Valuations in the new era

In 1934, the great investment theorist Benjamin Graham wrote of the pre-1929 stock bubble:

Instead of judging the market price by established standards of value, the new era based its standards of value upon the market price. Hence, all upper limits disappeared, not only upon the price at which a stock could sell, but even upon the price at which it would deserve to sell. This fantastic reasoning actually led to the purchase for investment at $100 per share of common stocks earning $2.50 per share. The identical reasoning would support the purchase of these same shares at $200, at $1,000, or at any conceivable price.

(Source: Four Pillars of Investing – Lessons for building a winning portfolio by William Bernstein)

William Bernstein writes further in “Four Pillars of Investing”, “Even the most casual investor will see the parallels of Graham’s world with the recent tech/Internet bubble. Graham’s $100 stock sold at 40 times its $2.50 earnings. At the height of the 2000 bubble, most of the big-name tech favorites, like Cisco, EMC and Yahoo! Sold at much more than 100 times earnings. And, of course, almost all of the dot-coms went bankrupt without ever having had a cent of earnings.

To see a similar pattern across time periods, across geographies and across asset categories, read the chapter on “Valuation” in the book “Riding The Roller Coaster – Lessons from financial market cycles we repeatedly forget”. There were cases of such ridiculous valuations in real estate stocks in India in 2007-08, real estate prices in Japan in the 1980s, tulip bulbs in Amsterdam, technology companies in the 1999-2000 – such events have occurred at an amazingly high frequency.

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Samudra manthan – Excessive turbulence

Think of all market turbulence as “Samudra manthan”. In the mythological story of samurai manthan, so many things came out, including poison and nectar. The market turbulence is no different. Every market turbulence brings out some poison and some nectar.

The poison kills many investors’ portfolios and reputations of some experts. On the other hand, we have seen in some episodes how the turbulence brought out the best. Some examples of the nectar are:

  • Birth of Securities Exchange Commission, Federal Deposit Insurance Corporation and Federal Reserve bank after the great depression
  • Beautiful tulip gardens of Amsterdam
  • Birth of SEBI, NSDL, NSE after the great Indian securities scam. Innovations like screen based trading, dematerialisation of securities, rolling settlement, etc.
  • Birth of companies like Amazon, Google, etc. in the DotCom boom

Such churning of the ocean is required to bring out the nectar.

Devastating crash

Between 1929 and 1932, Dow Jones Industrial Average (DJIA) – the then popular index in the US stock markets fell from a high of 381 to a low of 41 – drop of almost 90% from top to bottom.

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Even Big Ben wasn’t infallible

Going back to 1929, it is important to look at what happened to one particular gentleman and what impact it had on the whole society. Benjamin Graham was a young and upcoming investment manager and a professor. He had built good reputation as a portfolio manager and was managing a sizeable sum of clients’ money.

While he seemed to have seen the danger, he continued with his investment portfolio. At one point of time in 1929, while discussing with the legendary Bernard Baruch, young Ben Graham mentioned, “… someday, the reverse should happen.When he reflected on events some years later, Ben found it strange that though he sensed danger, he did not completely sell out of the market. (Ref: “Benjamin Graham on Value Investing – Lessons from the Dean of Wall Street” by Janet Lowe; Published by Penguin Books).

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Investor behaviour

Investor behavior is so predictably uniform irrespective of time, geography and vehicles of investment/speculation – Dr. Uma Shashikant

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Man and mania

Tulipomania, Ulipomania or IPOmania – “man” is the common denominator in all “manias”


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