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Old Book, New Cover

Jeff Bronchick

It is actually difficult to write investment columns in the midst of very tumultuous financial markets.

First off, is anyone else as sick as I am of every newspaper and news show restating the obvious cliches every time the market has a big day up or down? You know the drill: A pair of analysts are trotted out to opine whether the market will go down further, or rebound due to "bargain hunting." The obligatory stock recommendations are proffered with one-line explanations.

You very rarely hear the big "Who knows?" to which I would now like to attach my name. Do I have any idea whether this is a sharp two-week disaster and can be bought? I have no idea. Do I have any idea whether this 19-year bull market is officially over? Not a clue.

What I do know is that there were a lot of stocks that were both hugely over- and under-valued prior to the pain of the past few weeks and there has still been only a dent in the former. There are still plenty of things to buy that make sense and plenty of things to sell or avoid that make little sense. The "end of the beginning" seems like a popular refrain; but that, in my humble opinion, is a gross understatement. Here are some of my random thoughts:

• The more I see, the more the "New Economy" theme looks like the same old stuff: a few hugely successful companies spawning dozens of poorly equipped imitators, with the investment banks doing their duty to whip up enthusiasm to the nth degree. This is not about young people with goatees changing the world: this is once again about money. Let me say that, again, this is about money: Making it -- and worrying about missing out on making it. Funny how the papers are now full of stories of resumes surfacing from companies whose stock options are now hopelessly under water: So much for changing the world. Wall Street has a knack for ruining perfectly good ideas by throwing too much money at it and for the nth time, here we are again.
• While it is popular to say that many dot-com companies are down -- take your pick, 60%, 70%, 80% from their highs -- that is truly meaningless, as the highs were as nonsensical as some of the bedtime stories I am now reading to my twin girls. There is nothing more dangerous to your financial health than to buy a stock because it is x% off its high. If you manage to find a good short-seller, ask where he makes most of his money: It's on the last 10 points to zero.
• Speaking of which, explain this to me if you can. The basis of an audit of financial statements is predicated on the assumption that the auditee is a "going concern." Drkoop.com (KOOP Quote), Peapod.com (PPOD Quote), etc., etc. are now having their auditors reviewing their financial statements with "substantial doubts" as to their survival, due to limited cash on hand and a huge negative cash flow. In other words, unless there is an infusion of cash, the company will go out of business. Aren't there dozens of dot-com companies that are in the same predicament? What kind of pressure are their auditors under not to give their financial statements the "Don Corleone kiss of death?"
• Doesn't anyone remember the 1980's version of the dot-com financing model: payment-in-kind, or PIK, bonds? That was when corporate management, with the willing help of the investment banking community, financed deals with debt that paid bondholders with further bonds rather than cash interest -- for the simple reason that they didn't have the cash. The premise was that by the time the bonds turned cash-paying, they would simply be refinanced, making maturity and repayment an abstract and old-fashioned concept.
• What is so different about going public with a business plan that explicitly recognizes the need for further financing -- not to ramp up growth -- but simply in order to survive? The old adage of "raise money when you can -- not when you have to," has clearly driven much of the recent financing mania. Wasn't it just two years ago, in the midst of what I like to call the Asian-Connecticut crisis, that people were reminded once again that liquidity is not always a faithful spouse?
• This now brings us to a theme in the investing world that has be very common over the past two years. Otherwise intelligent people (some perhaps fearing for survival, others laboring under the burden of investment jealously) bought stocks that they admitted made no sense at the time. They thought they would only hold them until the game changed. I've got a box full of emails elaborating on this theory. I know the following is a cliche, but it's still a good one: "Sell to whom?" How can everyone get out at once? They can't -- and those that try get crushed in the rush to stick fleeing market-makers with unwanted goods.
• All of which makes the argument that stocks deserve little or zero-risk premium relative to Treasuries a cruel joke. Doesn't the risk of zero access to the capital markets necessitate some risk premium? Aside from Hasbro (HAS Quote) with Monopoly money, only the Treasury has the ability to print money in a pinch.

The real issue now for the longer-term thinking investor is whether or not the disasters in the silly stuff take the rest of us down with them. Performance was terrific for the last few weeks until about mid-morning last Thursday, when the selling hose started dousing nearly anything with a stock symbol. There is little fun in outperforming in a down market simply because what you own is going down less. Trading rallies aside, it will clearly be tougher to make money this year.

So what do you do when your portfolio is treading water? How about a little reading?

I've recently skimmed through a copy of The Ultimate Investor by Dean LeBaron and Romesh Vaitilingam. LeBaron is a near-legend in the industry for pioneering work in indexation and quantitative applications in investment management. The book is an excellent first read for relatively newbie investors looking for an intelligent bridge over the mindless ocean of investment drivel in financial magazines and on television.

For those who have a higher tolerance for intellectual punishment, the recent Association for Investment Management and Research's continuing education series booklet entitled Practical Issues in Equity Analysis is worth reading. While AIMR publications can sometimes turn the head of any non-Phd in applied mathematics, this is actually a reasonably readable series of articles for anyone who finds it occasionally fun to whip out the Excel spreadsheet and build a discounted cash flow model (and you know who you are).