Do You Want to Make Money or Would You Rather Fool Around?

In the early Sixties I was being trained on Wall Street to be a stockbroker. Only Merrill Lynch had a formal training program in those days; everyone else seemed to believe in on-the-job training. Boardrooms were where all the brokers sat surrounded by customers, many of whom were regulars. The customers spent part of every day watching the ticker tape parade by on the wall and trading stocks and stories. Brokerage offices were like social clubs. Broker and client knew each other. A stockbroker was often a family counselor and friend. The clients would come into the boardrooms as they would a neighborhood bar like Cheers: a place to be social, a place to keep warm, a place where everybody knows your name.

Big Arthur was a boardroom regular, a shoe dog by trade--a salesman of women's shoes. Whenever he wasn't on the road for his company, he sat in the front row, a row reserved for customers. And he traded stocks. Every day that he saw me, he'd say the same thing. "Don't get old. Whatever you do, don't get old." Then he'd pat an empty seat next to him. "Sit with me, kid. What good is life if you can't lie to the next generation?" Big Arthur wore English-cut suits and highly polished shoes. "Dress British, think Yiddish," he told me. "Contrast is everything in life. I act different than I dress, so it always surprises people. If you surprise people they usually like having you around. When my father brought us here from a little village outside of (continued on page 116)Make Money(continued from page 112) Kraków, he told me to lose the ghetto and become American. This is what I have tried to do. He also told me never to lose the kopf"--the head. But Big Arthur would never stay in a stock for more than two weeks. He'd make a few bucks, lose a few bucks.

"You can never really make any money that way," I said to him--after I had known him long enough to dare a suggestion of my own.

"I've already made my money," he replied. "But let me tell you something. In my business, the shoe business, they say the smell of leather keeps us together. We gamble every day on style and price and a million other things. There is no such thing as an easy business. Only from the outside does anything appear to be easy. Trading the market is entertainment for me, a place to screw around, a little kibitz, as they say."

"I could tell you about a stock that I think can double in two years," I said.

He looked at me and smiled. "How do I know I'm going to live that long?" Because of Arthur, I have asked every prospective client who comes into my office, "Are you serious about making money, or do you just want to fool around?" You'd be amazed at the number of people who have to think awhile before answering.

A crisis I was witness to that reinforces the importance of knowing history was the assassination of John F. Kennedy in November 1963. By then I was a practicing stockbroker, living at my parents' house. But the resident manager kept me on a modest salary as well ($85 a week), to fill in for the teletype operator and to do odd jobs--like changing the cellophane tape on the Translux ticker machines that ran all day, printing the trades on the New York Stock Exchange. In those days, rolls of tape were changed manually, and ink cartridges were inserted into slots so that the printing action became legible. Changing the rolls and ink cartridges was part of my job. (And I have always been a mechanically challenged person.) Virtually every day I would go home with blue ink up to my elbows. "I've heard of blue-collar workers, but this is just ridiculous," my mother would say.

"The resident manager says it builds character to know all the jobs in the office," I would tell her. "And the $85 a week is gravy." "The gravy is on your tie," she would say. Mother always got the last word.

I was changing the ink rolls when the rumor first broke about JFK. The brokers began screaming at me, "Get those inkers in. We can't see." The ticker tape was running with indistinct images: They needed the ink man to make the numbers real. And the numbers were falling as the rumors of the shooting became fact. Most people, I believe, when facing chaos, think of self-preservation. Heroes are the ones who look to save others. The brokers were still yelling, people from other offices on our floor streamed into our boardroom to watch the falling market, everyone was shocked by the news, gathering to be reassured by human contact. I was a rookie at this point in my career, and with panic building around me, my initial reaction was: It's over--my brief career, the stock market, the country in turmoil. The resident manager beckoned me with a finger into his office.

"You think that it's over, don't you?" he said.

"I really don't know what to think."

"Did you ever take an American history course?"

I admitted I had.

