, and which he added to on several occasions as his fame spread. This is the longest and most definitive list of these maxims that we have been able to find. It can be usefully compared to the shorter version, based on an article that appeared in a now defunct publication, the Christian Science Monitor’s World Monitor, which we used as the basis for our comments in Chapter 4.

1. For all long-term investors, there is only one objective—“maximum total real return after taxes.”

2. Achieving a good record takes much study and work, and is a lot harder than most people think.

3. It is impossible to produce a superior performance unless you do something different from the majority.

4. The time of maximum pessimism is the best time to buy, and the time of maximum optimism is the best time to sell.

5. To put “Maxim 4” in somewhat different terms, in the stock market the only way to get a bargain is to buy what most investors are selling.

6. To buy when others are despondently selling and to sell when others are greedily buying requires the greatest fortitude, even while offering the greatest reward.

7. Bear markets have always been temporary. Share prices turn upward from one to twelve months before the bottom of the business cycle.

8. If a particular industry or type of security becomes popular with investors, that popularity will always prove temporary and, when lost, won’t return for many years.

9. In the long run, the stock market indexes fluctuate around the long-term upward trend of earnings per share.

10. In free-enterprise nations, the earnings on stock market indexes fluctuate around the replacement book value of the shares of the index.

11. If you buy the same securities as other people, you will have the same results as other people.

12. The time to buy a stock is when the short-term owners have finished their selling, and the time to sell a stock is often when short-term owners have finished their buying.

13. Share prices fluctuate much more widely than values. Therefore, index funds will never produce the best total return performance.

14. Too many investors focus on “outlook” and “trend.” Therefore, more profit is made by focusing on value.

15. If you search worldwide, you will find more bargains and better bargains than by studying only one nation. Also, you gain the safety of diversification.

16. The fluctuation of share prices is roughly proportional to the square root of the price.

17. The time to sell an asset is when you have found a much better bargain to replace it.

18. When any method for selecting stocks becomes popular, then switch to unpopular methods. As has been suggested in “Maxim 3,” too many investors can spoil any share-selection method or any market-timing formula.

19. Never adopt permanently any type of asset or any selection method. Try to stay flexible, open-minded, and skeptical. Long-term top results are achieved only by changing from popular to unpopular the types of securities you favor and your methods of selection.

20. The skill factor in selection is largest for the common-stock part of your investments.

21. The best performance is produced by a person, not a committee.

22. If you begin with prayer, you can think more clearly and make fewer stupid mistakes.

Source: William Proctor, The Templeton Prizes, 118–120. Reproduced with permission.

Templeton’s Letters to His Clients

The archive of letters that Sir John Templeton sent to clients of his investment counsel firm Templeton, Dobbrow & Vance between 1940 and 1962 provides a rich source of material for students of investment. A number of these have been reproduced in full in Chapter 2. Here we reproduce a further small sample from the archive, grouped into a number of sections. They contain some fascinating insights into how his thinking about investment developed in the aftermath of World War II. This was a period during which the American economy grew strongly against a background of continued international tension. The postwar period was punctuated by periodic crises—most notably, the Berlin airlift crisis of 1948, the Korean War in 1951, Suez and the Hungarian uprising in 1956, and the Cuban missile crisis of 1962.

In the world of investment, two features of note that emerged toward the end of the period were (1) the first signs of inflation as an endemic feature of economic life in developing countries; and (2) the reversal of the traditional relationship between the valuations accorded by investors to equities and bonds. Historically equities had always yielded more than bonds, but since 1957 that relationship has reversed, creating the so-called reverse yield gap. Until the 1960s individuals remained the most important source of investment demand in the stock market. It was not until the late 1960s that mutual funds began to grow rapidly, eventually becoming the medium of choice by which private investors participated directly in the investment markets. The three decades since the 1980s have also seen a dramatic increase in institutional investment, with a corresponding decline in the amount of stocks and shares held directly by investors, rather than through funds.

Stock Markets

What follows are some examples of the letters that John Templeton sent to clients of his investment counseling firm discussing the level of the stock market and its implications for their portfolios. The message in each of them runs on broadly similar lines: This is where the market is trading, this is how that compares to the “normal” level, as calculated by the firm, with reference to historic earnings and replacement cost of assets, and this is what it means for the client. They invariably mention the advantage that comes from having cash in reserve to take advantage of those occasions when the market does fall below its normal level; and the benefits of reducing the equity exposure when the market has risen above that level. This contrarian approach was the essence of the Yale method. The efficacy of the method depended a good deal, of course, on the skill and accuracy with which Templeton and his colleagues were able to calculate the value of normal.

February 9, 1948: Ratio of Stock Yields to Bond Yields

In selecting a stock for purchase, the dividend rate receives more attention than any other one fact, especially among nonprofessional investors. The high cost of living has caused more and more people to seek stocks that pay high dividend rates.

Therefore, it is interesting to know that more than 100 listed stocks are now available, paying better than 10 percent return. Table I lists 112 stocks, each of which paid dividends in 1947 as great as 10 percent of the January 7, 1948, market price of the shares. All of these stocks are listed on the N.Y. Stock Exchange or the N.Y. Curb. There are now, of course, many nonlisted stocks with yields equally as high as those in this table and also many listed stocks which would qualify for inclusion in the table if the market price declined only fractionally.

The abundance of high yielding stocks results in part from the decline in stock prices in the last 19 months and in part from the increased dividends and extra dividends declared in the last few months. The average yield on the 65 stocks used in the Dow Jones Averages is now 5.36 percent. By comparison, the yield on the 40 bonds used in the Dow Jones Average is 3.79 percent. The stocks yield 41 percent more than the bonds. This is unusual. The past history on this subject can be studied in Table II, which shows the ratio between stock yields and bond yields for each year from 1871 to 1946. For the years prior to 1939, the source of this data is “Common Stock Indexes” by Alfred Cowles III and Associates; and for later years the figures in the table are the yields at the end of the year from the Dow-Jones Index of 40 bonds and the Index of 65 stocks. In only two of the 76 years covered by this Table were stock yields so great in comparison to bond yields as they are now.

To some extent the stocks whose dividend payments are high in relation to market price are concentrated in nine industries: 1. Amusements; 2. Automobiles, Trucks and Parts; 3. Food and Beverage; 4. Merchandising; 5. Mining and Metals; 6. Railroad and Railroad Equipment; 7. Sugar; 8. Textiles and Apparel; and 9. Utilities. This grouping is shown in Table 1 (not shown). However the scattering is wide enough that it would be easy to make up a well diversified portfolio consisting solely of stocks yielding over 10 percent.

Table 1 Index of Earnings of Corporations in the United States

This list of stocks, yielding 10 percent or more, is presented as an interesting curiosity—a peculiar phenomenon of the times. It is not presented as a means for selecting stocks for purchase. Probably the long-range overall results would be better, if stocks were selected at random rather than from this list. As a general rule it can be taken for granted that a stock will net sell as low as 10 times dividends if security analysts and persons close to the company expect the dividend rate to be long maintained.

The dividend rate is only one of a multitude of factors that should be studied when selecting a stock for purchase. All other factors being equal, for the investor with a low income tax bracket, it is better to buy the stock paying the higher dividend; but seldom ever can it be said that other factors are equal. Because stockholders are conscious of the dividend rate more than other facts, this element is often overemphasized. To be successful in the management of securities, it is necessary to buy the stocks that are oversold and to sell stocks that are overbought. Stocks with a high dividend rate are seldom oversold. Real bargains, from a long-term viewpoint, are found more often among stocks which have paid little or nothing in dividends for several years.

September 21, 1948: The Best Thing That Could Happen

The stock market went down yesterday. My friends in Wall Street are sad. I can understand their emotions; but it only illustrates again the fact that more and more investors should adopt and adhere to the long-range non-forecasting programs used by the clients of Templeton, Dobbrow & Vance, Inc. These programs are designed to profit from stock market cycles without the need for predicting such cycles.

For an investor following a program of this nature, as we have said before, the best thing which could happen is to have the stock market go down from today’s level of 177 to 128 before the next long bull market begins. An investor following an “average program” has 70 percent in common stocks today that will participate in the capital gains during the next bull market. However, if the market declines to 128 before the bull market begins, such an investor will have 100 percent in stocks with which to participate in future capital gains. In other words, if a bull market begins now the investor will make a large profit; but if the market first declines to 128 before the bull market begins he will make an extra $19,000 approximately on each $100,000 involved in the program.

If the market continues to decline the long-range programs will call for purchasing more stocks at successively low levels. Of course, if there were any way to know for sure that the stock market would decline to 128 we would wait until then to make any purchases. In fact, we would go further than that and sell out the stocks now held in order to repurchase at the bottom. But the fact is that no one can possibly know for sure what the stock market will do. It is also possible that a long bull market may start immediately. If there were any way to know this for certain, we should immediately buy common stocks on margin at once. Here again, no one can possible by sure what the stock market will do. The prudent and conservative policy is to follow a long-range program designed to profit from stock market cycles without the need for predicting either the timing or extent of such cycles.

Because the stock market declined yesterday and is now 9 percent below its level three months ago, investors generally are unhappy. Even for those investors who have not yet adopted a long-range program this emotion is illogical, if such investors are still in the stage of accumulating their wealth. Low market prices work to the advantage of an investor who makes it a practice to reinvest dividends or an investor who makes annual savings from his business or salary. For more than two years stock prices have been remarkably low in relation to earnings. In fact, today stock prices are lower in relation to earnings than in any peace-time year as far back as records are available. This means simply that a person with new money to invest can obtain unusual bargains. He can buy shares in some of America’s largest and soundest enterprises for less than five times the current rate of earnings. If the current rate of earnings is maintained, the net worth of his shares plus the dividends received will cause the value of his investment to double in less than five years. Even if future earnings were only one-half of current earnings, his purchases would still represent attractive bargains.

