Supermoney

Earlier, we looked at a convulsive period for the whole structure: the banking system that absorbed a run on commercial paper, and the investment community which absorbed—barely—the collapse of undercapitalized brokerage firms. It survived. The structure shuddered a lot but stayed intact, and has now been bolstered. Within the structure, however, changes continue to take place. Institutions continue to increase their share of the trading markets. (Much of the public stock, remember, comes from the conversion of the family company to Supercurrency, and that tends to stay locked up in trusts.) Here is what has happened, the institutional share of trading (in average shares per day):

1952	800,000
1955	1,300,000
1960	1,600,000
1965	3,500,000
1971	15,900,000

Plainly, the days of Mr. Smith in Portland, Oregon, selling to Mr. Jones in Portland, Maine, are mostly gone, and so is everything that went along with Owning a Share in America. In order to increase their share of the market, many small investors had to institutionalize their investing.

When I think of the individual investor taking to the field these days, a quarterback called Harry Theofilides comes to mind. (He comes to mind because a sportswriter called William Wallace did a column about him; otherwise he would not come to mind.) Harry Theofilides was five feet ten. He played with the Redskins until Vince Lombardi came, but Lombardi was not about to have a quarterback who was only five-ten. Harry Theofilides was cut, and went to the Jets, where he came off the bench in a game against the Giants, pumped the team to three touch-downs, including a couple of touchdown passes, and hit for something like seven of nine the following week against the Vikings.

“Nobody ever beat me out,” said Theofilides. He was cut for Al Woodall, who is six feet five, and went off to the Edmonton Eskimos in Canada.

“Ever since I’ve been in football,” Theofilides said, somewhat bitterly, “I’ve been told I’m too short, that I can’t see over the defensive linemen. Well, who can? Defensive linemen, when they come at you with their hands up, they’re over seven feet tall. Nobody can see over them. You do a quick slide into the gaps between them and then you look. Sonny Jurgensen told me he could never see; he just threw the ball where he thought the receiver ought to be.”

The individual investor has to be considered about five-ten on the investment field, and there are a lot of other people out there who, with their research and their computers and their staffs, are over seven feet tall with their hands up. The odds against a superior performance by an individual investor have to be considered to have gone up markedly since the people who are seven feet tall with their hands up have come onto the scene. It was easy enough for Mr. Jones in one of the Portlands to sell quietly to Mr. Smith in the other one; they were at least the same size.

Plainly, for a great number of investors, safety and a passive return are one course. The gap between the passive return, which doesn’t want to accept risk, and the aggressive return, which will accept it, has narrowed considerably. The return from a tax-free municipal approaches the average return on the bulk of industrial stocks. Utilities, unexciting as a part of the game and facing financing problems, still are assured of revenue growth. Some of them have partially tax-free returns, and have a tradition of increasing their dividends every year.

A second course is to buy the so-called great companies and not sell them. This is the course of the University of Rochester, which has had a remarkably successful investment portfolio. The university, being an institution, has a long time horizon; it is prepared to take the sudden down-drafts these stocks face in bad markets because it feels that over the course of a generation it will achieve a superior return. Rochester has large positions in Kodak and Xerox, both of which are in the university’s backyard, and some of which were given to it. The individual still faces the question, What is a great company? because great companies become mature and not-so-great. Early growth is an invitation to competition, and the growth companies of one era are not always those of the next. Nonetheless, it is possible, by concentrating on some of the characteristics below, to find companies which can be held for a long time.

Both of these courses assume the ability to leave the game element behind, entertaining as that may be.

Finally, a minority of individuals, those with some time and the proclivity to do their own work, can do very well. For the people who are seven feet tall with their hands up are that way for everybody—even themselves—and nobody anywhere can see over them. You will have to take a quick step and look in the gaps between them.

But a time may be coming in which it would be possible to be successful with just the old tenet that used to work, anticipate the institutions. While institutions are big and muscular, their records are not all that awesome. Furthermore, their managers talk to each other and tend to run in packs, like beagles. All you have to do is find the scent before the beagles do.

For institutions, too, have been burned. They love the security of a front-running company with growing earnings, and they are wary of small companies because they cannot move in and out of them well in size. If you can find the smaller, growing company and sell it to the institutions when it gets a bit bigger, you will have stepped into the gap between them. That sort of front-running means the stock can go onto the Approved List of the banks, and a trust officer can put it into his accounts without being criticized.