"Then you have to step back and recognize that we have this wonderful thing called a Constitution. This incredible event will pass as far as the markets are concerned. We have succession in place, and form, and people of enormous goodwill. Always bet against the crowd. There is a poet named David McCord who wrote this about Harvard:

" 'Is that you, John Harvard? I said to his statue. Aye, that's me, said John, and after you're gone.'

"It's true about Harvard," the manager said. "And it's true about America. Be a buyer."

That lesson has been fundamental in my investment decisions and should be equally fundamental in yours. Go against the popular mood when there is desperation around you.

I had another lesson that day, almost the flip side of being a buyer in chaotic times. A young client of mine came into the office, someone my mother would have called swervy. He had been a lacrosse player in college, with a reputation for dirty play.

"Kennedy's been shot," he said.

"It's unbelievable," I answered.

"What can we sell short?" he asked. "Chance here to make a score."

I recalled the Rothschilds' getting carrier pigeon reports of the Duke of Wellington's victory at Waterloo and going long on the British pound before the world knew the results of that battle. Would the SEC have called that inside information?

But I stared at my client, not really believing he had suggested selling short (betting against the market) at such an emotional time.

"I don't want your business," I said.

"You're a sucker," he said. "Suckers don't win ball games." And he walked out. I was a young broker, naive, perhaps, but it was my first brush with immorality in business. I told the resident partner about it and he smiled. "You lose your virginity, I think, three times in life," he said. "The first is when you lose it in the physical sense. The second, like today, is in a business sense, and you realize the world is not necessarily an honorable place."

"And the third?" I asked.

"Don't call me a cynic, but the third time you lose your virginity is the day you get married. You'll see what I mean." And he went back to his battle station on the phones.

The Second Part of the Trade

There are two parts to every sell decision when you plan to get out of a stock. The first is, at what price do I exit this stock position? The second part, and almost as important, is, what do I do with the money when I sell? Few people pay attention to the second part.

I have a friend who bought Exxon several years ago at 40, for all the right reasons, I thought. He figured the company was well managed, paid a good dividend and was positioned to serve the growing worldwide demand for energy that my friend believed would kick in as countries moved toward free markets. After he held it for several years the stock moved into the high 60s.

"I want to sell Exxon," my friend said. "I have a good profit. Bulls make money; bears can make money. Pigs never make money."

"Ah," I told him, "the old cliché. But you know, pigs often make more money than anyone else. They are not afraid to take a large position and ride it. Warren Buffett is essentially a pig by this definition." Warren Buffett is the second wealthiest American after Bill Gates.

My friend sold his Exxon at 66, paid his taxes and within a week bought Apple Computer at 33. "It's down from the 60s. I think it's cheap. Also," he reasoned, "I sold 1000 Exxon and bought 2000 Apple--same amount of money, double the amount of stock." Exxon subsequently moved on to all-time-high prices and paid a healthy dividend to boot. Apple dropped over the next year and a half to 14 and pays nothing. My friend's maneuver is comparable to quitting a job before you have a plan for the next one. When you make a decision to sell a stock, think about the second part of the transaction: What do I do with the (continued on page 122)Make Money (continued from page 116) money after I sell? And ask yourself this question: Is what I do with the proceeds going to be half as good as holding the stock I'm selling? Most of the time it isn't.

Selling Short

I'm an optimist. I believe that good things can come from bad events. This includes the stock market. I have some 1700 clients around the world. No more than one of these people ever sells a stock short in the space of a year. Why is this? Investors are optimistic people--they like betting for things, not against them. They particularly like betting on themselves. "I don't like wishing for things or people to fail," people say when asked about short selling. But it is a tool worth knowing about if you wish to have a full picture of your financial choices. Short selling is the mirror image of buying a stock and hoping it appreciates (going long). If you buy a hundred shares of a stock at 20 and sell it at 30, your profit is ten points, or $1000 before taxes and fees. If you sell 100 shares of stock short at 30, you borrow 100 shares from your broker to deliver to the buyer. If it drops ten points, you buy it in, closing the transaction. Then you deliver the bought-in shares to the broker you borrowed from. It dropped ten points, and $1000 profit is credited to your account (again minus taxes and fees). Professional traders short stocks all the time.