This memorandum is not written merely to point out the silver lining of a cloud. It is intended as a part of the long educational program to persuade more and more investors to adopt sound and long-range investment programs.

August, 1953: Lower Prices Expected

The Dow Jones Average of Industrial Stock Prices is now 271. We expect and hope that this average will decline below 190.

Most of our investment counsel clients follow long-range programs of the non-forecasting type. The program of each client is designed to fit his own needs and wishes. A typical program would call for having 60 percent in common stocks when stock prices are normal and 100 percent in common stocks when stock prices are very low. The change from 60 percent stocks to 100 percent stocks is made progressively, step by step, each time the general level of prices declines another 10 percent. The increased proportion of common stocks purchased at these successively lower levels is then held until stock prices eventually return to normal. When that happens, the proportion of stocks is reduced back to 60 percent, which means automatically that profits are taken and the fund is larger at the end of the cycle than at the beginning.

Our economic and financial studies now indicate that the normal level for industrial stock prices during the next 10 years may be between 289 and 303 on the Dow Jones Average. When prices decline 10 percent below normal, which means about 260, the typical program mentioned above calls for increasing common stocks to 70 percent. It calls for increasing to 80 percent in stocks at 234, 90 percent at 211, and 100 percent at 190 on the Dow Jones Industrial Average.

That is why we hope that the market will decline to 190. Only in that way will this typical client have an opportunity to use all of the reserve funds he is holding for the purpose of purchasing common stocks at bargain prices.

Of course, when preparing the program, it would be possible and reasonable, to schedule the purchases more closely together and thereby use up the reserve fund before the market declined as low as 190. Every client has a different program—a program designed to fit his own needs and wishes. Some clients have more stocks than others. Some are never completely in stocks and never completely out of stocks. Without changing the basic method the variations are infinite.

The reason why the particular program mentioned is not designed to use all of the reserve fund until the market is below 190 is the fact that it seems reasonable to expect that prices might go that low during the next bear market. This would be only 34 percent below normal and only 30 percent below today’s prices. The history of stock market cycles during the last 50 years teaches us that we ought to expect prices to decline more than 30 percent below normal once or twice in every decade.

In the next memo John Templeton expands on a theme that was to become a leitmotif of his approach to stock picking over the years. He notes that institutional investors are starting to buy blue chip stocks, driving up their valuations to heady levels, with price earnings ratios above 20 in many cases. These are price entry levels, he notes, at which investors are unlikely to be well rewarded over time. Bargain hunters will be better served looking at stocks selling for less than 10 times earnings.

December, 1953: Today’s Premium Prices for Those Stocks Favored by Trustees

Some stocks are more stable in price than others. Stocks that have had a long record of stability in prices, earnings and dividends are referred to as high-quality stocks. These are usually the shares of large and famous companies operating in industries of a non-cyclical nature.

Between October 17, 1951 and December 2, 1953, there has been a remarkable divergence in the price trends of high-quality stocks compared with the general list of stocks. This is unusual, and deserves careful study. In the long run, shares of small and young companies and shares of obscure companies have fared as well as, and perhaps better than, top-quality stocks. Accordingly, the rising prices for high-quality stocks coincident with declining prices for other stocks generally in the last 25 months is noteworthy.

To be specific, Standard & Poor’s Index of High-Grade Stocks increased 14.3 percent, whereas Standard & Poor’s Index of Low-Priced Stocks decreased 33.1 percent during the period referred to above. The Dow-Jones Index of 30 industrial stocks, which are mostly high-grade stocks of large corporations, increased 3.5 percent, whereas the general level of all stocks on the New York Stock Exchange decreased 11.4 percent. For the purpose of sampling how much the general list of stocks declined, we have studied the record of the first 100 common stocks chosen alphabetically which are listed on the exchange. This list, which naturally includes some high quality, some medium quality, and some low quality stocks, is attached to this memorandum and is well worth reading. It shows that in this short space of time there have been wide variations with increases ranging as high as 52 percent and declines as great as 63 percent. Thirty of these stocks increased, whereas 70 decreased in price.

This period of about 25 months has been unusual, and perhaps unique in the history of American stock prices. The Dow Jones Industrial Stock Average has fared 14.9 percent better than a general list of 100 stocks chosen alphabetically. The Index of High-Grade Stocks has fared better than the Index of Low-Priced Stocks by a full 48 percent.

By examining the causes for this divergence, we may find clues as to how long the divergence might continue. One cause has been the institutionalization of investments and another cause has been the widespread expectation of a recession in general business.

By institutionalization we mean that a larger than usual proportion of the total new money available for investment is coming in through insurance companies, trust funds, pension funds, profit sharing funds, mutual investment funds, and various other institutions.

One of the earliest influences of this nature was the large accumulation of investment funds in the hands of life insurance companies, banks and similar institutions. Until recent years such funds were invested only in mortgages, bands and preferred stocks. Therefore the funds available for the purchase of bonds have been large, while at the same time the funds from other sources available for common stacks have been small. This situation has been one of the causes for the change in the ratio between bond yields and common stock yields. The excellent studies of the Cowles Commission indicate that in the 68 years from 1870 to 1938 the yields of common stocks averaged 5.0 percent, whereas the average return was 4.2 percent on high-grade bonds and 4.6 percent on prime commercial paper for this same period. Now high-grade bonds yield 3.1 percent and common stocks 6.0 percent. The ratio of stock yields to bond yields has increased from 119 percent for the 68 years ending with 1938 to 193 percent at present. In fact, during these latest 15 years common stock yields have been very frequently more than twice as high as the yields on high-grade bonds.

In recent years an ever-increasing amount of institutional money has become available for the purchase of common stocks. Life insurance companies have been granted permission to invest part of their assets in common stocks. More recently the same permission has been granted to savings banks. At long last the laws of New York have been changed to permit trust funds (where the trust agreement is silent on the subject of investment media) to be invested partly in common stocks; and many other states have followed suit. Mutual investment funds, sometimes called investment trusts, have been investing in common stocks for more than 30 years but the quantity of money coming in through this source is now vastly greater. Colleges and other public endowment funds are shifting gradually into a higher proportion of common stocks.

Perhaps the greatest influence is the rapid rise of pension funds and profit sharing funds in the last two years. Over a billion dollars a year is now flowing into these funds and the rate is increasing. Only a part of such funds is used to buy common stocks but still the total for this purpose is great.

The men who manage these institutional funds are naturally cautious. When selecting common stocks, practically all of the funds flow into a small list of high-grade stocks of large and famous corporations. This has been the outstanding influence on stock prices recently. Because the supply of this kind of stocks is limited, the prices have been bid up at the very time when the prices of medium grade and risky stocks have shown a declining trend.

The divergence in trends for the different classes of stocks has been augmented, especially during the last two years, by the fear of a general business recession. The opinion has been widespread among investment analysts that a mild depression would begin soon; and some have thought that it would be more than mild. Therefore these security analysts and many of the larger investors whom they influence have been shifting funds into the shares of companies whose earnings are expected to be stable and out of the shares of companies whose earnings might suffer temporarily during a general business recession. To a considerable extent a recession has already been discounted in the stock market. Shares of many small companies and companies operating in cyclical industries are now selling at prices which are low not only in relation to prosperity earnings but also in relation to the average earnings which may be expected during the next full business cycle.

The fear of a business depression has endured for a long while; but by its nature this influence can be regarded as temporary. If the expected recession does not occur, the fear may decrease; and if it does occur investors are likely then to look ahead in anticipation of recovery. It is the nature of humanity that general fears and anticipations are constantly changing. On the other hand, there is no end in sight for the trend toward greater institutionalization of investments. Not only will the investments already made through institutions remain, but also there is likely to be a great increase especially in the field of profit-sharing funds and pension funds.

It has always been normal for stocks with a long record of stable earnings to sell higher in relation to earnings than is the case with the general, run of stocks. The relation between price and earnings is called the price-earnings ratio; and this is one of the most important elements in the study of stocks. The price-earnings ratio for high-grade stocks is normally higher than the price-earnings ratio for low grade stocks. Because of the factors discussed above, this spread is greater now than formerly. Because the trend toward institutionalization will continue, the spread may continue to be unusually wide by past standards.

The question of whether the spread will remain wide is important for investors; but even more important is the question of whether the spread will grow still wider. A high grade stock like Union Carbide is now selling for as little more than 20 times average earnings for the last five years whereas a medium grade stock like U.S. Plywood is now selling for less than seven times average earnings for those years. Some low grade stocks are selling for only three times earnings. Will this disparity increase? In some ways a divergence like this tends to be self-correcting. Naturally there is some limit to how great the disparity can get.

The limited quantity of top-grade stocks may encourage even trustees gradually to leak further afield. Furthermore, those who do not have the position of trustees, when they see the great disparity now existing, may begin to sell their top grade stocks to the trustees and use the proceeds for buying better bargains and better yields among medium grade stocks. It is enlightening to notice that the disparity showed up first in the difference between bond yields and stock yields. After a while this led to a general trend for institutions and trustees to include a few high-grade common stocks in their investment funds rather than only bonds. It is natural and proper for men acting as fiduciaries to be cautious; and so far they have been willing to purchase only top-grade common stocks. However, there may well develop a gradual trend toward seeking much greater values and greater yields than can be found among most top grade stocks.

