Wall Street in Crisis

The Anatomy of Market Cycles, of boom and bust, of Shrewd Manipulation and impulse trading -- and how to understand and Capitalize on them

On Monday, May 28, 1962, prices on the New York Stock Exchange crumbled rapidly before an avalanche of sell orders. The Dow-Jones industrial average plunged nearly 35 points to register its biggest one-day drop in over 32 years. Crashing through the 600 level for the first time since 1960, it hit a day's low of 576.93.

By the end of the day, many big-board stocks were selling at prices from 30 to 80 percent below their 1962 highs. Shares traded on the American exchange and over-the-counter markets followed suit and also went into nosedives. Headline writers were quick to respond to the developments being reported by the lagging ticker:

Black Monday Panic on wall Street

Investors Lose Billions as Market breaks

Nation fears new 1929 Debacle

Such were the scare heads that appeared on the front pages of the nation's newspapers after the New York Stock Exchange closed for the day. By the time later editions came off the press, experts and analysts, economists and pundits were offering their explanations, hindsight diagnoses and spur-of-the-moment prognostications. As is often the case in such situations, some of the second-guessers and crystal-ball gazers tried to gloss over the implications of the collapse, while others appeared to take an almost sadistic delight in prophesying even worse things to come.

Two days later, several newspaper and wire-service correspondents descended on my house outside London. They wanted to know my opinions and reactions and asked what I was doing because of the break in stock prices. I told them quite frankly that, while I sympathized whole-heartedly with anyone who had lost money because of market developments, I saw little if any reason for alarm and absolutely none for panic.

The overall current business picture was favorable and, what was even more important, gave promise of getting better in the future. There was nothing basically wrong with the American economy nor the vast majority of companies whose stocks were listed on the New York Stock Exchange. In my view, some stocks had been grossly overpriced. Irrational buying had driven their prices to totally unrealistic levels. The May 28 break was an inevitable consequence.

I said that I felt the stock market was in a much healthier and certainly in a much more realistic position because of the long-needed adjustment of prices. As for what I was doing, the answer was simple. I was buying stocks.

"I'd be foolish not to buy," I explained to a young correspondent who looked as though he thought I'd taken leave of my senses by buying when everyone else seemed to be selling.

"Most seasoned investors are doubtless doing much the same thing," I went on, feeling somewhat like a schoolmaster conducting a short course in the First Principles of Investment. "They're snapping up the fine stock bargains available as a result of the emotionally inspired selling wave."

I am an oilman. Since the petroleum industry is the one I know best, I bought oil stocks. By the end of the New York Stock Exchange trading day on May 29, my brokers had purchased several tens of thousands of shares for my account. I hasten to emphasize that I bought the stocks for investment and not for speculation. I fully intend holding on to them, for I believe they will continue to increase in value over the years to come.

It has long been the custom for journalists and financial writers to interview successful businessmen and investors whenever there is an "unusual" stock market development. The opinions, information and advice gathered from these sources are then published, ostensibly for the guidance of less sophisticated investors.

For as long as I can remember, veteran businessmen and investors -- I among them -- have been warning about the dangers of irrational stock speculation and hammering away at the theme that stock certificates are deeds of ownership in business enterprises and not betting slips.

Shortly before the 1929 crash, such authorities as Bernard Baruch were widely quoted as warning that stocks were greatly overpriced. During the 1960--1962 bull market, experienced investors were openly saying that large segments of the market were overpriced, and institutional investors -- such as banks and mutual funds -- began to ease off on their common-stock holdings.

In an article published in this magazine in December 1961, Wall Street Is Not Monte Carlo, I sought to make the point that the stock exchange is no gambling casino. I urged that selected common stocks be purchased for investment when their prices were low, not after they had risen to high levels during an upward, bull-market spiral. I also tried to define the difference between the speculator and the investor by likening the former to an individual who makes risky bets on the weather, and the latter to someone who confidently banks on the climate. My contention was -- and is -- that it is entirely possible to make excellent profits in the stock market if one buys carefully to invest -- not to speculate.

Unfortunately, far too few people listen to such counsel; far too many purchase stocks only because they hope to get (continued on page 134) Wall Street in Crisis(continued from page 89) rich quick or make a fast killing.

Get-rich-quick schemes simply do not work. On the other hand, well-planned, long-range common-stock investment programs have excellent chances for success, provided one buys low and refuses to be panicked by tremors.

I began buying common stocks at the depths of the Depression. Prices were at rock-bottom lows, and there weren't many stock buyers around. Most people with money to invest were unable to see the forest of potential profit for the multitudinous trees of their largely baseless fears. I had confidence in the future of the American economy and realized that the shares of many entirely sound companies with fine potentials were selling at only a fraction of their true worth.

