Thursday, March 19, 2009

Cheap Marble

I was telling my friend Tony Blankley about the depressed state of the stock market these days, and my belief that some stocks, already “bargains,” will be unprecedented investment opportunities when the economy does turn around at some unspecified in the (far?) future.

“There was a lot of cheap marble available after Rome fell," Tony replied with his usual wry wit.

“Yes,” I then said to Tony, “ but many years later, your former countryman Lord Elgin (and many others from several other countries) found that “cheap” marble so valuable they acquired as much as they could and carted it back to their home countries.”

Each of us has a point.

Tony is right that, no matter how high the current dividend and how low the current earnings per share, the “real” value of a stock investment made today depends on the dividend being maintained, and the prospects of the company making profits ahead.

I am reminded of my first class in an economics course I took at the Wharton School of Economics many years ago. The professor, who had also written the course book we used, began the class by saying, “You’re going to hear and read a lot about finance and investments in the next few years here, but I am going to tell you something in one sentence that you should always remember.”

We all held our breaths.

He then said: “The price of a stock is the anticipation of future earnings.”

As I remember, many of us students looked at each other with anticlimactic frowns, disappointed that some arcane and mysterious truth had not been given to us.

And yet here I am, many decades later, repeating his words with the experience of not a little investment of my own that has borne them out over the years, and made them particularly appropriate just now.

My point is that there are some stocks out there paying huge dividends (12% or more), selling at very low earnings per share multiples (five times earnings or less), AND holding cash that is near (or even in excess) of their current capitalization (or total value of the stock). How can you go wrong with a stock like that?

Tony’s point is that you could go wrong if our current economic straits don’t improve because the current “stimulus” and “bailout” strategies being legislated by the Congress at the urging of the Obama administration don’t work. (I for one don’t think they can.) Then earnings would fall, dividends would be lowered or eliminated, and cash would be devalued by accompanying inflation. (Inflation happens when the government prints lots of money to pay for stimulus projects and to bail out banks, failed investors and industries.)

There is a lot of neo-socialist rhetorical nonsense going around these days asserting that the current crisis demonstrates that capitalism has failed. Nothing could be further from the truth. In fact, it was the free market which finally blew the whistle on the phony mortgage banking system and caused it to crash. It was not capitalism that collapsed, it was a corrupted banking system that employed unintelligible instruments such as derivatives poorly understood by most of those who managed and invested in them; and enabled a few scoundrels and charlatans to steal money from trusting investors. Incompetence, lack of diligence and greed has abounded, but it was not a whistleblower who broke the news to the public, it was the free market system itself through the stock market and other institutions which did so.

Mr. Harry Markopolous of Erie, Pennsylvania did warn about the Madoff fraud years in advance, but no one with power over the stock market (in both the Clinton and Bush administrations) paid any attention to him. It was only after the stock market declined and individual investors needed cash that the fake scheme was revealed. (Similar but smaller frauds are now being revealed worldwide.) Many “whistleblowers” (and even some elected officials) warned for years that Fannie Mae loans were unsound, but it took the stock market correction and the economic downturn to demonstrate in concrete terms that this was so.

While we can’t be critical enough of the incompetent government, banking and investment bureaucrats who allowed the current state of affairs to happen, we cannot avoid placing a fair and proper responsibility in the current crisis on the public at large which took easy money, reckless credit and cheap promises uncritically and at face value.

A free market has no emotions. The failures and emotions are supplied by individuals, the small number in charge and the many who invest. Our economy is still the most vital in the world, and our system is the best yet devised. We must fix its shortcomings and defects, punish wrongdoers, and protect the public as best we can. I think the Obama administration wants to do the right thing and help people, but the current stimulus and bailouts strategies actually make the economic crisis worse. The free market is already telling us this, and eventually the president and the Congress will have to listen to it.

Meanwhile, there is plenty of cheap marble around. I’m skeptical about the short term, but my inherent optimism tells me a time for positive new investment and growth will return. Meanwhile, caution and skepticism needs to replace blind trust if the system which brought us to prosperity is allowed to repair and revive itself.

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