Another situation that deserves close study is the fact that certain stocks previously regarded as medium grade may gradually come to be regarded as top grade. For example, in the 10 years from 1935 to 1944 Minnesota Mining was regarded as medium grade and the price earnings ratio averaged only 11. Now this stock is regarded by many as top grade and its price is over 23 times the highest earnings ever reported. To use Wall Street slang, there are a good many red chips now that may become blue chips within a few years.

Of course, under certain circumstances the prices of low-grade stocks increase much faster than the prices of high grade stocks, sometimes many times as fast. For example, Norfolk & Western, which was regarded as a top grade stock in 1941, sold as low as 44⅞; in that year and is now available at 40⅞; whereas the price of St. Louis-Southwestern, a low grade stock, increased from 1½ at that time to 222 at present. The price of Missouri Pacific Preferred, another low-grade stock, increased from ⅛ to 40⅜. Conditions which lead to the popularity of low-grade stocks will occur again sometime; but this does not appear probable in the next few years.

Finally, it is worth noting that a really long-term investor will fare better if he selects stocks with low price earnings ratios, if all other factors are equal. For example, a stock purchased now for 20 times average future earnings will accumulate during the next 10 years $500 for the benefit of the other (either in the form of dividends or increased net worth) for each $1,000 invested; whereas a stock purchased now at seven times future average earnings will accumulate in the next ten years $1,429 for the benefit of the owner. If you pay 20 times earnings for the shares of a company with a steady earning power, you may actually be taking more risk than if you pay only seven times earnings for the shares of a company whose earning power is subject to fluctuations. To get the maximum combination of safety, income, and capital growth, investors should seek to buy stocks at low prices in relation to normal earning power.

It is normal for high-grade stocks to sell for higher prices in relation to earnings than medium grade stocks. The disparity has increased remarkably in the last 25 months. The unusually wide disparity may continue because most new money is flowing into stocks by way of institutions. For several reasons the disparity is self-limiting. Investors should favor good quality stocks; but those investors who are not trustees should be willing to pay only a fair and not an excessive premium for good quality stocks. Best results in the long run are likely to come from searching out stocks of improving quality and stocks that are real bargains.

The next memo can perhaps stand as the definitive illustration of the approach which John Templeton was taking to analysing the level of the stock market during his years as an investment counsel. The contrast between his analysis at two different dates (1950 and 1955) brings out clearly the different factors that contributed to his overall assessment. Note also the emphatic use of data to support and add weight to his arguments.

August, 1955

Templeton, Dobbrow & Vance Inc

Five years ago I wrote and published in the August 10, 1950 issue of the Commercial & Financial Chronicle an article stating five lines of thought leading to the conclusion that stock prices were then too low. Now it is interesting to bring up-to-date each of these five lines of thought which may help us to understand just how high stock prices are now. In the left column below you will find the 1950 article in its entirety; and in the right column facts and comments about the situation today. The comparison may help toward clear-thinking, despite the rosy glow which now pervades Wall Street and Main Street both.

“How High is the Stock Market”—1950	“How High is the Stock Market”—1955
The stock market is now dominated by the international situation. In the first 18 days after the invasion of South Korea industrial stock prices declined 13.5%. Some people think that this was only the beginning of a greater downward trend caused by the prospect of excess profits taxes and price controls. Others think that this was only a temporary reaction in a long upward trend caused in part by inflation. Some light may be shed on this subject by studying the question of whether stock prices today are high in relation to intrinsic value or low.	The stock market is now dominated by talk of a new era. The pessimism and fear caused by the great depression and by the war, which had an almost continuous influence on the minds of investors and businessmen for 20 years, have evaporated at last. One of the Washington news-letters states: “The most surprising thing our survey turned up, however, was a great unanimity of opinion. ‘Bears’ were very conspicuous by their absence. . . Even the doubters think 1956 will top or match 1955”. This, itself, is a warning signal. Further good news could not cause many more people to become bullish, because so many are bullish already. Conversely, however, any bad news causing a few of the many bulls to change their minds could increase considerably the number of bears.
Historically the market is in high ground. In May and June, 1950, the Dow-Jones Industrial Average was the highest in almost 20 years. Even now the DJIA is about 208, whereas the average level of the last 30 years was only 143. On the other hand, the prices of secondary stocks are much lower. Standard and Poor’s index of Low-Priced Stocks reached a peak of 315 in the first week of February, 1946, and this index is now only 151.	Stock prices are far higher now than ever before. The Dow-Jones Industrial Average is about 460, whereas the average level of the last 30 years was only 174. Standard and Poor’s broad average of 420 industrial stocks is now 86% higher than the 1929 peak.
In relation to earnings, stock prices are low. A record of earnings for 79 years is shown in Table 1. From this table it is easy to compute that the average earnings for the last 30 years were $7.48; but current earnings are $19.90. In other words, earnings are 166% higher than the average of the last 30 years. Therefore, it is not surprising to find that industrial stock prices are 45% higher than the average of the last 30 years. In fact, if stocks should sell now as high in relation to current earnings as has been normal for the last 30 years, then the DJIA would be 388.	In relation to earnings, stock prices are now very high. It now appears that earnings for this year will be just about 15% more than they were in the year 1950. Meanwhile, the Dow-Jones Industrial Average has risen from 208 to 460, which is a rise of 121%. The figure of 388 for stock prices mentioned 5 years ago looked very high indeed at that time; but now stock prices have not only reached, but exceeded this figure by 19%.
Next let us consider the subject of dividends. The average yield from dividends on industrial stocks has been 4.90% for the last 30 years; but the average yield today is 6.69%. At current dividends rates, stocks would yield 4.90%, the average of the last 30 years, if the DJIA were 283.	In relation to dividends, also, stock prices are now very high. The average yields from dividends on industrial stocks has been 5.00% for the last 30 years; but the average yield today is 3.63% on Standard and Poor’s Average. At current dividend rates, stocks would yield 5.00%, which is the average of the last 30 years, if the DJIA were 388.
Of course, there is a general opinion today that current earnings (and dividends) are abnormal. In fact, there are some people in Washington who say that current earnings of corporations are excessive. This is not a fair statement. It would be just as reasonable to say that current wage rates are excessive. Average earnings of factory workers have risen from a minimum $15.96 weekly 18 years ago to the current rate of $57.50 weekly, which is an increase of 260%. The increase in earning of corporations has been roughly the same as the increase in Gross National Product of the United States. Before 1941 Gross National Product had never exceeded $107 billion, but the current rate is $263 billion. Gross National Product is 117% higher than the average of the last 30 years; and a decline of only 18% would bring corporation profits down to the same percentage of Gross National Product as has been normal for the last 30 years.	Gross National Product is now estimated at an annual rate of $380 billion. This is 130% higher than the 30 year average. In other words, stock prices are now 164% above the 30 year average, whereas Gross National Product is only up 130%. This means that stock prices are abnormally high; because for several good reasons the long-term upward trend in stock prices has been normally less strong than the trend of Gross National Product.
Changes in Gross National Product are roughly proportional to the change in the sales volume of corporations. Accordingly, it appears that profits of corporations are only a little larger in relation to sales volume than has been normal for the last 30 years. It appears unlikely that Gross National Product will be any smaller five or ten years from now than it is today; and, accordingly, there probably will be no decline in the total sales volume of corporations. It is not possible to have a decrease in Gross National Product unless there is a decrease in employment or a decrease in the output per man hour or a decrease in the price level. Actually, it appears probable that all three of these factors will increase rather than decrease. Output per man hour will increase with increasing use of machinery. Total employment will probably increase because of the growth of population. The expense of military preparation points toward an increase in the price level.	The prospect for further increases in Gross National Product discussed in this article five years ago was largely ignored by investors at that time. Now the glorious and ever-expanding future for American corporations is a favorite subject for speakers and writers. This growth is not a new factor in the investment equation; it has been going on for more than a century. Because of this growth it has been normal for industrial stock prices to increase at an average rate of 3.20% annually compounded. If stock prices had risen only this much, we would not say that they were too high. But it is prudent to note that, taking the last 30 years as a base, this rate of growth would indicate that the Dow-Jones Industrial Average should now be 280 rather than 465. Again taking the last 30 years as a base and a normal increase in stock prices of 3.20% per year, we compute that 465 on the DJIA might be considered normal in 1971, but not in 1955. In other words, present stock prices may be discounting the future a long way ahead.
Since the invasion of South Korea, investors have been worried about a possible reduction in corporation earnings caused by price controls and excess profits taxes. It appears that these factors will cause some reduction; but also it is interesting to notice that during the years when excess profits taxes applied, from 1940 through 1945, the average annual earnings of corporations were 5% greater than the average annual earnings of the four years 1936 through 1939, which were taken as the base period. Also, investors have been fearful concerning increased government controls and the trend toward socialization. These too are serious problems; but it is interesting to notice that stock prices in European countries are considerably higher than they were 12 years ago even though these nations have travelled much further than the United States on the road to socialization.
The change in the level of stock prices can be compared with the change in the volume of liquid assets held by individuals. Unfortunately, statistics on the amount of liquid assets are not available for the earlier years; but 11 years ago, in 1939, the liquid assets of individuals were only $50 billion, whereas today they are $177 billion, an increase of 254%. By comparison, the increase of 48% in stock prices from 1939 up to today appears small.	There is no longer a surplus of liquid assets in the hands of individuals. In the 5 years from 1950 to 1955, stock prices increased 121%, whereas liquid assets held by individuals increased only 18%.
Another way to approach the question, “how high is the stock market”, is to study the value of the assets back of these stock. Corporations pay out in dividends only a part of the earnings and the other part which is retained adds to the assets per share and increases the normal future earning power. This has caused the average net worth per share stated on the books of corporations to increase 76% in the last 15 years. The present book value per share is 46% higher than the average of the last 24 years. Furthermore, because of the inflation which has occurred in the cost of buildings and machinery, the assets could not be replaced for the figures shown on the corporations’ books. Based on earnings retained in excess of dividends and modified to allow for changes in the purchasing power of the dollar, the Templeton, Dobbrow and Vance index of replacement costs is given in Table 2. The average for the index of replacement costs for the last 28 years was 161.6, whereas the current replacement cost is 282.3, a difference of 75%. Since replacement costs are 75% higher, it is not surprising that stock prices should be 45% higher as stated above.	Share prices are much higher now than usual in relation to the average net worth per share stated on the books of corporations. Table 2 shows that the Templeton, Dobbrow and Vance index of replacement costs averaged 197 for the latest 30 years whereas the current replacement cost is 365, a difference of 85%. This might justify a rise in stock prices of 85%; But stock prices have risen 164%.
Industrial stock prices were first publicly quoted in 1871, and since that time there has been a long-term upward trend in stock prices. In the 10 years before the First World War, 1905–1914 inclusive, they averaged 85.3, an increase of 84%. Since the Second World War cost the United States above five times as much as the First World War, it could be logically argued that it should have caused an increase in the range of fluctuation of more than 84%. However, in the 10 years before World War II the average level of the market was 131 (in terms if the DJIA); and it is only 59% higher now.	As stated five years ago, it seemed reasonable that the Second World War would cause an increase of at least 84% in the range of fluctuation for stock prices as compared with prewar. Five years ago, stock prices were only 59% above prewar, whereas now stock prices are 251% above.
Although the stock market is in high ground historically, the figures quoted above indicate that current stock prices are still below normal in relation to a) earnings, (b) dividends, (c) national income, (d) liquid savings of individuals and (e) the relatively permanent changes which have been caused in stock prices in the United States and also in other nations by previous great wars.	The conclusion of this study is totally different now from what it was five years ago. Not only are stock prices far higher than ever before; but also, stock prices are now (a) earnings, (b) dividends, (c) national income, (d) liquid savings of individuals and (e) previous changes in stock prices caused by wars. No one can say that the risk in buying or holding common stocks today is greater than at any time in the last 18 years.

