ultimately the collapse of all but a handful of companies. Even those that survived and prospered (RCA) often took many years to reach their earlier highs.
From an investor’s standpoint, the issue is not whether these industries are new or even revolutionary. The issues should be: 1) which companies are going to earn significant money, 2) when are they going to make it, 3) how certain is one about the five year outlook, 4) and how much does one have to pay for those future earnings. Warren Buffett recently pointed out that after many decades of “wonderful economic development” in the U.S., that there were approximately 400 companies earning $200 million or more after taxes per year. This is about the earnings level necessary to justify a $3.0 billion market capitalization. He goes on to suggest that maybe in five years there will be 450 companies earning $200 million after tax, many of those will be companies earning between $150-$200 million today. Thus in five years perhaps an additional twenty or so companies will come from today’s small or development stage companies. Yet the current market has dozens and dozens of companies in the high tech area alone with market capitalizations of over $3.0 billion. Many newly minted initial public offerings are getting $3.0 billion the day they come out. This is simply not sustainable, and many will be disappointed. Again, I can’t resist borrowing from Chancellor’s book. Quoting from a letter written to the Financial Times at the height of the railway speculative mania:
“There is not a single dabbler in Script who does not steadfastly believe- first, that a crash sooner or later, is inevitable; and, secondly, that he himself will
escape it. When the luck turns, and the crack play is sauve qui peut , or devil take the hindmost, no one fancies that the last mail train from Panic station will leave him behind. In this, as in other respects, ‘ Men deem all men mortal but themselves’.”
The present fixation on trend following, or as its euphemistically known “momentum investing”, has produced some startling statistics. A recent study by the brokerage firm Sanford C. Bernstein analyzed recent data from the NYSE and NASDAQ. The study pointed out that last year 79% of NYSE listed shares, and 200% of the NASQAQ base traded hands last year. In the 50 most heavily traded NASDAQ shares, the average holding period was just three weeks. Does anyone think that business fundamentals change that quickly, or are many engaged in what the economist John Maynard Keynes described when discussing stock market speculation as having “reached the third degree where we devote our intelligences to anticipating what average opinion expects the average opinion to be.”
That stock prices ultimately reflect a business’s earnings or cash flow generation is axiomatic. Stock price behavior in the short term and even the medium term is subject to the vagaries of the market. Tastes, beliefs, sentiment, in short a variety of emotional factors often influence prices. But in the end, it is free cash flow available for a company’s shareholders that matters.
Many of our shareholdings and those associated with the “old economy” fared poorly last year, and the trend continues into this year. These companies operate in areas with high barriers to entry, have long records of high earnings growth, and are leaders in their industry. Some are companies that have had temporary earnings declines, but are