becomes $413 million, which is over three times the tangible assets shown therefor. These figures appear the more anomalous when comparison is made with those of Presto. One is moved to ask how could Presto possibly be valued at only 6.9 times its current earnings when the multiplier for General was nearly 10 times as great. All the ratios of Presto are quite satisfactory—the growth figure suspiciously so, in fact. By that we mean that the company was undoubtedly benefit- ing considerably from its war work, and the shareholders should be prepared for some falling off in profits under peacetime condi- tions. But, on balance, Presto met all the requirements of a sound and reasonably priced investment, while General had all the ear- marks of a typical “conglomerate” of the late 1960s vintage, full of corporate gadgets and grandiose gestures, but lacking in substan- tial values behind the market quotations. S EQUEL: General continued its diversification policy in 1969, with some increase in its debt. But it took a whopping write-off of mil- lions, chiefly in the value of its investment in the Minnie Pearl Chicken deal. The final figures showed a loss of $72 million before tax credit and $46.4 million after tax credit. The price of the shares fell to 16 1 ⁄2 in 1969 and as low as 9 in 1970 (only 15% of its 1968 high of 60). Earnings for 1970 were reported as $2.33 per share diluted, and the price recovered to 28 1 ⁄2 in 1971. National Presto increased its per-share earnings somewhat in both 1969 and 1970, marking 10 years of uninterrupted growth of profits. Nonetheless its price declined to 21 1 ⁄2 in the 1970 debacle. This was an interesting figure, since it was less than four times the last reported earnings, and less than the net current assets available for the stock at the time. Late in 1971 we find the price of National Presto 60% higher, at 34, but the ratios are still startling. The enlarged working capital is still about equal to the current price, which in turn is only 5 1 ⁄2 times the last reported earnings. If the investor could now find ten such issues, for diversification, he could be confident of satisfactory results.* 466 The Intelligent Investor * National Presto remains a publicly-traded company. National General was acquired in 1974 by another controversial conglomerate, American Financial Group, which at various times has had interests in cable television, banking, real estate, mutual funds, insurance, and bananas. AFG is also the final resting place of some of the assets of Penn Central Corp. (see Chapter 17). Pair 8: Whiting Corp. (materials-handling equipment) and Willcox & Gibbs (small conglomerate) This pair are close but not touching neighbors on the American Stock Exchange list. The comparison—set forth in Table 18-8A— makes one wonder if Wall Street is a rational institution. The com- pany with smaller sales and earnings, and with half the tangible A Comparison of Eight Pairs of Companies 467 Table 18-8A. Pair 8. Whiting Willcox & Gibbs 1969 1969 Price, December 31, 1969 17 3 ⁄4 15 1 ⁄2 Number of shares of common 570,000 2,381,000 Market value of common $10,200,000 $36,900,000 Debt 1,000,000 5,900,000 Preferred stock — 1,800,000 Total capitalization at market $11,200,000 $44,600,000 Book value per share $25.39 $3.29 Sales $42,200,000 $29,000,000 (October) (December) Net income before special item 1,091,000 347,000 Net income after special item 1,091,000 def. 1,639,000 Earned per share, 1969 $1.91 (October) $.08 a Earned per share, 1964 1.90 (April) .13 Earned per share, 1959 .42 (April) .13 Current dividend rate 1.50 — Dividends since 1954 (none since 1957) Ratios: Price/earnings 9.3 ϫ very large Price/book value 70.0% 470.0% Dividend yield 8.4% — Net/sales 3.2% 0.1% a Earnings/book value 7.5% 2.4% a