Table 2 Templeton, Dubbrow and Vance Index of Replacement Costs for Common Stocks

Global Investing

If John Templeton is known for any one thing, it is as the man who persuaded the American public that it was both safe and profitable to invest outside their own borders. Today, when global stock markets have become a reality, it is easy to forget how difficult it was to change the parochial mind-set of the ordinary investor. At the time, however, it must have seemed like an uphill challenge. In 1954 Templeton set up the Templeton Growth Fund, which was to become one of the first diversified global stock investment funds of any note.

For tax reasons, the new fund was domiciled in Canada, but could be bought by investors in the United States. A number of other companies launched Canadian-based funds at the same time in an attempt to take advantage of a recent favorable tax ruling in the United States. The same year, he sent a note to his clients explaining why Canadian stocks were attractive at current prices. Perhaps he also calculated that if investors were not prepared to invest just across the border in North America, it was unlikely that they would be willing to do so anywhere else! This is the first recorded example we can find of Sir John recommending overseas stocks to his clients.

The Quantity of Good Canadian Stocks

Several investment trusts are now being formed by Americans who wish to invest in Canada. These trusts plan to pay no dividends; and therefore the American owners will have no income tax on the accumulation of dividend income and capital gains. Knowledge of the advantages of such investments is reaching more men of wealth; and the demand for shares of these new trusts is increasing. In fact, this appears to be the beginning of a new trend that may continue to develop for several years.

The question has been raised concerning the effect of this trend on the prices of Canadian stocks. The purpose of this memorandum is to provide some information on that subject. If all of the Canadian trusts now being discussed are eventually formed, it appears that something in the neighborhood of $100 million will become available for investment in Canadian stocks. Of course, this is a large sum of money; but it may have little effect on prices at present, because the quantity of good stocks available in Canada is so great.

For example, Aluminium Ltd. alone now has over $500 million worth of common stocks outstanding. Imperial Oil shares have a quoted market of almost $1 billion. International Nickel has over $600 million of stock outstanding, not including the preferred. There are many others. A list is attached to this memorandum that shows 25 stocks of Canadian companies, each of which has a market value of over $100 million.

The amount of cash that may become available through these new investment trusts [in the neighborhood of $100 million] is less than 1/2 of 1 percent of the Gross National Product of Canada, which was over $22 billion last year. Also, it is interesting to compare this new form of investment with the other forms of investment by Americans and other foreigners in Canada in previous years. For example, we estimate that in the year 1953 the inflow of long-term direct investment was about $385 million and new foreign portfolio investment was about $322 million.

Canada needs this new investment. Canada’s current trade transactions with the United States last year established a deficit of $984 million. This deficit was offset in part by the investments of Americans in Canada, as mentioned above. It is normal for young, growing nations to have a continual large inflow of capital for investment.

It is interesting to notice that the inflow of investments has not caused Canadian stocks to sell too high in relation to American stocks. Attached to this memorandum is a chart [not shown] that shows an index of Canadian industrial stock prices compared with American stock prices for the latest five years. This shows actually that in relation to American stock prices Canadian prices are now lower than usual.

In young and growing nations it is customary for corporations to distribute in dividends only a small share of the earnings. However, the attached tabulation shows [not shown] that the 25 Canadian stocks listed now have an average dividend yield of 4.15 percent, which compares with a yield of 4.81 percent now on the Dow Jones Industrial Index of American Stock Prices.

Mr. Murray Shields, talking before the American Management Association last month, made the following interesting comment about Canada: “There is reason for confidence that the quarter century from 1952 to 1977 will bring an expansion in Canadian population from 14 to, roughly, 28 million and an increase in production from $1,595 to $3,000 per capita, which would lift the total production of goods and services from $23 billion to $83 billion in 1952 Canadian dollars.” Of course, in 1977 dollars this estimate would be even greater.

Canada encourages investors; and political conditions will probably continue to be favorable in Canada. For the eighth consecutive year, Canada has had a surplus in the national budget. This has helped Canada to reduce its national debt from 113 percent of Gross National Product in 1946 to 46 percent of Gross National Product on March 31, 1954.

In the mid-1950s Sir John Templeton made a long trip to Europe, during which he visited 10 countries. He reported back on his impressions to his clients. His letters make fascinating reading today, not least because one can measure the accuracy of his impressions with the benefit of hindsight. They provide a powerful insight into the way he thought about the global investment scene. Note in particular his ability to marry specific examples to general observations and the clarity of the thinking and expression. Knowledge about what was happening in Europe would have been low. More examples can be found in the Templeton memos page of the Independent Investor web site.

At the time these letters were written, the European Union was still a gleam in the eye of a small group of politicians and bureaucrats. They dreamed of unifying Europe, partly in the belief that this would be economically advantageous, but primarily as a means of preventing a further outbreak of war. Two World Wars had devastated the continent of Europe, leaving many cities in a state of complete ruin. Every country faced the challenge of economic and political regeneration. As an investor, comparing the valuations of European and U.S. stocks, and sensing the growth potential, Templeton could see that this was likely to create attractive investment opportunities.

Observations from the Viewpoint of an Investor (Letter to Clients, May 1955)

Spain

The lion’s share of the good investment opportunities are found in the United States. Therefore, American investors tend to be nearsighted and insular. Such narrowness of vision can be dangerous. I do not mean that Americans should put much money into foreign shares. There are many good reasons for preferring U.S. shares. I mean only that good judgment is the foundation of investment success; and the risk of error is reduced if the investors’ judgment is not based narrowly on knowledge of investment comparisons, present and past, in the United States alone.

The future for investors in the United States may be just a repetition of the past, but also it may not be. My visit to the tomb of Columbus in Seville reminds us that Spain once flourished as the economic and financial capital of the world. It is not so now. The national income of Spain is less than one-fortieth the national income of the United States.

It is thought-provoking to notice that, from the 1948 average, share prices in Spain are up only 5 percent, whereas in the United States they are up 138 percent. This is all the more curious, in view of the fact that Spanish national income is up 136 percent, which compares with an increase of only 37 percent in the United States.

Because a terrible drought in 1953 ruined the wheat crop and olive crop, and because a severe freeze in 1954 greatly reduced citrus production, which is Spain’s chief source of foreign exchange, the nation has been subject to strong inflationary pressure. The inflation led to a nationwide increase in salaries and wages during the 1953–1954 winter, ranging from 30 percent to as high as 45 percent in some sectors, if social benefits for workers are included.

The common people of Spain are poor but gay. The church is very strong; and political conditions appear stable. Stock trading is active, especially through the facilities of the large banks. Shares of 78 established corporations are traded on the exchange in Madrid. There are also stock exchanges in Bilbao and Barcelona. Some of the favorites with investors are as follows:

Name	Business	Yield
Banco Hispano Americano	Branch Banking	2.15%
Hidroelectrica Iberia	Electricity	4.15%
Sevillana Electricidad	Electricity	5.13%
Ebro Azucarera y Alcoholes	Sugar	3.61%
Tabacalera	Tobacco	4.01%
Espanolo de Petroleos	Oil	2.17%
Altos Hornos de Vizcaya	Steel	4.25%
Telefonica	Telephone	3.02%

The yield on these stocks is less than the average U.S. stock yield. However, government bonds in Spain yield about 3.90 versus 2.80 percent in the United States. This is the first of several brief and private summaries I plan to write after talks with bankers, investors, and corporation executives in various countries in Europe.

