8. WHERE THE MONEY IS

Before we go on to such practitioners of market diagnosis as chartists and the random-walk lads, I have to tell you a couple of things in case you think you are learning how to make a million dollars overnight. You may indeed learn this, but if you are that alert you could probably learn a lot from Poor Richard’s Almanac, too.

Really big money is not made in the stock market by outside investors. That may come as a shock to you. You may not even care, since by “really big” I am talking about multiples of millions rather than just, say, one lousy million. It is certainly possible to make ten or twenty times your money as an outside investor in the stock market given enough time, enough intelligence, enough emotional detachment, enough luck, and somebody smart on the other end of the phone. It is possible because a lot of people have done it.

Who makes the really big money? The inside stockholders of a company do, when the market capitalizes the earnings of that company. Let me tell you a little story as an example, and for once, I am not changing the names and numbers of the players because it is such a nice story.

Once upon a time there was a little boy who lived in Chicago named Max Palevsky. His father had come to this country because the streets were paved with gold, but they weren’t, and so to support his family he became a painter. Houses, not canvas. Max grew up and went to the University of Chicago and studied philosophy. His father said, “Philosophy? Max, how can anyone make a dime from philosophy?” Max didn’t know, but he wanted to study philosophy, and so he went right on studying philosophy. In graduate school he was still studying philosophy, notably logic. After eleventy-seven years in graduate school he got a bit fatigued with the academic environment, and so one day he went to work for Bendix as a logician. Bendix was trying its hands at computers and Max was there to tell the computer how to think, since the computer didn’t know what was logical.

One day Max moved on to Packard-Bell, which was also trying its hand at computers, and one day after that Max decided to start his own company. IBM dominates the computer field, but even IBM cannot do absolutely everything well at all times, and Max thought there was a niche in the computer field that IBM wasn’t covering, in the area of small computers. So Max got together with Art Rock, who had made some money and some friends at Hayden, Stone. Art had moved to San Francisco and formed a firm, Davis and Rock, to invest venture capital in ideas such as Max’s. Max put up $80,000 and Art Rock’s people put up $920,000, and from a sheet of yellow paper Scientific Data Systems was born.

The idea was right and the people were able and Scientific Data Systems began to make money on its small computers. A group of underwriters sold some stock to the public and the market on the first day capitalized—i.e., decided—that the earnings of SDS were worth a paper value of $50 million. That made Max’s piece worth a little less than $10 million. Currently, after some notable triumphs, the market says SDS is worth about $688 million, and that makes Max’s piece worth about $64 million.

You can’t do that in the stock market unless you start with a hell of a lot in the first place.

The nice part of the story is still to come. One spring evening I was sitting in Max’s hotel room on Central Park South and we were watching the lights go on in Central Park and I asked him what difference the $64 million made. Max thought for a minute and then he said it hadn’t made any difference. He still lived in the same house and had the same friends. He did have a problem, because every once in a while his children would read in the paper that their father had roughly $64 million and he didn’t want them to grow up with any false values. And of course, he did have the fun and the satisfaction of creating a company and beating IBM. Then he added one footnote.

“It has made one difference,” he said. “It made my father happy. My father said, ‘I did the right thing. I was right after all.’”

And Max said, “Right about what?”

And his father said, “I was right what I thought before I came, about the streets, and the gold.”

So if we are talking about real big money, forget the stock market. Max’s story, in varying degrees, of course, has been duplicated by the principals of a hundred other companies. That $240 million may be a paper value, but if you own a piece of it you can trade the paper in for all the nice tangible things you can think of, and even after they get the carpeting in on your boat you will still have a lot left. Engineers know this well; they follow the trail of the stock options. You have stock and as long as there are buyers for it that currency is just as good as greenbacks. You can whisk engineers out of RCA and Sperry Rand and General Electric because the engineers there are too far from the top and if they have options they are small in relation to the size of the company. So if you have a device or a process for which there is a ready market, and you can corral some engineers, that is the way to the big money.

Sometimes this process of capitalizing the earnings in a glamorous field takes hardly any start-up money at all and isn’t limited to the arcane disciplines of computer technology. Let us say three fellows are working for an advertising agency on the Cosmo Hair Cream account. One is the producer of Cosmo’s television commercials, one is the writer who gets the ideas, and one is the account executive, i.e., salesman and mother hen, who has the Cosmo people in his pocket. In the old days, just taking home $60,000 a year would have been enough for our three heroes. Now they meet in one of those Manhattan restaurants where the maître d’ has a posture like a cobra and has his hand out for ten dollars at lunch. Our three heroes decide to form their own agency. What are their expenses and their risks? Well, they will have to rent an office and hire a couple of people, but since their plan is to take the Cosmo account with them, those expenses will be covered. Otherwise, no machinery, no inventory, no problems except how to get the accounts. In two years our heroes will have ten other accounts, the firm will have nice profits, and they can go public. Their own shares in the firm—sold at twenty times earnings—are worth a couple million apiece, and that beats $60,000 a year. (They will take that anyway, just as soon as they get that stock well distributed.)

When you buy the stock of Winken, Blinken and Nod, the new ad agency, or of Digital Datawhack Computers, you may have a chance at a very nice percentage gain. But the marvel of market capitalization, of public ownership, has already given the principals sixty times their money. Entrepreneurs, of course, are not always rewarded so lavishly, and there is always the chance that you can’t sell your computers or that they blow out the light bulbs or that Cosmo will go back to the old agency.

But if a room full of people called a sales organization can go public (and many have), and another office of people called an ad agency can go public, there is really no limit to the concept. A number of brokerage firms are hungrily waiting for the day when they can go public, i.e., not only sell everybody else’s stocks but their own, too. (Before they do, you will hear that the tremendous capital needs of Wall Street can only be met by outside financing, that the present commission rates simply do not cover the expansion that has to be made, and that half the members of the New York Stock Exchange are going broke. Then one rather offbeat firm will go public, followed by a stampede, so that the members of the New York Stock Exchange, instead of having one or two million dollars’ worth of other people’s companies and a share in their own, can have one or two million dollars’ worth of other people’s companies and twenty million dollars’ worth of their own. As Lincoln Steffens said, “I have seen the future, and it works.”)

Eventually there is no reason why doctors and lawyers should not go public too; it may take longer, but at some point a smart lawyer is going to see that if Bardell, Pickwick, Motley and Slick were a corporation instead of just a bunch of lawyers, they could sell the stock at twenty times earnings and that, in fact, a hungry underwriter has already suggested this. (In good markets, there is always a hungry underwriter. In bad markets, everybody is hungry and all the energies go into demanding that commissions be raised.)

Once the lawyers make it safely public, you can look forward to Brain Surgeons, Incorporated, which will be sold by brokers as “the most direct way of participating in the broadening growth of medical care, of Federal aid programs, of the increased attention to the nation’s health, and of the growing trend to schizophrenia.”

I am not making any value judgments. This is the way things are, and the Game has been so successful that, like everything, it will get more and more successful until it stops being successful. One of our learned economists has described our economic system as “state socialism for the rich.” If socialism is the public ownership of the major institutions and industries of the nation, maybe we are just taking a unique way of getting there.