Here's how you can use this technique: You know you want to own superior companies like Procter and Gamble, Exxon or J.P. Morgan. And you hope to prosper with those companies for years. You occasionally want to own companies you have a strong feeling about, such as Ralph Lauren, Staples or Starbucks, because you use and like their products or services.

What if you have a bad experience with a company, its products or services? If you reward good companies by becoming a co-owner (with, other shareholders), how about punishing corporations that don't fulfill your expectations? Most of the time, your instincts will be shared by others. The stocks you admire will eventually go up and the stocks you don't will decline.

Don't spend your life looking in the rearview mirror. Recently I bought a computer for my business, a Compaq with all the bells and whistles. I was advised by my staff about the products, and they purchased everything from Comp USA. The total bill was $2700. After the equipment was delivered, it seemed the PC was missing a sound card. Could we get Comp USA to address the problem? There followed five days of waiting on hold for half-hour stretches, then runarounds and buck-passing. "Tell them I'm canceling the order," I told my crew. "Let them come and pick it up." When we told them we were canceling, we finally got service. But the experience was disenchanting, to say the least. I could have bought a computer at a dozen places. So if they were selling service, Comp USA was a disaster. I inferred that if I was having problems with Comp USA, many other people were probably in the same boat. I told my staff, "I'm going to pay for the computer by shorting Comp USA stock." I sold short 500 shares at $35 a share and within three weeks covered the stock, closed out my short position at 28-1/4, for a profit of approximately $3500. Of course I have to eventually figure in the tax on my profit. But I turned a bad experience into a happy and profitable one. And I got a good story out of it as well--a psychic victory I could share with others. "Let's go for the laptop now," I told my crew, and when the stock ran up again to $36 or so, I shorted 600 shares, covering again around 31-1/4 in less than two weeks. We're getting there, as far as the laptop is concerned. But I'm probably not going to short the stock again for myself. You have to be careful about being too greedy.

I had a purpose in shorting Comp USA. And I had a target. A few months after I covered the shorts, the stock sold down to the high teens, eventually going below 8. But the principle was the lesson here. You can watch for areas in business that disappoint you and profit from them.

Trust Your Instincts

I would rather do my own research on companies, independent from what management of the companies tells me. Chief executives of public companies are cheerleaders for their own regimes. They tell you optimistic news because they desperately want their predictions to come true. May of my biggest mistakes have come from being too close to management. Once, a president of a direct mail company told me, "We're going to be a $100 stock." The company was selling for 8-1/2. He was offended when I said to him, "I'd settle for 20."

"You've got no vision, son," he said. "That's why you're a stockbroker and I run my own business." I went to the parking lot after seeing the president, and pulling in next to my car were two employees in a company station wagon. "I manage people's money," I said to them, "and I'm thinking about buying stock in your corporation. How do you like working here?"

The first employee said, "They treat us like mushrooms in this company."

"Yeah," said the second employee. "Kept in the dark and covered with shit."

"And management grabs with both hands," added the first. "Not much trickles down to us. I'd sell it short if I were you."

Often you get misinformation from both management and employees. The boss is only optimistic. The workers see only the warts. Same company. When I get a chance to talk to management I always seek out an employee or two to hear the other side of the story. It helps in evaluating the investment possibilities.

Have you noticed articles in magazines and newspapers in the past several years about the so-called paperless society? Like world peace and loving your neighbor, this is a dream that is probably unreachable. When I was talking to a thoughtful friend about this subject, he said to me, "Do you know about Iron Mountain?"

"Is it a novel by Thomas Mann?" I asked.