When I first bought Tide Water Associated Oil Company stock in 1932, its price was as low as $2.12 per share. The average per-share open-market price of the stock rose steadily, as shown below:

1933 $8.23

1934 9.39

1935 11.61

1936 15.54

1937 20.83

The price fell off during the 1938 slump, but this was just one of the expected tremors. I not only held on to the shares I owned, but bought more.

My confidence was fully justified in the years that followed as the value of the stock increased many, many times, and I -- along with all the other stock-holders -- also collected handsome dividends.

In May 1932, I also started purchasing Petroleum Corporation stock. In that month, I bought 10,000 shares at $3.45 per share. I continued to buy steadily until, by September 14, 1933, I held a total of 190,000 shares. In that month, the shares were worth nearly $15 each; the average per-share cost of my 190,000 shares was only $6.537.

I have reached back to the Depression era for two examples based on my own experiences. I could cite others from that period and from subsequent ones. Some stocks I own today are worth more than 100 times what I originally paid for them. But many other investors have had even greater successes. More examples would serve only to further underscore the same basic truth, one that every investor and would-be investor would do well to paste in his hat:

Sound stocks, purchased for investment when their prices are low and held for the long pull, are very likely to produce high profits through dividends and increases in value.

This is a self-evident "secret" of successful investment that vast numbers of people disregard. There are other not-so-secret secrets that investors would do well to learn and consider as inflexible rules in their stock market dealings.

Highly important among them is the axiom that no one should ever buy a stock without knowing as much as possible about the company that issues it. In more cases than legitimate brokers would care to count, such so-called investors have insisted on buying large numbers of shares in companies without having the foggiest notion of what those companies do or produce.

In my aforementioned Playboy article, I listed 10 questions to which the prospective investor should obtain satisfactory answers before investing his money in the stock of any company. These are as valid now as they were then, and will, perhaps, bear repeating here:

1. What is the issuing company's history -- is it a solid and reputable firm with seasoned, efficient management?

2. Is the company producing or dealing in goods or services for which there will be a continuing demand in the foreseeable future?

3. Is the company in a field that is not overcrowded, and is it in a satisfactory competitive position in that field?

4. Are company policies and operations farsighted and aggressive without calling for or involving unjustified and hazardous overexpansion?

5. Will the corporate balance sheet stand up under close scrutiny by a critical and impartial auditor?

6. Does the company have a satisfactory earnings record, and does the price of its stock bear a reasonable relationship to those earnings?

7. Have reasonable dividends been paid regularly, and, if some dividend payments were missed, was there good and sufficient reason and explanation?

8. Is the company well within safe limits insofar as both long- and short-term borrowing are concerned?

9. Has the course followed by the price of the company's stock over the last several years been fairly regular, without any violent, wide and apparently inexplicable swings?

10. Does the per-share value of the company's net realizable assets bear a favorable relationship to the per-share value of its common stock?

Many stock buyers failed to ask these questions during the last two years. In some cases, they bought the stocks of companies that had not paid dividends nor even shown a profit for some time. But the issues would "get hot," as speculators are wont to say, and multiply several times over their issue price within a matter of weeks or even days. Then, someone would realize that the heat was being generated solely by irrational buying -- and the prices would plummet.

Another valuable investment secret is that the owners of sound securities should never panic and unload their holdings when prices skid. Countless individuals have panicked during slumps, selling out when their stocks fell a few points, only to find that before long the prices were once more on their way up.

Unhappily enough, these basic principles of sound investment were flung out the window by the armies of amateur stock buyers who bid market prices up to dizzying heights during the lifespan of the late, great bull market. This widespread disavowal of all fiscal fundamentals helped set the stage for boom-and-bust.

In order to achieve any understanding of the whys and wherefores of the May 28, 1962, Wall Street price collapse, it is helpful to first quickly trace the course of the market over the last 12 years. The easiest way to do this is by following the Dow-Jones industrial average.

At the 1950 low, the Dow-Jones industrial average stood at 161.60. It climbed to 293.79 by the end of 1952, dropped to 255.49 in mid-1953, then climbed steadily to 521.04 in 1956, from which level it drifted down to around 420 at the end of 1957.

From 420 in 1957, the Dow-Jones average rose to well over 650 in 1959, made some up-and-down zigzags and hit a late-1960 low of 566.05. From that base, it shot up to an all-time peak of 734.91 on December 13, 1961.

As the bull market roared upward through 1961, Wall Street veterans dusted off the oft-quoted pre-1929 crash saying that the stock market was discounting not only the future, but the hereafter as well.

Many years ago, the per-share price us. per-share earnings ratio was widely -- though unofficially -- adopted as a reliable rule-of-thumb indicator of stock values. "Ten times earnings" was long considered the maximum permissible price one could pay for a stock and still reasonably expect to make a profit.

