May 2002
Many of you probably remember The Beverly Hillbillies show with its humor for both young and old. One of the puzzling and often repeated themes was “Mr. Drysdale’sNightmare” which relates directly to current investment markets with lessons about confidence, diversification and liquidity.
Recall that Jed Clampett and Granny deposited their oil money in the Commerce Bank, Milburn Drysdale ‘s bank. From time to time, Jed and Granny would show up at the bank unannounced and ask to see their money … they wanted to count it. Mr. Drysdale, with his able assistant Miss Jane Hathaway, would get flustered and panic. I confess to having never understood what the fuss was about since I sided with Jed and Granny and thought Mr. Drysdale should have simply showed them their cash.
What adults understood when watching the show was that banks lend or invest most deposits, keeping just a little cash on hand for routine daily withdrawals. In effect, what the Clampetts were single-handedly doing was causing a “run” on Mr. Drysdale’s bank. In many respects, causes for Mr. Drysdale’s woes of days past are similar to why portions of the bond and stock markets are hurting so much right now. (The most important word in the last sentence is “portions.”)
As with the Clampett case, investors ask for their money back every once in awhile. If a company is financially strong, and if the market for its obligations is deep and broad, there will be no problem meeting the demands of the occasional investor who decides to liquidate holdings. If a company has over-borrowed and/or over-promised, the demands from investors or creditors may result in a drastic reduction in the price of those securities.
Let’s be specific. Just after September 11th, the banking system in America had thousands of Jed Clampetts at its door. At one point, individual banks with downtown New York City operation centers owed well over $100 billion in unsettled wire transfers. Being well capitalized and part of the strongest financial system in history (i.e., U.S. Federal Reserve), these banks were able to readily handle all the demands of global investors.
Another example is IBM, a company which has the financial strength to weather storms. Although not currently on our Buy List of 35 Blue Chip companies, IBM has the financial flexibility to “put their money where their mouth is” when it comes to their stock price. IBM’s shares have dropped almost 40% from their high to just over $80.00 a share lately. Rather than sit idly by, IBM boldly announced a stock repurchase plan of over $3.0 billion which can be used to stem unusual selling pressure (i.e., show Jed Clampett some of his cash) and provide shareholders a long term investment opportunity (hopefully). Only companies with sound financial balance sheets and positive relationships with their banks can commit to such repurchases.
While the American banking system and companies like IBM have the flexibility to meet massive financial demands, not all companies do. Enron, Global Crossing, Worldcom and other notables have been unable to handle an avalanche of investor demands to sell their debt and equity securities. In Worldcom’s case, the greed which partly led to a shaky financial picture included a $400 million loan to their CEO (which is now unlikely to be repaid). It is during difficult periods that the fundamentals of capitalism and orderly markets are tested. When things appear to go inordinately well, such as during the 1990s, we find both excess and laziness. During these heady times, far too many money managers abandoned the objective of preserving their clients’ capital in favor of preserving a benchmark. A few aggressive, and sometimes unscrupulous, companies took advantage and when they told big stories, they attracted knee-jerk investment. Some investment managers felt forced to buy stocks at values that no reasonable serious investor could justify. Having abandoned traditional valuation guidelines, these investment managers must now try to figure out what to do as an encore. Fortunately, only twenty or thirty of America’s largest companies appear to have these problems.
With the exception of a few global trouble spots, we are comforted by a number of positives … relative peace with Russia, a growing economy, low interest rates, robust housing values and the most productive workforce in history. Moreover, the growth prospects are immense in places like China. After a recent Chinese business trip, one of our clients summarized the opportunity there by saying it was “colossal, frightening and numbing.” Despite ongoing risks in the Middle East and a potentially inflationary weakening of the dollar, we are soundly in the bullish camp … for the right stocks.
We have continued to add new Buy List companies which have low debt, proven business plans and global scope. These are companies with reasonable valuations and sound finances that need not panic if someone asks for their money back. As always, we remain committed to quality and diversification, as we pursue our objective to preserve our clients’ capital and provide for long term growth.