Embracing Financial Nonsense

Al Jacobs

For those of us whose money-making endeavors date back a ways, what I now intend to discuss will probably cause consternation. The reason for this is nothing more than human nature.

As we mature and develop attitudes of good and bad or right and wrong, we instinctively take offense when what we cherish as proper, or despise as improper, are suddenly described in a way to challenge our beliefs. And we are particularly enraged when such deviant views are warmly endorsed by the spokespersons of society.

Along with my contemporaries, dating well back into the mid-20th century, we understood the fundamental principles of money management. In addition, we could easily distinguish an unsound financial practice at a glance.

It is for this reason I react with dismay when I see bizarre events introduced to the investment world as if they are conventional transactions to be emulated. We will discuss some of these situations shortly … but first, return with me to a more archaic era to view how we analyzed data and evaluated details. Though our approach in determining value may seem antiquated, we normally arrive at sustainable results.

Although memories tend to come and go, there are certain things which stick into our heads. For me, one of them is a short paragraph from a book titled The Sophisticated Investor, dating back to 1959. Its author was Burton Crane, a financial writer for the New York Times from 1937 to 1963. I’ll share a portion of that paragraph with you.

“How do we pick out the stocks that are going to do spectacularly better than the average? The easiest thing in the world is to pick out a good, sound, solid, respectable stock, one that wears woolen underwear and brushes its teeth after ever meal. Such a stock will earn its dividend year after year. It will never go up with the other flighty stocks – at least that’s the way it seems. The most profitable – and for a time the safest – stocks to own are those.”

Just so you’ll know, this constituted the basis on which I administered a testamentary trust from 1974 to 1995, and it proved to be exceptionally profitable.

While quoting the advice of old timers, here’s a sage comment from an obscure 1978 newspaper clipping which millions of Americans might do well to follow: “The best way to earn 18% on your money, risk-free, is by not going into hock to a department store or bank credit card. That’s what most of them charge – 1½% a month.” Hmm … I see from my Chase credit card statement the rate increased to 27.99%. Perhaps we’d all be better off if we returned to the 1950s, before credit cards appeared,

This last bit of guidance from the past century can be credited to Andrew Tobias, an American who still writes extensively. The following is from his book The Only Investment Guide You’ll Ever Need.

“I have terrible news about brokers and money managers generally – news which I expect you’ve suspected, but couldn’t quite believe all along. There are no brokers who can beat the market consistently and by enough of a margin to more than make up for their brokerage fees. I’m not saying the stock market is all luck. Nevertheless, it is enough of a crap shoot that luck has a great deal more to do with it than any professional money man is going to want to admit. By and large you should manage your own money. And no one but you is going to manage it for free.”

We’ve now returned to the present, and it’s time to see what mode of investing this 21st century specializes in. As I scan the financial page of my local newspaper, I see the Tesla Automotive Company, a manufacturer of electric autos, just reported a first quarter 2021 profit of $438 million on revenue of $10.4 billion. With 1.133 billion shares outstanding, this represents quarterly earnings of 38.6¢ per share – or average annual earnings of $1.54.

Based upon this, and my expectation from an earlier time of a price-to-earnings ratio not to exceed 15, I expect the current value of the stock to be no greater than $25 per share. A check of the share’s closing price on May 19 reveals $586.78. My immediate reaction: I must have Tesla mixed up with another company.

And as I dig down more deeply into their report, I see the firm received $518 million from the sale of regulatory credits. These are credits or points given by the state and federal governments to firms, as an incentive to produce zero pollution vehicles. Tesla receives these credits for free and can sell them at a profit to other automakers who cannot meet regulatory requirements. Checking even more closely, I note an additional $101 million of the profits to be from the speculative sale of something known as bitcoins.

As I read it, although $438 of profit is reported, $619 million of income relates in no way to receipts from the sale of vehicles. Thus in the auto-making business, Tesla lost $181 million in a single quarter. And as I look back over the 18 years since Tesla’s origination, not a single calendar quarter ever produced a dime’s profit in auto sales. Despite this reality, as an automaker the firm is highly regarded and the value of their stock soars. I can come up with no rational explanation.

Oh … and speaking of “something known as bitcoins,” I’ve investigated these as well. For those of you unfamiliar with this device, it’s “digital currency” created in 2009 by an unknown person. Transactions involve no banks, no transaction fees and allow anonymity. Bitcoins exist either in an imaginary bank account, known as a cloud, or on a user’s computer. You may think of them as peer-to-peer currency, in that no central authority issues them or tracks their transactions.

What will become of this milieu is hotly debated, as it’s mostly unregulated. Whether bitcoin rises or falls in value seems to be dependent upon the euphoria of its supporters, so its record is one of wild volatility. You might note the field of cryptocurrency is not confined to this single example. At present there are more than 1,100 other players, though all far less prominent than bitcoin. There are analysts, who predict these will enjoy broad adoption as a “store of value” similar to gold. Others, however, view it as a passing fad, to be a relic of the past within the next few years.

To give you a little history, the 2009 value of each unit was 8¢ each. However, for no particular reason other than erratic speculation, the value began to rise. At the beginning of 2013 it was worth $13.50 – and during November of that year it rose from $200 to $1,075. In 2017 its volatility defied description; during October it was valued at roughly $20,000, but within a month it returned to $3.500. Since then its values and volatility defy rationality, with it reaching $64,863.10 – its highest value ever – on April 16, 2021. But over the past month it’s been oscillating incoherently, with its May 21, 2021, closing value at $35,691.01.

As to the future of this digital currency concept, despite the monetary success of Bitcoin thus far, I agree with the doubters. I firmly believe any investment craze easily prone to manipulation and with no sound basis for value must end – normally amidst chaos and recrimination. We shall see what the future holds.

With several unsettling details now behind us, it’s time to decide whether investment in the United States is being reasonably engaged in. I admit to having selected a pair of extreme examples to make – or perhaps over-make – a point. Perhaps I overstated the extent of the irrationality; I acknowledge that the bitcoin hysteria is no more grotesque than was the 17th century Dutch tulip bulb mania.

For an indication of whether or not the Dow Jones Industrial Average is fairly valued, we must look at its price-to-earnings ratio. At this time, based upon actual reported earnings in the past year, the DJIA P/E ratio is 20.0. This is somewhat unattractively high compared to its historical average of about 16, but not grossly so … and as the average was 29.25 a year ago, it’s clear we are involved in – as presidential candidate Warren Harding assured the nation – “a return to normalcy.”

To further verify the averages, the P/E ratio of the S&P500 is currently 21.0. A year ago it was 23.33. Again, it’s a bit high, but not significantly so. In all, it appears an overwhelming portion of the investment public is conducting itself with decorum. That the mass of our citizen investors are investing shrewdly and profitably is doubtful.

For those of you who regularly read my articles, you’re aware I question many of the techniques employed by the financial councilors. However, I do not believe most Americans are involved in the highly speculative insanity which receives undo attention by the media. I’m convinced the Tesla and bitcoin fanatics are the rare exceptions. In short, all is reasonably well here in Utopia.

Al Jacobs, a professional investor for nearly a half-century, issues weekly financial articles in which he shares his financial knowledge and experience. Al may be contacted at al@abjacobs.com


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