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Reflections from 20 Years of Investing (1994-2000)

June 21, 2013 | About:
John Emerson

John Emerson

142 followers
"Wisdom comes by disillusionment." --George Santayana

Today's edition will profile my early investment years which upon further recollection, started in 1994--maybe I should change the title of the series to "Reflections from 19 Years of Investing". The series will be written informally and serve as sort of an investment diary which chronicles my evolution as a value investor. As the title suggests, today's discussion will cover the period from 1994 to the end of 2000.

Investing was hardly an appropriate term for describing my methodology when I began purchasing stocks. Rather, what I was engaging in was pure speculation and I would be unable to distinguish the difference between the two concepts for a number of years. That said, by the latter part of the 1990s I was developing some rudimentary value concepts and I started to develop some value investing skills that would serve me well later on in my investing career.

Initially, my only investing resource was my television. I began to watch CNBC religiously as well as view the nightly business report which ran on my local PBS channel. At least I watched those channels when I was not working. I had started my own little home improvement business in 1995 and the experience helped me conceptualize essential accounting notions as well as provided me with some valuable insights about the nature of businesses and the effect of competition on sales and profits.

Although I did not realize it at the time, the profitability of my business would have a limited duration due to several factors: First off, the business possessed little in the way of a competitive advantage and held no barriers to entry. Secondly, it was largely fueled by a favorable set of economic circumstances that would also hold a limited duration. Later on in my investing career, I internalized those critical concepts and that knowledge has greatly influenced my investing acumen.

When I later read and reread Chapter 20 of the Intelligent Investor, I would fully understand the pure genius of Benjamin Graham's insightful quote: "Observation over many has taught us that the chief losses to investors come from the purchase of low-quality securities at times of favorable business conditions". You see I owned a low-quality business which would turn out to be highly cyclical and I had greatly benefited from a temporary period of favorable business conditions. In the future, I would buy shares in a number of low-quality businesses but I would only buy them during periods of unfavorable business conditions and only if they traded at large discounts to their net tangible asset value or their net current asset value. In other words, I internalized the key value concept of buying out-of-favor businesses when they were trading at large discounts to their intrinsic value.

Finally, I will end my introductory section by acknowledging two other fundamental developments which where necessary in my transformation to a competent value investor: Number one, I purchased a computer in the late 1990s and from that point on I used it extensively to learn about value theory by reading hundreds of articles, as well as utilizing the Internet to analyze equities. Second, I began reading dozens of books on investing. The first book I read was the Peter Lynch classic "Beating the Street" and the second was Graham's "The Intelligent Investor."

My First Stock Purchases

I still remember the names of the first three stocks that I purchased nearly 20 years ago. They gold mining companies: Pegasus Gold, Eco Bay Mines and Battle Mountain. I came to purchase the stocks after consulting with one of the telemarketers at the home improvement company where I was employed as a commission salesman. Now "that takes some explaining Lucy." You see, the telemarketer was a former Wall Street investment adviser who developed a nasty cocaine habit and served multiple tours of duties at some of the finest rehab facilities in the U.S., apparently to no avail.

Although at the time I was talking to him, he appeared to be on the straight and narrow, in reality, he was heading straight to his supplier with money that he borrowed from a number of his co-workers which included me. For informational value, never loan money to an "ex-junkie" who consistently wears long-sleeve shirts that cover the entire back of his hands - I never saw more than the guy's fingernails. You see he shot up his medicine through the veins on the back of his hands. Please forgive my temporary digression.

Anyway, the drug addict gave me the 800 number of one of his former cohorts who happened to be a gold bug, and the rest is history - so was two-thirds of my $15,000 "investment" after a matter of months. For younger readers, gold and gold mining stocks were not the place to be in the 1990s, as gold steadily plummeted to less than $250 an ounce.

Undaunted by the loss, I abandoned the gold mining sector and invested my remaining $5,000 in Intel (INTC). Why Intel you might ask? To the best of my recollection, I had heard a number of analysts talking about the stock on CNBC and unlike many of the other technology stocks, it appeared to me to be cheap. I have no idea how I came to that conclusion since I had no ability to price equities at the time. I was still in stock picking kindergarten and the concept of a PE ratio was entirely over my head, let alone the concept of free cash flow or return on equity.