He looked down his nose at me. "It's the largest records-management business in America." Iron Mountain's revenues exceed $400 million a year. I believe in eyes-and-ears investing, popularized by Peter Lynch. I came back from lunch with my friend that day and found an intern in my office sitting at a desk surrounded by annual reports stacked so high they almost obscured him from view. "What the hell is this?" I asked my crew.

"A new rule," they said. "Any company we invest in, we have to keep the annual reports on file for five years."

"That's ridiculous," I said. They shrugged, used to my railings against bureaucracy. Go to any law firm or corporate office, and you'll find them drowning in paper. Much of this volume has to be saved for X number of years, a requirement of the IRS and other government agencies. Iron Mountain fills an extraordinary need in society. Companies and individuals have their documents picked up by the storage company, paying rent every month while the paper continues to mount. What about microfilming everything? This solution is years away from being practical. Meanwhile, Iron Mountain continues to buy up storage companies around the country and abroad, growing by acquisition, installing its systems and quietly building an empire.

I see Iron Mountain trucks on the streets of my city. Several times I have stopped to talk with the drivers. "How long have you worked for the company?" (continued on page 153) Make Money (continued from page 122) I've asked. "How do they treat their employees?" In all cases I got wonderful reports about the decency of management and the work ethic it fosters. The trucks are always spotless, as contrasted with one of their competitors, whose vehicles seem ill maintained. I like to invest in companies that reflect pride in what they do. I bought the stock at $12. It now sells at $29 and the reasons I bought it are just as compelling today.

The Most Hated Companies

These stories and themes bear repeating, particularly when the timing seems right. I often believe in going against the grain of popular investment thought. I believe in being a contrarian. If you take this route in investments, or in life in general, you stand the risk of being wrong, sometimes for long periods, until the crowd turns your way. But when it does turn your way, prices almost always go much higher than the average smart person expects.

A classic example from several years ago is drug stocks, vilified and shunned by most of Wall Street when Hillary Clinton and Ira Magaziner were addressing (to the investment community's horror) the issue of health-care reform.

I was buying Merck in the high teens (recently above 70), and Bristol-Myers around 15 (recently at 70), when Bristol was even yielding on its dividend alone in the five percent range. "How can you be buying the drug stocks?" clients asked. "They've lost their pricing power. It's all over."

"Open your eyes and look around," I said. "I'm getting at least five calls a week to look into long-term health care (nursing homes and the like) for my clients and/or their parents and grandparents. Demographics say that the elderly are growing exponentially in number, they all take drugs in increasing amounts and they're living longer. Every day the drug companies come out with new remedies for what ails us, and it's a whole lot cheaper to take a pill than to be hospitalized. And I'm excited because I can buy these companies so cheaply."

Merck, for example, has more than quadrupled in the past four years. When certain stock groups are out of favor, the reverse is true: They almost always go lower than even smart people would imagine. Over the years, knowing the psychological nature of market behavior, I've tried to nibble at my favorite areas, buying them slowly and holding cash back to take advantage of even lower prices if they occur. For instance, if I like a beaten-down stock and it's selling for $20, I'm disciplined enough to say, "I am going to buy 1000 shares for myself," and then buy 300 shares. One almost never buys at the lowest point unless it is, as I call it, dumb-ass luck. Usually the stock trades lower sometime later, and I will add to my holdings gently, perhaps 100 shares at a time, until I lower my cost average. And eventually I accumulate my 1000 shares. If you have an investment portfolio, always make sure you have flexibility--that is, some cash on the side. If your funds are completely committed to the market, you cannot add to your holdings when prices decrease.

What happens to the most hated companies? Often a catalyst comes in, most likely in the form of new management that intends to revitalize the dormant company. In the past several years this has happened at IBM, American Express, Time Warner and AT&T--companies that were reviled on Wall Street and, if accumulated during their years in the desert, turned out to be major winners.