Then, in the late 1920s, GM-Du Pont's John J. Raskob -- whose outlook was judged quite bullish -- ventured the opinion that certain stocks might be worth as much as 15 times their per-share earnings. After the 1929 crash, ratios were, of course, very much lower and, even as late as 1950, the price-earnings ratios of the stocks listed in the Dow-Jones industrial index averaged out to about 6:1.

Views on the price-earnings ratio underwent considerable revision in recent years. Some knowledgeable investors allowed that in a rapidly burgeoning economy, stocks of especially healthy companies might reasonably sell for as much as 20 times their per-share earnings. Other professional investors argued persuasively that when healthy companies had tangible assets with net, per-share replacement or liquidation values in excess of per-share prices, the importance (continued on page 141) Wall Street In Crisis(continued from page 134) of the price-earnings ratio would logically dwindle.

But certainly no seasoned investor approved -- or even envisioned -- such situations as developed in 1960--1962, when frenzied buying drove prices so high that some issues were selling for more than 100 times their per-share earnings. In more than a few instances during the 1960--1962 period, staggering prices were paid for the stocks of companies that had only negligible assets, questionable potentials -- and that hadn't shown much in the way of profits for a considerable time.

It has been suggested that the boom that began in 1960 was caused by people buying stocks as a hedge against inflation. If this is true, the insane inflation of certain common-stock prices was an extremely odd way to go about it. But the hedge theory appears even less valid when one remembers that buyers consistently ignored many fine stocks that, by any standards of measurement, were underpriced and concentrated on certain issues, continuing to buy them after their prices had soared out of sight. All evidence inclines the observer to believe that the great mass of nonprofessional buyers was obeying a sort of herd instinct, following the crowd to snap up the popular issues without much regard for facts. Many people were doing their investment thinking -- if it can properly be called that -- with their emotions rather than with their heads. They looked for lightning-fast growth in stocks that were already priced higher than the limits of any genuine value levels to which they could conceivably grow in the foreseeable future.

It is an old Wall Street saw that the stock market will always find a reason for whatever it does -- after having done it. Innumerable theories have been advanced to explain why the market broke on May 28. The blame has been placed on everything from "selling waves by foreign speculators" to the Kennedy Administration's reaction to the aborted steel industry price increase -- in fact, on everything but the most obvious reasons.

The factors that bring on financial panics are many and varied. For example, in 1869, the cause was an attempted corner on gold. In 1873 and 1907, bank failures started the trouble. In 1929, the stock market was vastly overpriced, and the general state of American business and the rate of America's economic expansion were such as to justify little or none of the stock buying that carried prices to the towering peaks from which they inevitably had to fall.

Despite all the efforts that have been expended to draw a close parallel between the 1929 crash and the 1962 price break, the two have practically nothing in common.

True, some segments of the stock market were grossly overpriced in 1960--1962; far too many stocks were priced far too high. But the nation's business outlook was -- and is -- generally good in 1962, and the economy is expanding at a merry clip. There are no hidden, deep-down structural flaws in the economy such as there had been in 1929.

There are other great differences. In 1929, stock speculation was done mainly on borrowed money; shares were purchased on the most slender of margins. Thus, when prices collapsed, credit collapsed, too.

Then, of course, there is the most important difference of all, the one the calamity howlers conveniently forget. May 28, 1962, was not a crash. It was a healthy -- if somewhat violent -- adjustment that was long overdue.

As I've said, some stocks were selling for more than 100 times their earnings during the height of the 1960--1962 boom. Now, it would be at best difficult for a company to expand enough to justify stock prices that were, say, even 50 times the company's per-share earnings. Even assuming that every penny of the company's earnings were paid out in dividends to common-stock holders, the stockholders would still be receiving only a two-percent return on their investment. But if all earnings were distributed in dividends, there would be no money left for the company to spend on expansion. That, of course, would effectively eliminate any possibility of capital growth. Yet, even with these glaringly self-evident truths staring them in the face, people bought overpriced stocks.

Such were the difficult situations that developed -- and that caused the stock market to fall. Experienced investors should have been able to read the warning signals loud and clear long before the May 28 break took place.

As I stated previously, the Dow-Jones industrial average shot to its all-time high of 734.91 on December 13, 1961. The downward movement began immediately afterward and continued through December 1961 and January 1962. There was a brief recovery that continued until March, when the Dow-Jones average edged up over 720, but the graph line shows the recovery was an uncertain, faltering one. The downward trend was resumed in March -- and the graph line from then on makes a steep descent that is broken by only a few spasmodic upward jogs.

The May 28, 1962, price break had its beginnings in December 1961. The downward adjustment was badly needed and completely unavoidable. That it culminated in the sharp price plunge of May 28 is due to the emotional reaction -- verging on panic -- shown by inexperienced investors who were unable to realize that what was happening had to happen and, what was worse, who understood almost nothing of what was going on around them. To paraphrase Abraham Lincoln, all stock market investors cannot fool themselves all of the time. The awakening had to come -- and it did.