Observations from the Viewpoint of an Investor (Letter to Clients, June 1955)

Italy

Italy is still poor. The national income averages only moderately over $300 a year per capita, whereas in Switzerland it is $1,000 and in the United States about $1,900. The average wage is approximately $2 a day; but the employer must pay about 30 percent more to the government for pensions and other workers’ benefits.

Even so, the present per capita income is the highest in the history of Italy. It is estimated that the standard of living is one-third better than pre-war. The rate for foreign exchange has remained steady for six years at 625 lira for one dollar. Taking 1948 as a base, industrial production has increased 76 percent. The cost of living is up only 21 percent. Most interesting of all, the average price of common shares is up 158 percent, which is greater than the rise of share prices in the United States.

In most European countries, information about corporations is both scarce and unreliable. The quantity of information available to investors in Europe is only a very small fraction of that available in America on U.S. stocks. This lack is especially obvious in Italy. Even the chief of the stock market department of a large bank often knows only the dividends and not the earnings of even the most popular stocks.

One of the reasons for lack of information is widespread tax evasion. Most corporations understate both earnings and assets to avoid taxes. Most citizens omit dividends when reporting their income and practically all omit capital gains. This is not regarded as dishonest as it would be in America. The rare citizen who reports all his income is regarded simply as a fool.

The government has tried in recent years to change this attitude toward taxes; and further steps are under consideration. However, so little progress has been made that many tax collectors still use the informal “rule of three.” This means that the collector assumes that the taxpayer has greatly understated his income and, therefore, multiplies the stated income by three to estimate the actual income.

This attitude does not result from high tax rates on income. In fact, tax rates are low by U.S. standards. A man with an annual income of $15,000 would pay only about 10 percent income tax. The maximum income tax rate of 50 percent is not reached until the income is over l,000 times the per capita average income. Corporations are subject to a variety of taxes; but for the largest corporations it usually works out that they pay about 50 percent of their reported income. The interest on government bonds is tax exempt for all taxpayers.

The pattern of investment yields in Italy is especially thought provoking for an American. In the United States, yields on industrial stocks at 4 percent now are low by historical standards; but they are still one-third better than the yields on any treasury bonds or high grade industrial bonds; and they are not much different from the yields on first mortgages.

Industrial shares in Italy now yield even less than in the United States; but by contrast the rest of the yield pattern is about like this: treasury bonds 6 percent, corporation bonds 6½ percent, public utility common shares 7 percent, bank loans 7½ percent, mortgages bought by banks 11 percent, and first mortgages bought by private citizens 15 percent or even more. The mortgage yields are especially peculiar, in view of the fact that the principal is payable in full in two years or less. Banks usually lend only 30 percent of the sale price of the mortgaged house or apartment and private citizens only 50 percent.

For the purpose of illustration only, I will mention some of the investment facts about Montecatini, which is aptly described as the du Pont of Italy. Montecatini sales last year were 126 billion lira and the profit 10.3 billion after paying an almost equal amount in taxes. Nine point seven billion was distributed as dividends. It is customary in Italy to distribute a greater part of reported earnings than in the United States. Montecatini shares now sell for 2,600 lira each and the annual dividend is 115 lira. The 4.4 percent yield on Montecatini is above average for Italian industrials.

There are now restrictions on the transfer of cash into or out of Italy for investment; but such restrictions are regarded as temporary. If Italian shares are bought with U.S. dollars and then sold, one-half of the original investment can be transferred back to the United States two years after purchase and the other half two years later.

The gain, if any, must remain in Italy. Dividends and interest can be transferred up to a maximum of 6 percent annually. Excess income and gains are put into a so called “foreign account” at a bank and can be reinvested or spent in Italy. Alternatively, the funds in a “foreign account” can be sold by one foreigner to another.

Yugoslavia

Turning now to Yugoslavia, this country is interesting to an investor, primarily to see what can happen when a nation is taken over by communists. Yugoslavia is a police state. Thousands still live in terror. Various local elections are held every few days; but, of course, elections are a mockery when no one dares speak a work against the ruling gang.

Personal capital has survived in Yugoslavia in only three forms:

1. Farms up to a maximum of 25 acres if worked by the owner.

2. Small shops up to a maximum of five employees.

3. Homes if occupied by the owner.

There is one bank. This bank holds cash deposited by citizens and makes loans at 6 percent to peasants and to state-controlled cooperative enterprises. The government occasionally sells bonds to the workers; but this resembles more a special kind of tax rather than a free investment operation. Russia also has recently sold a small bond issue to its workers, which serves the purpose of diverting more funds to expansion of heavy industry and away from private consumption of goods.

The leading hotel where I stayed in Ljubljana, the capital of Slovenia, can serve as an illustration of business in Yugoslavia. It is run by a director appointed by the state and by a committee of eight employees elected by the other 116 employees. A travelling state inspector visits the hotel every two weeks and is the real authority on all important matters and plans.

The communists call this a worker-owned cooperative business; but actually the workers have no rights of ownership except the right to share in bonuses up to 25 percent of net profits. The other 75 percent is taken by the state as a tax. The previous owner was not executed as an enemy of the state; but received nothing for his hotel except vague talk about compensation eventually. He receives a nominal monthly wage as an adviser.

Yugoslavia is dreadfully poor. The poverty is universal. At the free market rate of 500 dinars to the dollar, the national income is only $100 a year per capita. Nearby Switzerland, with similar topography and resources, has 10 times as much income per person.

It is strange to drive the roads of Yugoslavia and never see a privately owned auto. There are a few trucks and autos owned by cooperative businesses but only a few. It would stamp a man as an enemy of the state to have enough money to own an auto. The neighboring countries are overcrowded with motor scooters and bicycles with little motors; but I did not see even a bicycle motor in Yugoslavia. The price of a bicycle is about five months’ wages for the average citizen.

Templeton’s successful foray into the Japanese stock market from the late 1960s onward was to help make his name as a global investor. What did he see in Japan that few other foreign investors were able to see? It was not simply, as his assistant Mark Holowesko observed, that stocks were cheap, though they certainly were that, with household names such as Toyota and Sanyo selling for one point for low multiples of current year earnings. He had also observed the fact that the Japanese were an exceptionally hardworking people, with a culture of saving, and that its policymakers were in the process of fashioning a successful export-led industrial strategy. This note to investors shows that Templeton was already enthusing about Japan’s potential before 1960.

Japanese Stocks (Letter to Clients 1959)

Japanese products are capturing export markets throughout the world. Many Japanese products are being imported into the United States in large volume. Japan is winning the competitive struggle in these cases partly because of low wages. The difference in wages is apparent from the fact that the Gross National Product is $305 per capita in Japan compared with $2,600 per capita in the United States.

Japan is a nation of 92 million people whose livelihood depends upon their ability to export a major share of their products. In the last decade, these industrious people have developed great skill in making radios, ships, dinnerware, cameras, and numerous other products. By importing the newest types of machinery, their output per man hour has increased. It is significant that Japanese cameras are now selling even in Germany, which was long the lowest-cost producer of high-grade cameras.

From 1951 until the end of 1958, industrial production in the United States increased 18 percent, whereas industrial production in Japan increased 173 percent. Both Japan and the United States have been troubled less by inflation in these years than many other nations. The cost of living, which is a measure of inflation, increased 11 percent in the United States and 24 percent in Japan. From 1954 until today, the cost of living in Japan rose only 1 percent a year.

Only 10 years after Commodore Perry landed in Japan, stock exchanges were founded in Tokyo and Osaka. In 1948, Japan established a government agency called the Securities Exchange Commission to regulate its investment markets. The most widely used index of Japanese stock prices is called the Dow Jones Index. The activity on the Tokyo Stock Exchange has been averaging over 50 million shares a day this year.

Japanese bonds of good credit, maturing within four years, now sell to yield 8 percent, whereas similar bonds in the United States yield 4.2 percent. Japanese stocks now yield 4.35 percent, whereas stocks in the U.S. Dow Jones Industrial Average now yield 3.29 percent. The Japanese Stock Journal, published weekly in English, is sent by air mail to its subscribers in the United States, and this journal gives prices and information about 500 stocks.

U.S. residents may purchase Japanese stocks freely in U.S. dollars exchanged at the official rate of 360 yen for $1. If the purchases are registered in advance with the Japanese Government, the interest and dividends can be converted into U.S. dollars and transmitted to shareholders without delay. Capital and capital gains cannot be converted back into dollars promptly; but two years after a U.S. resident purchases a Japanese stock, he may convert back into U.S. dollars at the official rate, 20 percent each year. If the world trade position of Japan continues to strengthen, this rule about delay in converting capital back into dollars may later be eliminated.

The tax treaty between the U.S. and Japan provides an unusual and remarkable advantage for U.S. purchasers of Japanese stocks. The treaty provides that Japan will withhold no tax on dividends. Each $100 in dividends is converted and transmitted in full to the U.S. shareholder. The shareholder may report the dividend plus 25 percent, which is $125, on his Federal income tax return; and then, after computing his U.S. income tax, he is allowed to deduct $25 from such tax.

For example, let us assume that a U.S. shareholder, in the 30 percent top tax bracket, receives $100 in dividends from U.S. stocks and $100 from Japanese stocks. His net tax on the U.S. dividends would be $26 (after the usual dividend received credit), while his net tax on the Japanese dividends would be only $12.