Another part of this discussion is the squeeze syndrome--when you desperately need money for taxes, or tuition, or any variety of pressing reasons and you have to sell stocks to raise the cash. When you need to liquidate almost anything, you'll get the worst prices. It's like needing a job. When you desperately want employment, the interviewer can usually spot your desperation. When you act as if it's the last thing you need, when you're confident and loose, you project that attitude and suddenly everyone wants you. Life is not fair, of course. So you know that when you're squeezed for funds, your stocks will be at fire-sale prices. That's the squeeze syndrome.

The Judicious use of Margin Debt

Most people who own homes have mortgages. And they have credit card debt. Seldom do people who maintain stock and bond portfolios incur any margin debt from borrowing against their accounts. But this borrowing can sometimes be a useful tool.

Say you need $15,000 for a tax payment and you have a $100,000 portfolio of stocks and bonds. I might say, "Don't sell anything now to raise the $15,000. It will diminish the value of your holdings to $85,000 and probably result in capital gains taxes on what you're selling--a double whammy. Temporarily borrow the $15,000 (you can borrow up to half of your portfolio value and get the funds immediately if you sign a simple margin agreement). This borrowing ensures a couple of things: You continue to get all your dividends and interest on the $100,000 value, because you haven't sold anything, and you are charged interest on the loan, typically about a point over the prime rate, which accrues on your account. You do not need to send in a monthly check. And you receive an offsetting credit for your margin interest against any dividend or interest you receive, so there is some tax benefit from the borrowing."

The kicker here is that I expect, in managing my clients' money this way, to repay the borrowings from assets that are appreciating. If the portfolio increases in value, I will get the debit balance down, selling dribs and drabs from each position so as to be conscious of the tax implications. I have done this successfully for years, not going overboard in borrowing, as that may jeopardize the account, but meeting emergencies with common sense and using the clients' assets to their advantage. This process takes constant attention on the part of anyone who is watching your money.

Bellwethers in the Marketplace

There is a famous story, perhaps apocryphal, about the market. Supposedly, in 1929, Joe Kennedy was having his shoes shined on Wall Street. The man doing the shining was holding forth on his own market performance and his current favorites. Kennedy went right from his shine to his office and heavily sold the market short and made a killing during the crash of 1929. The obvious lesson is that when the shoeshine boys are playing the market and winning, it's time to head for the exits. Everyone who watches the money of others has favorite superstitious signals for the tops and bottoms of market cycles. I have had dozens of clients over the years who think they are unique in saying, "You want to make money in the market? I have a foolproof formula: Just do the opposite of everything I do." These people, of course, are trying to ward off the evil eye. They don't really mean it and they aren't really signals for the top. Signals come from people who act contrarily to their usual behavior. For instance, a woman in Oregon, a client of mine for 20 years, called me when the Dow Jones industrial average was flirting with 10,000. She had never called me before. Her husband, a doctor, had always checked in, assessing the health of the family portfolio. "I've never taken much interest in finances," she said to me, "but I've just joined an investment club and I'm curious about some issues." I'm happy she's becoming interested. But at 10,000 on the Dow? This was a classic sign of being close to a top. In the summer of 1998, I saw people whose children were out of the house moving from the suburbs into the city. Because of the growth of their stock accounts in the past few years, these people were priding themselves on paying more than the asking prices for houses and condos. One man moved into town and, in a sealed bid, offered $250,000 more than the asking price for an apartment. "Hey, location, location," he told me, "It it's a primo building, I can't ever lose money." From 1990 until the past several years, you couldn't give apartments away, or sell commercial space at premium prices. Americans, more than any people on earth, forget pain as soon as it disappears. All memory of gas lines, recessions, wars, the daily obsessions with money supply or the Nikkei average is gone. We are natural optimists, which, as a national characteristic, is wonderful. But never say never, or think that this time it's different. It's not. Look for your bellwether signs.

When money seemingly has no meaning and is being thrown at goods--houses, art, common stock--we are heading for a painful adjustment. It's just a question of when. Remember, trends run much longer in both directions than the average person thinks they will.

