Leithner & Co Pty Ltd - Drivers' Licenses and Fishing Licenses

DRIVERS’ LICENSES AND FISHING LICENSES

Part I

1 January 2004

As a protection against financial illusion or insanity, [historical] memory is far better than law. When [in the early 1970s and late 1980s] the memory of the 1929 disaster failed, law and regulation no longer sufficed. For protecting people from the cupidity of others and [themselves], history is highly utilitarian. It sustains memory and memory serves the same purpose as [government regulators] and, on the record, is far more effective.

John Kenneth Galbraith
The Great Crash of 1929 (1954, repr. ed. 1997)

Benjamin Graham’s major works were first published during the early 1930s and late 1940s. Yet some investors have come to realise and The Wall Street Journal has recognised (“Investment Books Turn More Bearish Following the Stock Market’s Tone 30 August 2001) that these works’ themes are as relevant today as they were fifty or more years ago. To cite just one example, in The Intelligent Investor: A Book of Practical Counsel (Harper Business Essentials, 1949, 2003, ISBN: 00605556621) Mr Graham criticised the fact that “aside from forecasting the movement of the general market, much effort and ability are directed in Wall Street toward selecting stocks or industrial groups that in matter of price will ‘do better’ than the rest over a fairly short period in the future.” Graham noted that this endeavour “is [not] suited to the needs and temperament of the true investor. As in all other activities that emphasise price movements first and underlying values second, the work of many intelligent minds constantly engaged in this field tends to be self-neutralizing and self-defeating over the years.”

As a typical example, consider a broker’s circular dated 13 August 2001 and signed by a Senior Client Advisor (let us call him Fred) who claims more than 20 years experience and is employed by a major multi-national broker with branches across Australia. Half of the circular’s contents appear under the heading Fred’s Specials – Stocks I Expect Could/Should Double (or More) Over the Next Twelve Months. Fred’s statements with respect to the items on his list can be grouped into three categories:

Reassurances: “shares in the following companies are relatively small market capitalisation stocks that I follow very closely … Every recommendation on my ‘specials’ list is value-based on current and potential future fundamentals.”

Incitements of Clients’ Greed: “the common thread linking [these companies] is that I believe they all have the potential to provide investors with exceptional capital growth over the next twelve months (without high risk).”
A Virtual Declaration of Prescience: “each and every one of the following stocks has multiple drivers and/or features which have the potential for generating significant market interest in the company’s stock – both initially and ongoing … When these certain events occur, [their] share prices will escalate accordingly.”

With respect to the first entry on the list (its name is not relevant; hence let us, with apologies to Pierpont, The Australian Financial Review’s most insightful correspondent, call it Blue Sky Mines NL), Fred makes a series of specific statements. These statements, closely mirroring the general statements about the list as a whole, also fall into three categories:

Technical Gobbledegook: Blue Sky Mines “has the fully patented EARS and ERMS processes for converting ilmenite in mineral sands into titanium dioxide pigment ….”

Momentous Events Which Will Occur Shortly: “in July 2000 the company signed a major joint venture agreement with X Ltd … [and] future significant developments are in the pipeline … Recognition of BSM’s key strategic value … is rapidly increasing [and] the Y Joint Venture is very close to announcing [that] plant construction is about to commence ….”
A Virtual Assurance That This One’s Gonna Be A Gusher: “various stockbroker reports have given BSM shares a valuation of between $0.40-$0.50 [versus its current price of $0.11]… I believe BSM’s share price has a very high probability of more than doubling over the next twelve months.”

It is tempting to conclude, as Richard FitzHerbert suggests in his excellent book Blueprint for Investment: An Approach for Serious Long-Term Investors (Melbourne, Wrightbooks, ISBN 0947351663), that advisers like Fred in effect hold fishing licenses rather than driver’s licenses. To obtain and retain a driver’s license one must do more than merely pay a prescribed fee: one must also demonstrate some minimal ability to operate a specified category of vehicle. In contrast, to hold a fishing license does not presuppose any ability to catch fish. Indeed, from the point of view of the licensor it is preferable that no such ability exists: given some number of fish, incompetent fishermen enable more licenses to be issued (and hence more revenue raised). The possession of a fishing license confirms only that the licensee has paid a fee and that, if its holder remains within the rules, he will not be fined if he is caught fishing.

This, from the point of view of the person who holds the license, is very fortunate. According to The Wall Street Journal (15 August 2001), “Wall Street analysts – those professional brokers who should know all about the subject – appear to have played hooky the day it was taught in business school. A study of analysts’ picks over the past three years shows that the stocks they rated ‘buy’ or ‘strong buy’ had far more risk than the average stock in the market and only marginally higher returns. Not only should investors have avoided the stocks that brokers were touting, the study said, but also they should have actually bought the stocks on which they were lukewarm … The study helps to explain why Wall Street analysts looked so prescient as stock markets soared in the late 1990s. And it shows why so many of them have been so wrong since then.”

....continued in Part II