As fate would have it, Intel tripled in about a year and my bank roll was miraculously restored with my only loss being the time value of my money. Bear in mind that saving accounts actually paid interest 20 years ago.

Another point I need to make about the 1990s was the exorbitant transaction fees that investors would rack up at a typical investment house. I was using Dean Witter at the time and I recall it cost me about $250 in commission to purchase a $5,000 position in a stock. To add insult to injury, when I cashed out the losers, they charged me an additional 5% fee which was much lower than the original commission since 67% of my investment had been eaten away. Of course, after I did more investing, my fee structure was lowered but it was still outrageously high compared to the most expensive discount brokerage houses of today.

When I eventually transferred my holdings to a discount brokerage in 2007, I was paying a flat fee of one percent on the total asset value of my holdings which was deducted quarterly. For that amount I received unlimited trades and full access to all the Morgan Stanley (formerly Dean Witter) research. One percent may not seem like a great amount, but on a million dollar account that amounted to $10,000 a year. Needless to say, I greatly reduced my transaction fees by shifting to a discount brokerage house, where I received $10 trades.

Investing in the 1990s

The 1990s was the era of virtually all technology stocks or anything remotely related to the internet, without regard to irrelevant factors such as the intrinsic value of a company or its earnings yield. Even revenues did not seem to matter as Internet IPOs routinely rose to nosebleed trading levels in excess of 100 times their revenues. It was a time when Jim Cramer openly berated Warren Buffett as being out of touch with new era of Wall Street and proclaimed that JDSU stood for: "Just Don't Sell Uniphase."

It was the era of flipping IPOs where the investment banks provided their top customers with access to large share lots of a seemingly endless string of Internet-related companies which went public. As soon as the IPOs started trading, their prices rapidly ascended, many times recording multibaggers in weeks or even days. Fortunes were quickly made and all sense of caution was thrown to the wind in the interest of recording quick profits. Traders arose early to place orders on momentum-based technology stocks and sold out their positions before noon in favor of attending multiple-martini lunches. Such insanity would carry on for years.

I can not remember too many of the stocks which I purchased during the mid 1990s - the brain has a way of blocking out traumatic experiences - but I do recall purchasing Motorola, AT&T, National Semiconductor and Newmont Mining. As I recall, I was steadily bombarded with the advice that a person should always hold around 10% in gold as a hedge and being a "sensible" investor I decided that gold should continue to play a part in my portfolio. The trouble with that advice was that during the 1990s one had to perpetually reload his gold shares to maintain the 10% weighting since the price of gold and the mining companies continued to drop precipitously throughout the decade. I continued to hold Newmont well into the early 2000s until I eventually abandoned investing in gold stocks. Those "hedges" cost me tens of thousands of dollars.

I did enjoy one moment of glory during the decade of the 1990s. I finally decided to roll over my 401K funds into an IRA account after they had been sitting in a Sears account for many years. Shortly after transferring the account (which consisted of Sears stock and cash which resulted from the sale of mutual funds), I sold out my entire allotment of Sears shares at almost exactly their high. As I recall, the shares fetched about $63 at the time of my sale. They never again returned to that lofty level and a few years later the company became the fish which was swallowed by the minnow when Eddie Lampert led the takeover of Sears by K-Mart which was emerging from bankruptcy proceedings. I must confess that my "perfect" sale of Sears stock was not based on any significant assessment of the intrinsic value of Sears stock; instead it was a case of a "blind squirrel finding an acorn" as the old saying goes.

Overall, my early investing experience could be described as a self-perpetuated disaster which was a direct result of entering a game which was still well beyond my level of comprehension. My long-time friend and former broker once advised me: "You should stick to picking horses and let me take care of your stock investments." At that point in my investing career, his advice was well founded.