Industrial output may continue to expand in Japan at a rate far greater than that in the United States. Companies that produce quality products for export at low prices can grow faster than the total industrial production of Japan. Our studies of the Japanese economy indicate that the best growth industries will include electronics, electrical apparatus, automobiles, drugs, dinnerware, and cameras. Within these industries, the companies with the best growth trends include the following five:

Toyota Motor is Japan’s leading automaker. The company is producing 6,500 vehicles a month, which is 43 percent of total Japanese production. Its capacity is 8,000 a month and this will soon be increased to 20,000. Profit has tripled in the last five years. In the first three days after the “Toyopet” car was shown in New York, 100 were sold and nearly 100 auto dealers from numerous states applied for the sales franchise. Japanese buyers of the Toyopet Crown must wait three months now for delivery. The Japanese Government’s five-year plan, announced in 1957, provides for an increase of 180 percent in automobile production.

Matsushita Electric Industry is a leading producer of radios, television sets, household appliances, and electronic tubes. It has recently developed facilities for producing 800,000 transistors a year. On May 31, it will split its stock 3 for 2 and issue 1 million new shares for cash. The dividend on the new stock is expected to be 10 yen a year, which is equivalent to 15 yen on the present shares. Net profit has increased in everyone of the last 10 semiannual fiscal periods. During this five-year period, profits more than tripled.

Sanyo Electric has an equally strong growth trend. It produces a wide variety of electrical and electronic apparatus and household appliances. In the last five years, profits have averaged 6.7 percent of sales and 64 percent of capital. The capital has grown from 400,000 to 3,000,000 yen.

Sankyo Pharmaceutical is the most rapidly growing of the major drug firms and is now second largest in Japan. It exports drugs throughout the East and also in Europe. It has technical assistance contracts with leading drug makers in the United States, Denmark, Switzerland and France. The share price is 6.4 times earnings; whereas the price of Merck shares now is 31 times earnings.

Riken Optical has the strongest growth trend in the camera industry and has now become Japan’s leading producer. In the semi-annual fiscal period ended March 1959, profits were twice as high as in the preceding period; and the stock will be split 3 for 2 in June.

In conclusion, it is significant that only 1.59 percent of Japanese stocks are held by foreigners. Investments in Asia are not popular. The Japanese rule, which prevents prompt repatriation of capital, causes U.S. investors to hesitate. Conservative investors quite properly feel safer with investments at home.

Crises and World Events

The Cold War was won at the end of the 1980s when the Soviet Union collapsed under the weight of its own contradictions. It is salutary to remember however that for most of the 40 years that John Templeton was actively managing money, the threat of a nuclear war between the Soviet Union and the United States and its European allies remained a real and ever present concern. It was something that he consistently highlighted as the biggest threat to his otherwise broadly optimistic outlook for the United States. The end of the Second World War was followed by a series of political and military crises that heightened investors’ sense of insecurity. In 1950 the United States and the Soviet Union did confront each other in the Korean War. John Templeton wrote a number of memos to his clients in the run up to the conflict.

October 1949: In Case of War

I hope that there will be no war! This natural feeling appears to dominate Wall Street thinking. Perhaps that is why almost nothing has yet been written on the subject of how to protect wealth in case of war. But an investment counselor must avoid wishful thinking. It is his duty to plan ahead, to try to guard against each danger, however remote, whether the origin of the danger is economic, political or military.

In the military field, there now appear to be only three possibilities:

1. No war.

2. War which the United States wins.

3. War which Russia wins.

If we could see into the future, we would know which of the three possibilities to use as the basis of investment policy. Without this foreknowledge, we have no choice but to try to protect against all three at once, in so far as that may be possible.

It is helpful to study the vicissitudes of investors in the United States from 1914 to 1921 and again from 1939 to 1946; but this time the conditions are likely to be very different, because the nature of the next war (if any) is likely to be very different. Accordingly, we must ponder also the vicissitudes of investors during those years in England, France, Italy, Japan, Germany and Russia.

When war began in 1939, prices on the N.Y. Stock Exchange rose 15 percent in two weeks and then declined 41 percent in 27 months. After the Japanese attack bought the United States into the war, stock prices declined 9 percent in two weeks and then steadied. In case of war with Russia, nothing so mild as this experience should be expected.

With universal desire for peace among the American people, it is most unlikely that the United States will strike the first blow. The chances are that if a war occurs it will begin with a surprise attack by Russia. Stalin would be foolish to attack France or England first, because that would give the United States a chance to mobilize and launch an atomic attack in retaliation. It seems sensible to assume that the first blow will be an attack against American cities. Probably the blow will not be preceded by threats and diplomatic tension, but rather by false words of friendship in order that the victim may be totally surprised. The atomic bomb puts an enormous premium on surprise.

In previous wars the aggressor could not possibly strike a decisive blow the first day, except against a very small nation. Now it is at least conceivable that the victim could be so crippled in the first hour, that it would no longer be an even match against the aggressor. The original atomic bomb at Hiroshima killed 71,000 and injured 68,000. If the new bombs are twice as powerful and if 200 could be brought into cities secretly and exploded about the same time, the mortality might be 28,000,000.

There is no way to predict the date of an attack; but it is most unlikely that Russia yet has a stockpile of atomic bombs. Therefore an attack within the next year is unlikely. This gives us time in which to prepare protections calmly and carefully.

The worldwide communist organization is many times as large as the Nazi fifth column was in 1939; and using atomic and bacteriological weapons this secret force may be more destructive than the Russian air force and submarines.

In case of war, the stock exchange might remain closed a long time. Some bank records might be destroyed. Wartime taxes and wartime rent and price controls are likely to be imposed immediately and in more drastic form than heretofore. Nonessential businesses might be closed promptly for the duration.

In other words, after war begins, it may be too late to think about rearranging your assets. On the other hand, two facts greatly complicate the matter of trying to rearrange your assets properly in advance. In the first place, it is possible that there will be no war; and in the second place even if there is a war, there is likely to be no advance warning.

Whether there is or is not any overt war, the investor should seek some protection against erosion in the value of the dollar. Without war, the gradual and intermittent trend toward inflation (which has existed in America for seventeen years) is likely to continue because of repeated wage increases and frequent deficits in the federal budget. Federal finances already strained by one world war might not be able to stand another. In case of war, government expense would be vastly greater than receipts. Goods of every kind would be scarce. Such is the basis of inflation.

Inflation was the result of war in China, Greece, France, Italy and elsewhere. Owners of cash or bonds in those nations found that after the war such assets had only negligible value. This means that, whether there be war or peace, it is a reasonable precaution in planning an investment program to keep the major part of your assets in equities, such as common stocks and real estate, rather than in cash or bonds.

During a war, rent controls may make rental property temporarily unproductive; and wartime taxes may temporarily restrict the dividends on common stocks. But when the war is over, the owner will still own a valuable asset. Some forms of property such as bridges and city real estate may be subject to extensive damage, but some other form of property such as oil in the ground are almost indestructible.

It is an old axiom that, “possession is nine points of the law.” In normal times this may be an exaggeration; but not in times of national crisis. At such times, a house in which you live is a safer asset than a bank account. But of course there are reasonable limits to this idea; for example, a man of calm judgment will not, through emotion or fear, buy diamonds and bury them in the cellar, because this would deprive him of dividends on the funds. Also, even if a war did occur, disruption of the de Beers syndicate might remove the scarcity value of diamonds. The Precautions which are justifiable now are simply those which increase the degree of “possession” of your assets without detracting from the value of the assets or pursuit of your career in peace time.

Precaution against war is an influence which bears on investment planning in ways too numerous to mention in this brief paper. For example: (1) If two stocks are equally good bargains, you may choose the shares of the company in an essential industry rather than shares of the company whose work is nonessential. (2) If your stocks are held in the vaults of your broker or your bank, in some cases you might ask the custodian to keep them registered in your name, rather than the name of a nominee, if that would cause no inconvenience. (3) If other factors are equal, you may choose shares of a utility that has numerous properties in small towns rather than a utility with all assets concentrated in a city like Detroit.

The sensible precautions against the risk of war have been kept in mind when planning investment programs for our clients along with the other major risks facing investors in a rapidly changing world. This will receive increased emphasis in the coming year. He who succeeds in preserving assets for the next twenty years needs a broad viewpoint and an open mind in matters of economics, politics and atomic science.

June 26, 1950: News from Korea

Investment counsel clients of Templeton, Dobbrow & Vance Inc, with few exceptions, follow carefully prepared, long-range programs of the nonforecasting type. Accordingly, there is no need for them to make any purchases or sales when unexpected news upsets the market as it did today. From a long-range viewpoint stock prices are still not too high. In fact they would have to go up over 10 percent from today’s level before they would even be considered normal.

However, because the stock market was upset today we thought that clients might be interested in hearing from us on the subject. Usually, when unexpected news causes the stock market to decline sharply the first day does not represent the full extent of the movement; and it would not be surprising if the market is unsettled until the situation in Korea is resolved one way or the other. If, however unlikely as it is, a major war should materialize investors should remember that in all countries, at all times, war has been an inflationary rather than a deflationary influence in the long run. Of course we will be watching this incident in Korea, along with the multitude of other factors which must be considered in the management of your investments.

June 27, 1950: Another War Scare

After the news last weekend from Korea, the Dow Jones Industrial Average declined 10.41 points on Monday. On Tuesday afternoon it was announced that President Truman has dispatched units of the fleet to Korean waters; and on the Stock Exchange the high speed ticker was as much as 20 minutes late in reporting transactions. Now at two o’clock the DJIA has declined 5.56 points from yesterday’s closing level.