Current assets/liabilities 3.0 ϫ 1.55 ϫ Working capital/debt 9.0 ϫ 3.6 ϫ Growth in per-share earnings 1969 versus 1964 even decrease 1969 versus 1959 +354% decrease a Before special charge. def.: deficit. assets for the common, sold at about four times the aggregate value of the other. The higher-valued company was about to report a large loss after special charges; it had not paid a dividend in thir- teen years. The other had a long record of satisfactory earnings, had paid continuous dividends since 1936, and was currently returning one of the highest dividend yields in the entire common- stock list. To indicate more vividly the disparity in the performance of the two companies we append, in Table 18-8B, the earnings and price record for 1961–1970. The history of the two companies throws an interesting light on the development of medium-sized businesses in this country, in contrast with much larger-sized companies that have mainly appeared in these pages. Whiting was incorporated in 1896, and thus goes back at least 75 years. It seems to have kept pretty faith- fully to its materials-handling business and has done quite well with it over the decades. Willcox & Gibbs goes back even farther— to 1866—and was long known in its industry as a prominent maker 468 The Intelligent Investor TABLE 18-8B. Ten-Year Price and Earnings Record of Whiting and Willcox & Gibbs Whiting Corp. Willcox & Gibbs Earned Price Earned Price Year Per Share a Range Per Share Range 1970 $1.81 22 1 ⁄2–16 1 ⁄4 $.34 18 1 ⁄2–4 1 ⁄2 1969 2.63 37–17 3 ⁄4 .05 20 5 ⁄8–8 3 ⁄4 1968 3.63 43 1 ⁄8–28 1 ⁄4 .35 20 1 ⁄8–8 1 ⁄3 1967 3.01 36 1 ⁄2–25 .47 11–4 3 ⁄4 1966 2.49 30 1 ⁄4–19 1 ⁄4 .41 8–3 3 ⁄4 1965 1.90 20–18 .32 10 3 ⁄8–6 1 ⁄8 1964 1.53 14–8 .20 9 1 ⁄2–4 1 ⁄2 1963 .88 15–9 .13 14–4 3 ⁄4 1962 .46 10–6 1 ⁄2 .04 19 3 ⁄4–8 1 ⁄4 1961 .42 12 1 ⁄2–7 3 ⁄4 .03 19 1 ⁄2–10 1 ⁄2 a Year ended following April 30. of industrial sewing machines. During the past decade it adopted a policy of diversification in what seems a rather outlandish form. For on the one hand it has an extraordinarily large number of sub- sidiary companies (at least 24), making an astonishing variety of products, but on the other hand the entire conglomeration adds up to mighty small potatoes by usual Wall Street standards. The earnings developments in Whiting are rather characteristic of our business concerns. The figures show steady and rather spec- tacular growth from 41 cents a share in 1960 to $3.63 in 1968. But they carried no assurance that such growth must continue indefi- nitely. The subsequent decline to only $1.77 for the 12 months ended January 1971 may have reflected nothing more than the slowing down of the general economy. But the stock price reacted in severe fashion, falling about 60% from its 1968 high (43 1 ⁄2) to the close of 1969. Our analysis would indicate that the shares repre- sented a sound and attractive secondary-issue investment—suit- able for the enterprising investor as part of a group of such commitments. S EQUEL: Willcox & Gibbs showed a small operating loss for 1970. Its price declined drastically to a low of 4 1 ⁄2, recovering in typical fashion to 9 1 ⁄2 in February 1971. It would be hard to justify that price statistically. Whiting had a relatively small decline, to 16 3 ⁄4 in 1970. (At that price it was selling at just about the current assets alone available for the shares). Its earnings held at $1.85 per share to July 1971. In early 1971 the price advanced to 24 1 ⁄2, which seemed rea- sonable enough but no longer a “bargain” by our standards.