You will be, by now, paying some attention to the accounting, and you will be listening hardest to your own common sense. You will have husbanded your time and not wasted it on those industries—about 80 percent of them—that do not have favorable characteristics in the long term. Very likely, the company you find will be financially strong, so that it will not have to sell more stock or borrow unfavorably. It will have a leading edge in its key products and the capability of improving that edge, through research if that is the way it is done. It will have control over its own prices, and a labor component low enough not to be a problem, or at least controlled labor costs. It will be in an area that common sense will tell you is growing. All of these things will have contributed to its nice profit margins and its profits.

All of these factors can be the ones to look for in finding something adolescent that is bought to be sold. If in addition, the company has something unique that makes competition difficult, you may have a great company that can be held.

In the 1960’s it was fashionable to look to high technology for all of these characteristics, as well as for the something unique. Xerox and Polaroid were protected by rings of patents. But the lead time in patent protection is diminishing; if one polymer is patented, there may be a similar one which works equally well. Further, virtually everybody in the investment business underestimated how much the government flow of research and development money meant, even though the best of the pure companies (as the two above) were not dependent on that. In Avon Products, it was the sales force that was so hard to duplicate.

I have a bias about this particular philosophy which you should correct for, because it is the one that served best when I was first learning. A bunch of us sat at the knee of one of the great apostles of the Growth Theory, a man who went out to the mutual funds and pension funds and preached the true gospel. Since then we have learned that those growing earnings can be such a security blanket to the buyer that he pays too much for them, so even when the stepladder is true and the company is going to maintain the growth, it pays to buy them at the low end of the swings in their price-earnings ratios. Periodically Mr. Market gets manic. A true growth company may swing from selling at twenty times earnings in a bad market to forty-five times in a hypertensed market, and it does pay to wait for the troughs.

Anyway, we sat at the great man’s knee, and then we went out to apply the theory. We would wait tensely while the mentor graded our papers. I bring this up because I remember bringing in a stock that provides the perfect example of what an individual can do by himself. The mentor had bid us study Gillette. The mentor held up a pack of Blue Blades, very dramatic. “This will double, and if you know a double, you can do better than that.” People used up the Blue Blades, threw them away, and bought more. Gillette dominated its market with an army of salesmen. Its displays were on every drugstore counter, and it was going into other grooming items.

What else was like Gillette? We were to go out scouting. I took a careful walk around a drugstore, and then I went to the manuals, and then I brought my stock to the mentor and waited for my very good grade.

I had a stock called Tampax. It had no debt, no preferred, and plenty of cash. Its product was a leading product. It was like Gillette in that you used it, threw it away, and bought more. It had flexibility in the pricing. Its profits grew every year. I wanted an A for my idea.

I got a B, and I protested.

“It’s a very good little company,” said the mentor. “I suppose Kimberly-Clark or Scott could compete with it. But what is so unique?”

“What is unique is that when people go to the drugstore, they don’t know the name of any other product,” I said. “Like Kleenex. Tell me the name of what else competes with Kleenex. A generic name is better than patents.”

The mentor wouldn’t change my B to an A.

“It’s a solid B,” he said. But the earnings grew perhaps 15 percent a year; we were looking at technological companies whose earnings grew 50 percent a year, making oscilloscopes and particle accelerators and other patented, super-sophisticated stuff, protected by patents and by technical staffs with hundreds of Ph.D.’s in physics.

“Yours is a population-growth stock,” said the mentor. “I don’t see why it’s ever going to grow considerably faster, although that fifteen percent could compound. Texas Utilities and Coca-Cola increase their earnings every year too, and those stocks are already on the approved lists of all the banks.”

So I didn’t buy Tampax at 5, adjusted for splits. The mentor was right for that time: the technology stocks moved much faster. A couple of years later the pace accelerated, so that their patents were no protection, and then there was price-cutting in some of the products. Some of those technological companies are far bigger today, and some are treated as cyclical companies. But Tampax is around 120. I feel dumb every time I think about it.

There are numbers of other examples of front-running, solidly managed companies in growing fields with some sort of edge about them. Some of the ones that worked in the recent past were as easy to understand as Johnson & Johnson, Band-Aids and baby powder, and McDonald’s, the ubiquitous hamburger stands. MGIC, the Mortgage Guaranty Insurance Corporation, filled a conspicuous gap in mortgage insurance. Not only did these companies make it through the sixties and the Big Bear, but they are up better than 1000 percent from their lows of a decade ago. (That doesn’t mean they are necessarily headed for that in the decade ahead.)

You have plenty of competition in looking for the outstanding steady growers, but you only need one for real success, and you can be sure that if you find one, somebody—a nice bank probably—will buy it from you at a premium some other time, even if you are only five-ten and the other fellows are seven feet tall with their hands up.