The stock market has behaved in somewhat the same manner on numerous occasions in the past:

1. The day after President Truman was unexpectedly reelected in November 1948 the DJIA declined from 189.76 to 182.46; and the decline continued until it reached 171.20 on November 30 and then rallied moderately for several months.

2. When the Dow Theory gave a bear market signal on the first day of September 1946, the DJIA declined from 189.19 to 178.68. Eleven weeks later the market established its lowest point at 163.55, which proved to be the lowest point for the next 2½ years.

3. On the day after the attack at Pearl Harbor, the DJIA declined from 116.60 to 112.52. The lowest point of that movement was reached 15 days later at 106.34, after which the market rallied for three weeks.

4. On May 13, 1940 at the time of the fall of France, the DJIA declined from 144.85 to 137.63. The lowest point of this decline was established four weeks later at 111.84, which was lower than at any time in the following 18 months.

5. On September 1, 1939 shortly before England declared war, the DJIA declined from 134.41 to 127.51 and then rallied the same day to show a net profit at the close of the market. Within eight days thereafter the market had risen from 135.25 to 155.92, which is 15 percent.

6. When Hitler invaded Czechoslovakia in March 1939, the stock market declined gradually from 152.28 on March 10 to 121.44 an April 8; but although a world war started five months later, the market remained above this war scare low point for the next two years.

It is interesting to note that the wide decline in stock prices yesterday took almost 4 billion dollars off the paper value of all stocks on the Stock Exchange. However, the total shares which changed hands yesterday represented only 7/40ths of 1 percent of all the shares listed on the Exchange. Also, it is interesting to reflect on the fact that, whereas 3,910,000 shares were sold yesterday, there were also 3,910,000 shares bought yesterday; and possibly the purchasers may be more intelligent than the sellers.

Of course it is unlikely that any major shooting war will result from the current situation in Korea, but it is interesting to remember that every major war has been an inflationary rather than a deflationary influence. In every nation where such information is available, stock prices have always fluctuated in a higher range after the war than they did before the war.

At a time when the stock market is upset as it was on Monday and then again today, those investors who follow carefully prepared long-range programs of the non-forecasting type have no cause for concern. Such programs are designed to profit from stock market cycles without the need for predicting such cycles. It is not necessary to be lucky in guessing unexpected events; and when such events occur it is not necessary to make any guesses about the short-term effect on the stock market. Such contingencies are provided for in a carefully prepared program. Peace of mind is one of the by-products of a good program.

Under such programs the investment in common stocks is reduced only when the market rises above normal. Therefore, no selling of stocks is called for at present. At the close yesterday the market was about 11 percent below normal. This is not low enough to call for any purchasing of additional stocks. It does not appear likely that the market will decline enough to call for buying any more stocks than have already been purchased, which purchases were made in the bear market that terminated last year; but if it should, clients who have been following such long-range programs have funds in their Conservation Sections for use in making such purchases.

Future Prospects

John Templeton was always happy to talk (and usually enthused) about the future prospects for the United States and what they might mean for the benefit of his investors. It was his good fortune to be born and live his life during a period that saw the United States become the world’s dominant economic and military power. He was at pains to convince his clients, and later investors in his funds, not to be deterred from their investment plans by bear markets, recessions or other episode of bad news. His technique was to use detailed statistics and examples from history to show that setbacks were invariably temporary. Another recurrent theme was the inability of economists or forecasters to predict economic or market setbacks before they happened. We reproduce some examples of his forward-looking pieces here, the first (a memo to clients from March 1953) given more than 35 years before the last (a speech to clients of the Templeton business at the time of the severe 1990–1991 recession). The charts he referred to have been excluded because of space constraints.

March 1953: Fifteen Years of Increasing Prosperity

Business History

With regard to business and investments, the years from 1938 to 1952 were truly remarkable. The last real depression in the United States ended 15 years ago in March 1938. At that time over 11 million people were unemployed. Then, in that month, Hitler invaded Czechoslovakia and started a chain of events, which has caused vast changes in business and investment conditions. The extent of these changes is not generally understood. In 1938 Gross National Product of the nation was only $85 billion, whereas today the current rate is $360 billion annually. The output of the nation measured in dollars is more than four times as great as it was 15 years ago. Of course, the value of the dollar has changed greatly also. This change can be measured by the fact that the index of the cost of living has increased 88 percent. The most widely used index for production in terms of physical units is the Federal Reserve Board Index of Industrial Production. This index is now 163 percent above its average level for 1938. The business history during this 15 years of increasing prosperity is measured by the figures in Table I [not shown].

In 1938, 44 million people were employed. Today the total is 61 million, not including those in the Armed Forces. One of the greatest changes that has occurred is that of wage rates. Average earnings of factory workers increased 206 percent between 1938 and 1952.

Bank deposits and currency increased greatly, which contributed to general inflation of prices. The increase from 1938 to 1952 was 232 percent. Most of this increase occurred in the first seven years. When the war ended in 1945, the increase had been 195 percent. Since the end of the war the increase in bank deposits and currency has been only 13 percent.

Current Business Situation

Investors and businessmen ought to study the causes of this great boom. Three causes, which seem to me most fundamental and most influential, were (1) vast increase in public debt, (2) a vast increase in private debt, and (3) accumulated shortages of goods.

From July 1940 until June 1946 the federal government had a budgetary deficit of $211 billion. This deficit was met in part by the sale of Government bonds to the banks and by an increase in the supply of currency. The results of this flood of money can hardly be overemphasized. It is significant to notice that this flood has stopped. Since June 1946 the federal government has actually taken in over $20 billion more in cash than it has disbursed.

March 7, 1957: The Golden Century, An Address by John M. Templeton at Palm Beach

You and I should be deeply thankful that we live in this century, when the knowledge accumulated by men through the ages is beginning to bear fruit in material progress beyond the imagination of previous generations. In terms of material products, mankind will consume more in this century than in all previous centuries added together. You and I should be deeply thankful for the good fortune of having been born in the United States. In terms of material goods, this one nation alone will produce more in this one century than the total output of all nations throughout the history of the world up until the beginning of the 18th century.

For a few minutes, let’s turn back our memories to the dawn of this century, in the year 1900. The total Gross National Product of the United States was then $20 billion. The people living then could hardly imagine that the automobile industry, whose annual sales were less than $10 million would grow more than 1,000 fold. Now the sales volume of this industry alone is almost as large as the dollar sales volume of all industries in the nation in 1900.

When this century began, the electric power industry and the telephone industry were in their infancy, but today these industries alone also total as much as the commerce of the whole nation at that time. The aviation industry did not really begin until 10 years after the start of this century, but now the aviation industry alone produces goods worth over $9 billion a year. In this century the oil industry has increased an hundred-fold and is still growing. At the beginning of the century chain stores were almost unknown, but now our people buy every year through chain stores much more than the total sales of the nation in 1900. The radio industry and the television industry were not even dreamed of then, but now these industries produce $5 billion worth of goods per year. Perhaps these examples are enough to prove that we truly do live in the Golden Century of the earth. I hardly need mention the other great industries born in this century such as motion pictures, organic chemicals, refrigeration, rayon, nylon, air conditioning, plywood, aluminum, plastics, and others.

You who live in Florida or often visit Florida can see all around you the signs of this golden century. The population of Dade County alone is now greater than the population of Florida at the beginning of the century. Beachfront property valued as low as $1 a foot in 1900 can now be sold for as much as $5,000 a foot.

The first part of this century has been a golden era not only for consumers but also for investors. Fortunes could have been made and were made simply by buying land almost anywhere in South Florida at the beginning of this century. Those who were wise enough to invest $100,000 in General Electric in 1910 now have an asset worth $4 million. One hundred thousand invested in duPont at the same time increased 160 fold and is now worth $16 million. One hundred thousand in International Business Machines as recently as 1922 is now worth $29 million. One hundred thousand in Lincoln National Life shares in 1934 increased 60 fold and is now worth $6 million. One-tenth of a million invested in American Airlines as recently as 19 years ago is now worth $2 million. The dividend paid annually now on a share of Douglas Aircraft is twice the price of the stock just 25 years ago.

Those of you who studied economics are probably more interested in indexes that show the average growth of all industry than in these colorful examples. Therefore, on the attached chart [not shown] a line is plotted that shows the growth of Gross National Product year by year for 56 years. Gross National Product means the output of all goods and services in the nation. As I have mentioned, Gross National Product at the beginning of the century was only $20 billion, whereas now it is 20 times that great. We as investment counselors, and you as investors may be even more interested in the second line, which is the index of all industrial common stocks actively traded on the New York Stock Exchange. This shows that $1 million invested in a general cross section of all industrial stocks at the beginning of the century would now be worth $12 million. Lastly, I have drawn a line that shows the accumulation which would have occurred if all dividends had been reinvested. Startling as it may seem, by reinvesting dividends, $1 million invested by a tax-exempt institution in a random selection of industrial stocks would have grown in 56 years to $250 million. It is certainly no exaggeration to say that this century has already proven to be a golden age for investors to an extent almost unbelievable at the beginning of the century.

People who come to talk with investment counselors are usually anxious to hear more about the possibilities of the future than about the facts of the past. The only certainty about the future is the fact that it will be different from the past. Nevertheless, it is entertaining to project forward for the remaining 43 years of this century the trends that have existed thus far. On this same chart, three straight lines are drawn projecting the past trends on to 1999. If past trends did continue, then by 1999 Gross National Product of the United States would have grown from $412 billion now to $3 trillion a year. The index of industrial stock prices would have tripled; and a fund in which all dividends were reinvested would have increased 22-fold. These figures would be greater except for the fact that today, at the starting point, industrial stock prices are already considerably above the trend line.