* General Observations The issues used in these comparisons were selected with some malice aforethought, and thus they cannot be said to present a ran- dom cross-section of the common-stock list. Also they are limited to the industrial section, and the important areas of public utilities, A Comparison of Eight Pairs of Companies 469 * Whiting Corp. ended up a subsidiary of Wheelabrator-Frye, but was taken private in 1983. Willcox & Gibbs is now owned by Group Rexel, an electri- cal-equipment manufacturer that is a division of Pinault-Printemps-Redoute Group of France. Rexel’s shares trade on the Paris Stock Exchange. transportation companies, and financial enterprises do not appear. But they vary sufficiently in size, lines of business, and qualitative and quantitative aspects to convey a fair idea of the choices con- fronting an investor in common stocks. The relationship between price and indicated value has also dif- fered greatly from one case to another. For the most part the compa- nies with better growth records and higher profitability have sold at higher multipliers of current earnings—which is logical enough in 470 The Intelligent Investor TABLE 18-9. Some Price Fluctuations of Sixteen Common Stocks (Adjusted for Stock Splits Through 1970) Price Range Decline Decline 1936–1970 1961 to 1962 1968–69 to 1970 Air Products & Chemicals 1 3 ⁄8–49 43 1 ⁄4–21 5 ⁄8 49–31 3 ⁄8 Air Reduction 9 3 ⁄8–45 3 ⁄4 22 1 ⁄2–12 37–16 American Home Products 7 ⁄8–72 44 3 ⁄4–22 72–51 1 ⁄8 American Hospital Supply 3 ⁄4–47 1 ⁄2 11 5 ⁄8–5 3 ⁄4 47 1 ⁄2–26 3 ⁄4 a H & R Block 1 ⁄4–68 1 ⁄2 –68 1 ⁄2–37 1 ⁄8 a Blue Bell 8 3 ⁄4–55 25–16 44 3 ⁄4–26 1 ⁄2 International Flavors & Fragrances 4 3 ⁄4–67 1 ⁄2 8–4 1 ⁄2 66 3 ⁄8–44 7 ⁄8 International Harvester 6 1 ⁄4–53 28 3 ⁄4–19 1 ⁄4 38 3 ⁄4–22 McGraw Edison 1 1 ⁄4–46 1 ⁄4 24 3 ⁄8–14 b 44 3 ⁄4–21 5 ⁄8 McGraw-Hill 1 ⁄8–56 1 ⁄2 21 1 ⁄2–9 1 ⁄8 54 5 ⁄8–10 1 ⁄4 National General 3 5 ⁄8–60 1 ⁄2 14 7 ⁄8–4 3 ⁄4 b 60 1 ⁄2–9 National Presto Industries 1 ⁄2–45 20 5 ⁄8–8 1 ⁄4 45–21 1 ⁄2 Real Estate Investment Trust 10 1 ⁄2–30 1 ⁄4 25 1 ⁄8–15 1 ⁄4 30 1 ⁄4–16 3 ⁄8 Realty Equities of N.Y. 3 3 ⁄4–47 3 ⁄4 6 7 ⁄8–4 1 ⁄2 37 3 ⁄4–2 Whiting 2 7 ⁄8–43 3 ⁄8 12 1 ⁄2–6 1 ⁄2 43 3 ⁄8–16 3 ⁄4 Willcox & Gibbs 4–20 5 ⁄8 19 1 ⁄2–8 1 ⁄4 20 3 ⁄8–4 1 ⁄2 a High and low both in 1970. b 1959 to 1960. general. Whether the specific differentials in price/earnings ratios are “justified” by the facts—or will be vindicated by future devel- opments—cannot be answered with confidence. On the other hand we do have quite a few instances here in which a worthwhile judg- ment can be reached. These include virtually all the cases where there has been great market activity in companies of questionable underlying soundness. Such stocks not only were speculative— which means inherently risky—but a good deal of the time they were and are obviously overvalued. Other issues appeared to be worth more than their price, being affected by the opposite sort of market attitude—which we might call “underspeculation”—or by undue pessimism because of a shrinkage in earnings. In Table 18-9 we provide some data on the price fluctuations of the issues covered in this chapter. Most of them had large declines between 1961 and 1962, as well as from 1969 to 1970. Clearly the investor must be prepared for this type of adverse market move- ment in future stock markets. In Table 18-10 we show year-to-year A Comparison of Eight Pairs of Companies 471 TABLE 18-10. Large Year-to-Year Fluctuations of McGraw-Hill, 1958–1971 a From To Advances Declines 1958 1959 39–72 1959 1960 54–109 3 ⁄4 1960 1961 21 3 ⁄4–43 1 ⁄8 1961 1962 18 1 ⁄4–32 1 ⁄4 43 1 ⁄8–18 1 ⁄4 1963 1964 23 3 ⁄8–38 7 ⁄8 1964 1965 28 3 ⁄8–61 1965 1966 37 1 ⁄2–79 1 ⁄2 1966 1967 54 1 ⁄2–112 1967 1968 56 1 ⁄4–37 1 ⁄2 1968 1969 54 5 ⁄8–24 1969 1970 39 1 ⁄2–10 1970 1971 10–24 1 ⁄8 a Prices not adjusted for stock-splits. fluctuations of McGraw-Hill common stock for the period 1958–1970. It will be noted that in each of the last 13 years the price either advanced