Signs of junctures in markets correspond with people's mood swings and with pronouncements such as "IBM will never come back," or "American Express can never recover." Same for Chrysler, banks, drugs, Union Carbide after Bhopal. Con Ed after it cut its dividend long ago, and endless other stocks that were once declared dead. Another classic sign of a top is when the investment business is the first career choice for Harvard Business School grads. Remember that human nature never changes--only buzzwords do.

Your Stake in Life Stock

I frequently hear variations on this story: "I inherited all this Coca-Cola"--or Eli Lilly or Gillette, or some other splendid company--stock from my grandfather, and I took it to my friends at the local bank. They have a trust department. They told me that I had much too much Coca-Cola, that I was too concentrated and that I had to diversify."

"It's too risky," the bankers said, "for you to have all those eggs in one basket. Sell at least half the Coca-Cola stock and spread the proceeds over a variety of investments."

I say this is bad advice. Fifteen years ago I was given a perk by my company--free counseling from an expensive firm that did executive planning. At the time I had a good deal of my net worth in American Express stock (indeed, it represented the largest part of my assets outside of personal real estate). After looking over my financial situation, my young counselor told me, "The first thing you have got to do is diversify. You have way too much American Express."

"Are you rich?" I asked him.

"Not yet," he admitted. "But I have high hopes."

"Well," I said, "I'll tell you something that my father told me. The only way you can get truly rich in our society is to own a business that can be sold, potentially for a lot of money. No matter how much you make in annual salary, you're going to spend it or have the rest, of it taxed. You'll never accumulate enough to be rich. If you don't own your own business, you have to own enough stock in a public company to set you free when and if the stock moves up substantially in price. I believe in American Express," I told the counselor. "It's tough to kill a great name, no matter how hard management may try to. I don't want to work this hard forever. So I'm not selling any of my American Express. As a matter of fact, I'll keep accumulating it on weakness."

That's what I told the counselor who advised me to diversify. The stock was then around $35 a share; recently it sold for $125, not counting dividends of 90 cents per share, or the spinoff of Lehman Brothers stock, then at around $20, which now sells at over $70 a share. So much for diversification.

Years ago I called this process having your Stake in Life stock. It is a way to have your own company. It is your opportunity to build a real net worth in the stock market through concentration.

For years, every time I would see an enormous portfolio, it was almost always an estate that came in for me to liquidate. These estates usually had a sampling of wonderful companies that had been bought for pennies a share (adjusted for splits), and they had never been sold over many years of ownership. This experience taught me a lesson: You can accumulate great wealth if you buy the best companies and hold them, if you do not trade them in for other merchandise.

Refining this further, I believe that to structure the ideal financial life you should identify, as early in your working life as possible, one or two companies that you believe in for the fixture. I don't care what those companies are, but they should share certain characteristics:

(1) They should have universal appeal, like GE or Gillette or McDonald's.

(2) They should have instant namebrand identification, like Coca-Cola or Microsoft.

(3) You should dispassionately believe that the products or services these companies provide will continue to be in demand for years to come--products or services you and your family find special.

Start to buy one of your choices, even in small amounts, through stock discounters so that it is a low-cost enterprise. Reinvest the dividends in stock if you can. Treat this exercise like a savings account, contributing the same amount every month, or on a special date like a birthday.

Every time the stock goes down 15 or 20 percent (and there will be plenty of times like that over the years), you should buy more. This takes discipline. And the smartest among you, when the market dips, will shout, "Hooray! Now I can add to my Stake in Life company at bargain prices."

Your Stake in Life stock is not for sale, unless some predator takes it off your hands in a buyout. But by then it will undoubtedly be a long-term capital gain and you can begin the hunt for the next gem.

Your very few Stake in Life stocks form the core of your holdings. Everything else will build around this core: bonds, preferred stocks, the common stocks that you will buy and sell at various times.

Of course, the more of something you hold, the higher the risk. But as a wealth-building strategy, concentration over time with well-thought-out companies can set you free.