Now let us investigate briefly the question of whether future growth trends are likely to be more rapid or less rapid than heretofore.

Those who study population trends tell us that the rate of growth in the future is more likely to be above rather than below the past rate, which averaged 1.4 percent annually. More important than population is the growth of the nation’s industrial plant and equipment. In the first 25 years for which figures are available, this nation invested an average of $6 billion a year in new industrial plants and equipment. In the most recent five years, such expenditures have averaged $29 billion annually and reached a record $35 billion last year. This indicates that the rate of increase in the productive capacity of the nation has been even greater recently than it was in the first half of the century.

Another factor that contributes to the increase in the figures for Gross National Product is inflation; because the Gross National Product is stated in terms of dollars whose purchasing power has decreased at an average rate of 2.8 percent annually. Because of the continually rising wage rates and the power of the labor unions, it is likely that inflation will continue a very long time, with only temporary interruptions.

Most important of all factors that have made this a golden century in the economic sense, is the increase in output-per-man-hour resulting from new inventions and new production methods. This progress is based on scientific research and industrial research. Therefore, it is important to study the amount of money that a nation spends on research. These figures are most encouraging because they show that research expenses in the United States have increased from one-quarter billion dollars annually 20 years ago to $4 billion annually at present. Altogether, without going into more detail, I can say that the forces indicating an even greater rate of growth in the future are at least as strong as those forces indicating the opposite.

Those investors who want to benefit from the future progress of the nation must give the utmost care to the proper selection of their investments. During the first half-century, many investors failed to share in the growth of the nation, because they invested in the wrong kinds of investments or in the wrong industries. At the beginning of the century, among the largest investment fields were mortgages on real estate and bonds and shares of railroads; but neither of these gave the owner any real participation in the great growth of the nation resulting largely from new industries.

In the remainder of the century, because scientific progress is increasingly rapid, it is likely to be even more important to select growth industries and growth companies. Such selection is by no means an easy task. The outlook is constantly changing. However, our staff of security analysts does have a list of industries regarded as having the best prospects at present for maximum future growth. Listed in alphabetical order this list includes air conditioning, airlines, atomic power, electronics, new metals, plastics, prefabricated houses and rockets. These are self explanatory except that you might like to know what we mean by “new metals”. In this category, we include aluminum, nickel, uranium, titanium, molybdenum, tungsten, cobalt, chromium and magnesium as well as zirconium, lithium, beryllium, tantalum, thorium and others.

Concerning the airline industry, the rate of growth is shown by the fact that for every passenger mile of air travel in 1932, there will be 200 miles of travel in 1957. Yet, today, the market values at only $600 million all common stocks of all 12 trunk airlines, which is just 1/18th of the market value of General Motors alone.

Now in conclusion, I would like to emphasize two important warnings for investors. The first of these is the fact that the progress of the nation could be stopped by atomic war, by socialism or by other great unpredictable forces. The second warning is that the free economy necessary for growth carries with it a strong probability that there will continue to be occasional business depressions and occasional drastic cycles in stock prices caused by great waves of optimism and pessimism. It will be possible in the future, as it has been in the past, to have a fortune wiped out by getting overloaded in common stocks at the wrong time.

There will be great investment opportunities in the common stocks of the best-managed companies in new industries; but in years when stock prices are high, wise investors will keep large reserves of high-grade bonds, in order that they may have the means with which to buy real growth stocks the next time a major bear market puts common stocks again on the bargain counter. A carefully prepared plan for each investor is the cornerstone of investment success.

Sectors and Themes

From time to time Templeton used his letters to clients to address specific ideas and themes that had been identified in his firm’s research. As an example we reproduce here a piece he wrote about the outlook for oil stocks, a theme he returned to many years later, when his predictions had been fully borne out.

1945: Extra Value in Oil Company Shares

Oil is a cheap and convenient source of heat and energy. Eventually it will become scarce and the price probably will rise.

Statistics on the demand for crude oil indicate a strong upward long-term trend. Demand in 1937 was 22 percent greater than in 1929. The pre-war peak in 1941 was 18 percent above 1937. Last year demand was 20 percent above the pre-war peak. Estimates by economists in the industry indicate that in the fifth post war year demand may be 13 percent above the best wartime rate recorded so far. Domestic consumption of gasoline has shown an increase in every year except 1932 and 1942.

The total amount of oil discovered in the United States since 1859 has been 50,230,000,000 barrels according to the American Petroleum Institute. Production up until the end of last year amounted to 29,777,000,000 barrels. In other words, the remaining proven reserves in the United States are 20,453,000,000 barrels. This is now being exhausted at the rate of 1,743,000,000 barrels a year. The proven reserves outside the United States, which are estimated at 31,400,000,000 barrels, are being used up at a moderately slower rate.

The underground storage of 20,453,000,000 barrels in the United States is not all immediately available. It can be recovered only over a period of many decades. If no further oil were discovered the scarcity would probably become serious within three or four years. Even at the present production rate of 1,743,000,000 barrels annually petroleum engineers estimate that a large proportion of the producing areas are forced to operate at a higher rate than should be permitted if the maximum oil is to be recovered from the structures in the long run.

Additions to the underground reserves of the United States through discovery of new pools have been declining sharply in recent years. Thus in 1944 only 511,000,000 barrels were added to reserves compared with some 929,000,000 barrels in 1937. It is significant that new discoveries have added only about 385,000,000 barrels annually to reserves in the six years ended December 31, 1944. These figures do not include the increased reserves through revisions of estimates and extensions of the older fields, of course.

Also, significant is the fact that the number of dry holes drilled has been increasing. About 3,600 wild cat wells were drilled last year of which 11.5 percent struck oil, 3.1 percent gas, and the remaining 85.4 percent were dry holes. Some of the most promising areas have already been covered by seismograph napping parties four or five times.

While the cost of locating new reserves has risen sharply, the price of crude oil except in special areas is no higher than it was seven years ago in 1938. The industry has agitated for a general price increase, but such efforts have been repeatedly blocked by the CPA.

In the last 30 years the price of crude oil in the United States has been as low as 33 cents a barrel for a few weeks in 1931 and as high as $3.50 a barrel for several months in 1920. Crude oil prices are not revealed in foreign areas, but it is significant that retail prices of gasoline and fuel oil in almost all countries abroad before the war were substantially above United States prices. A price increase of as much as 50 cents or $1 a barrel at some time in the future would not appear unreasonable, as you can see from the following tabulation of the price of Mid-Continent crude 36.0 to 36.9 gravity:

Eventually, when oil becomes really scarce, a price increase up to $4 or $5 a barrel would probably result in the use of substitute fuels or in the extraction of oil from other materials. The known deposits of oil shales and tar sands are sufficient to postpone the exhaustion of oil resources for several generations, but extraction from those sources is quite expensive. Also, coal can be converted into gasoline; and much progress has been made toward reducing the cost of the process especially in Germany. Until the price of crude oil is much higher than now, the conversion of coal or other organic materials into oil cannot be a source of competition, because the raw materials for such a process of chemical metamorphosis cost more than tile current price of crude oil. At present, because of the labor in mining, the cost of a ton of coal exceeds the cost of a ton of crude petroleum.

An increase of as much as 50 cents or $1 a barrel in the price of crude oil would attract only minor use of substitute fuels and probably no oil production from substitute sources. Furthermore, a price increase of such proportions should encounter little consumer resistance. An increase of 50 cents a barrel in the price of crude oil would cause an increase of only 1 cent a gallon in the retail price of tile oil products.

Whereas a price increase of 50 cents a barrel would have little effect on the demand for oil, it would have a large effect on the asset value and earning power of the companies which own the major proven reserves. In the attached tabulation [not shown] the added value caused by a price increase of 50 cents a barrel is computed for 20 oil companies. The approximate increase in earnings per share is also computed by use of 1944 production figures. The increase in asset value shown in Column 3 is based on the assumption that producing properties would command a sale price of 30 cents a barrel more if the posted price of crude oil increased permanently by 50 cents a barrel. The increase in earnings per share shown in Column 6 is based on the assumption that 30 cents a barrel extra would be carried through to net earnings after taxes if the posted price were 50 cents higher.

The figures for added asset value are derived from the estimates of proven reserves shown in Column 1. Such estimates are subject to a wide margin of error. The number of gallons to be produced from a particular field depends on production methods, prices and other variables. The careful estimates of company geologists are made available to stockholders in only rare cases. Furthermore, the figures in Column 1 contain no allowance for natural gas reserves, which are so important for Phillips and others. The huge reserves held by Gulf, Standard of California, and Texas in the Near East are not included. Despite these limitations, it seems indisputable that a stockholder can form a more accurate judgment of the value of his shares if he has some estimates rather than none.

No one can tell when an increase in the price of oil may occur. From time to time in the future there may even be temporary downward adjustments as there were in the past when exploration methods were improved by new inventions and when huge new flush fields were found. Peroration has been made very effective in recent years, however, and this protects to an important extent against sudden price cutting. In the long run, the powerful influences of increasing scarcity and higher discovery costs point unmistakably toward large and permanent price increases.

The current market prices of oil company shares seem to take account of the potential added value only to a very minor extent. The present prices can readily be justified solely on the basis of current earnings, past average annual earnings, and stated asset values. Assets of almost all oil companies are now worth more than the amounts shown on the books. Earnings are greatly understated by Amerada and several others.

As can be seen by the last column of the table, potential added values are very large in relation to current market prices. This is especially marked in the case of Amerada, Gulf, Lion, Ohio, Pure, and Skelly.