or declined over a range of at least three to two from one year to the next. (In the case of National General fluctua- tions of at least this amplitude both upward and downward were shown in each two-year period.) In studying the stock list for the material in this chapter, we were impressed once again by the wide difference between the usual objectives of security analysis and those we deem depend- able and rewarding. Most security analysts try to select the issues that will give the best account of themselves in the future, in terms chiefly of market action but considering also the development of earnings. We are frankly skeptical as to whether this can be done with satisfactory results. Our preference for the analyst’s work would be rather that he should seek the exceptional or minority cases in which he can form a reasonably confident judgment that the price is well below value. He should be able to do this work with sufficient expertness to produce satisfactory average results over the years. 472 The Intelligent Investor COMMENTARY ON CHAPTER 18 The thing that hath been, it is that which shall be; and that which is done is that which shall be done: and there is no new thing under the sun. Is there any thing whereof it may be said, See, this is new? it hath been already of old time, which was before us. —Ecclesiastes, I: 9–10. Let’s update Graham’s classic write-up of eight pairs of companies, using the same compare-and-contrast technique that he pioneered in his lectures at Columbia Business School and the New York Institute of Finance. Bear in mind that these summaries describe these stocks only at the times specified. The cheap stocks may later become over- priced; the expensive stocks may turn cheap. At some point in its life, almost every stock is a bargain; at another time, it will be expensive. Although there are good and bad companies, there is no such thing as a good stock; there are only good stock prices, which come and go. PAIR 1: CISCO AND SYSCO On March 27, 2000, Cisco Systems, Inc., became the world’s most valuable corporation as its stock hit $548 billion in total value. Cisco, which makes equipment that directs data over the Internet, first sold its shares to the public only 10 years earlier. Had you bought Cisco’s stock in the initial offering and kept it, you would have earned a gain resembling a typographical error made by a madman: 103,697%, or a 217% average annual return. Over its previous four fiscal quarters, Cisco had generated $14.9 billion in revenues and $2.5 billion in earnings. The stock was trading at 219 times Cisco’s net income, one of the highest price/earnings ratios ever accorded to a large company. Then there was Sysco Corp., which supplies food to institutional 473 kitchens and had been publicly traded for 30 years. Over its last four quarters, Sysco served up $17.7 billion in revenues—almost 20% more than Cisco—but “only” $457 million in net income. With a market value of $11.7 billion, Sysco’s shares traded at 26 times earnings, well below the market’s average P/E ratio of 31. A word-association game with a typical investor might have gone like this. Q: What are the first things that pop into your head when I say Cisco Systems? A: The Internet . . . the industry of the future . . . great stock hot stock Can I please buy some before it goes up even more? Q: And what about Sysco Corp.? A: Delivery trucks . . . succotash . . . Sloppy Joes . . . shepherd’s pie school lunches . . . hospital food . . . no thanks, I’m not hungry anymore. It’s well established that people often assign a mental value to stocks based largely on the emotional imagery that companies evoke. 