The anatomy of a stock market boom-and-bust such as the country is experiencing is not too difficult to analyze. The seeds of any bust are inherent in any boom that outstrips the pace of whatever solid factors gave it its impetus in the first place.

An old and rather corny comedy line has it that the only part of an automobile that cannot be made foolproof by a safety device is the nut that holds the wheel. By much the same token, there are no safeguards that can protect the emotional investor from himself.

Having bid the market up irrationally, these emotional investors became terrified and unloaded their holdings just as irrationally. Unfortunately, an emotionally inspired selling wave snowballs and carries with it the prices of all issues, even those that should be going up rather than down.

Withal, I believe it is absolutely essential for the American public to bear in mind that:

1. The nation's economy was relatively sound on Friday afternoon, May 25, 1962, when the New York Stock Exchange closed for the weekend.

2. The U.S. economy was just as sound on the following Monday morning, when the stock exchange reopened.

3. The economy was basically no less sound when trading ended on that hectic Monday. If anything, it was on firmer ground than before because stock prices had been brought down. Few -- if any -- industrial orders were canceled. Few -- if any -- jobs were lost. Few -- if any -- business establishments were forced to close their doors. Few -- if any -- investors, large or small, were completely wiped out as so many had been in 1929.

I realize that all this is scant comfort to those who lost money when stock prices fell on May 28. It can only be hoped that they will profit from the painful lesson.

The wise investor will recognize that many stocks being offered on the market are still considerably underpriced. For example, there are many issues selling for as little as one third or even one fourth the net, per-share liquidation values of the issuing company's assets. To understand what this can mean to the stockholder, consider the case of the Honolulu Oil Company.

Several months ago, the directors and stockholders of the Honolulu Oil Company decided for reasons of their own to dissolve the company. One of my companies, Tidewater Oil, and another oil company learned of this decision and together signified their desire to buy Honolulu Oil's assets.

The stockholders of Honolulu Oil had their choice of two ways in which they could sell their company's assets. First, they could sell their stock to the two buying companies. Or, alternatively, they could hold their stock, sell the actual assets and distribute the proceeds among themselves before formally dissolving their company.

Honolulu Oil's shareholders chose the latter method. The company's stock was selling at around $30 per share -- but, so valuable were its tangible assets, that the price Tidewater Oil and the other buying company paid for them worked out to about $100 per share. This, of course, was the sum each Honolulu stockholder received for each share he held when the company was dissolved. In other words, the cash value of Honolulu Oil's assets was more than three times as much as the total value of its issued stock.

Naturally, shareholders can reap this particular type of windfall profit only when the company concerned is dissolved. But it should be plain to see how much added safety there is in investing in a company that has tangible assets with a net liquidation value greater than the value of its stock. If, as an example, the net liquidation value is three times that of the stock, then, in effect, each dollar of the stockholder's investment is secured by three dollars' worth of realizable assets.

There are more such companies than one might imagine. They can be found in various industries, but I am most familiar with companies in the petroleum industry and, more particularly, with those engaged in the business of producing oil.

Several oil stocks issued by sound, thriving companies are selling at prices well within any reasonable price-earnings ratio limits. They are among the nonglamor issues that, for some reason, were largely overlooked by the buying public during the height of the 1960--1962 boom. Some of these oil companies also have tangible assets worth three, four and even more times the total value of their issued stock. It might be of interest to consider just one reason why this is so. Producing oil companies normally carry their oil and gas leases at cost on their balance sheets. A lease for which a company paid, say, $25,000 is carried at that figure even though it covers a property on which the proven crude-oil reserves in place are, as is entirely possible, 50,000,000 barrels.

On the books, the lease is shown as an asset worth $25,000, even though any other producing oil company would gladly pay several million dollars to take it over. The implications of this bit of oil-business accounting intelligence will not be lost on the alert investor.

Similar situations exist in many other industries, and the astute investor will find them and profit from them. A cursory glance at New York Stock Exchange listings at the time this article is written shows that there are nearly 60 stocks in various industries paying five percent or more in dividends. As this is written, the giant Bethlehem Steel Company's dividend rate is 6.4 percent; the Chesapeake & Ohio Railroad's rate is almost eight percent.

My own confidence in the stock market has not been shaken by the May 28 price break nor by later drops. I am still a heavy investor in common stocks. I'm still banking -- to the tune of many millions of dollars -- on the healthy climate of the American economy and the bright future of American business.

This, in essence, is the only advice and counsel a successful, experienced investor can give to anyone who wishes to reap the benefits of a boom and to avoid the losses of a bust.