1 But the intelligent investor always digs deeper. Here’s what a skeptical look at Cisco and Sysco’s financial statements would have turned up: • Much of Cisco’s growth in revenues and earnings came from acquisitions. Since September alone, Cisco had ponied up $10.2 billion to buy 11 other firms. How could so many companies be mashed together so quickly? 2 Also, roughly a third of Cisco’s 474 Commentary on Chapter 18 1 Ask yourself which company’s stock would be likely to rise more: one that discovered a cure for a rare cancer, or one that discovered a new way to dispose of a common kind of garbage. The cancer cure sounds more excit- ing to most investors, but a new way to get rid of trash would probably make more money. See Paul Slovic, Melissa Finucane, Ellen Peters, and Donald G. MacGregor, “The Affect Heuristic,” in Thomas Gilovich, Dale Griffin, and Daniel Kahneman, eds., Heuristics and Biases: The Psychology of Intuitive Judgment (Cambridge University Press, New York, 2002), pp. 397–420, and Donald G. MacGregor, “Imagery and Financial Judgment,” The Journal of Psychology and Financial Markets, vol. 3, no. 1, 2002, pp. 15–22. 2 “Serial acquirers,” which grow largely by buying other companies, nearly always meet a bad end on Wall Street. See the commentary on Chapter 17 for a longer discussion. earnings over the previous six months came not from its busi- nesses, but from tax breaks on stock options exercised by its executives and employees. And Cisco had gained $5.8 billion selling “investments,” then bought $6 billion more. Was it an Inter- net company or a mutual fund? What if those “investments” stopped going up? • Sysco had also acquired several companies over the same period—but paid only about $130 million. Stock options for Sysco’s insiders totaled only 1.5% of shares outstanding, versus 6.9% at Cisco. If insiders cashed their options, Sysco’s earnings per share would be diluted much less than Cisco’s. And Sysco had raised its quarterly dividend from nine cents a share to 10; Cisco paid no dividend. Finally, as Wharton finance professor Jeremy Siegel pointed out, no company as big as Cisco had ever been able to grow fast enough to justify a price/earnings ratio above 60—let alone a P/E ratio over 200. 3 Once a company becomes a giant, its growth must slow down—or it will end up eating the entire world. The great American satirist Ambrose Bierce coined the word “incompossible” to describe two things that are conceivable separately but cannot exist together. A company can be a giant, or it can deserve a giant P/E ratio, but both together are incompossible. The wheels soon came off the Cisco juggernaut. First, in 2001, came a $1.2 billion charge to “restructure” some of those acquisi- tions. Over the next two years, $1.3 billion in losses on those “invest- ments” leaked out. From 2000 through 2002, Cisco’s stock lost three-quarters of its value. Sysco, meanwhile, kept dishing out profits, and the stock gained 56% over the same period (see Figure 18-1). PAIR 2: YAHOO! AND YUM! On November 30, 1999, Yahoo! Inc.’s stock closed at $212.75, up 79.6% since the year began. By December 7, the stock was at $348— Commentary on Chapter 18 475 3 Jeremy Siegel, “Big-Cap Tech Stocks are a Sucker’s Bet,” Wall Street Journal, March 14, 2000 (available at www.jeremysiegel.com). . to convey a fair idea of the choices con- fronting an investor in common stocks. The relationship between price and indicated value has also dif- fered greatly from one case to another. For the. Observations The issues used in these comparisons were selected with some malice aforethought, and thus they cannot be said to present a ran- dom cross-section of the common-stock list. Also they. astonishing variety of products, but on the other hand the entire conglomeration adds up to mighty small potatoes by usual Wall Street standards. The earnings developments in Whiting are rather