Forming the Rudiments of Value Theory

Towards the end of the decade I was beginning to gain a grasp of certain techniques in identifying equities which were trading below their intrinsic value. I started to become influenced by several value managers who made regular appearances on CNBC. At that time, Buffett rarely appeared on TV and it would still be a long time until I started digesting his annual letters or reading any of the books that chronicled his theories and methodology in regard to value investing.

The two TV gurus, who drew my closest attention and subsequently influenced my investing theory, were Mario Gabelli and Robert Olstein. Gabelli's commentary alerted me to the existence of hidden assets which could frequently be detected by analyzing the balance sheet and Olstein's analysis convinced me of the importance of attempting to understand a company's accounting practices while emphasizing the importance of free cash flow rather than relying solely on accrual earnings. Any time either one of them appeared on TV, I took out a piece of paper and jotted down notes while I listening intently to their recommendations.

As I recall, the first sound value idea that I employed independently was Philip Morris (PM). The name was later changed to Altria but the ticker symbol remained the same. A number of years later when I read Jeremy Siegel's book "Stocks for the Long Run" it was revealed to me that Philip Morris was among the all-time great buy and hold propositions. The long term performance of the company was phenomenal and its steady dividend stream was among the best that Wall Street had to offer.

In the late 1990s, Philip Morris (PM) became a sizable value proposition based upon the fear that its tobacco division would be sued out of existence, hence destroying the value of entire company. While the tobacco division was a huge cash generator, characterized by popular global brands which sold a highly addictive product, it was hardly the whole story of the company. At the time I made my investment in Philip Morris, the company also owned Kraft Foods and the Miller Brewing company which would later be spun off or sold.

The Miller Brewing company had been purchased in the mid-1960s for a paltry sum in the neighborhood of $130 million. When the company sold three and half decades later, the business fetched $5.6 billion when the assumption of debt was figured in, and Philip Morris kept a 36% stake in the business. Talk about a stellar return on investment!

I originally bought Philip Morris at around $40 a share. It subsequently dropped to the mid to low $20s and for the first time in my investing career I bought more shares of a falling stock. I doubled my position at under $25 a share and eventually the fear that the company would be sued into bankruptcy subsided; at that point, the stock began a long upward ascent.

I do not recall when I sold out of Philip Morris but I know I held it for a few years and it was my first real success in the market. According to my records, the stock traded at $44 dollars a share entering 2001 (it rose much higher before I sold it) and accounted for 17% of my largest stock portfolio. It’s dividend rate at the time was approximately 3.4%.

Aztar: My First Major Value Blunder

I will close this edition of the series by recalling the first major value investing blunder which I committed. The blunder was a direct result of impatience, one of the deadliest crimes that a value investor can perpetrate on his long term returns.

By this time in my investing career, I was beginning to recognize buying opportunities and for the first time I grasped Gabelli's concept of purchasing hidden assets at a huge discount to their intrinsic value. About that time my former broker had alerted me to the potential value of Aztar and one day when I was watching Mario Gabelli on CNBC, the casino was mentioned as one of his value picks. "The Chairman" pointed out that its main holding, the Tropicana, was listed on the books at an enormous discount to its current real estate value.

Once the crown jewel of Vegas strip, "the Trop" was built in the late 1950s; its property was located on the far south point of the strip at the southeast corner of the intersection of Las Vegas Blvd. and Tropicana Ave. For years, it set alone as an oasis in the middle of the desert, holding the advantage of being much closer to the airport than the other casinos.

As the Tropicana aged, its isolation became a problem. As the shine wore off the aging casino so did its profits, as "high rollers" steadily abandoned the property in favor of newer and more elaborate places to sacrifice their money. However, by the mid 1990s, all that was about to change since the Tropicana would soon be sitting on hottest corner of the Las Vegas strip. What facilitated the change was the opening of the new MGM Grand in 1993. The MGM was built across the street from the Tropicana, directly to its north. After the MGM Grand opened, the desert steadily filled in around the intersection and new casinos were built on Las Vegas Blvd. both north and south of the once isolated Tropicana.

In the late 1990s I purchased shares of Aztar between $4 and $7 a share. The price was volatile and the casino was frequently the subject of buyout rumors which never came to fruition. While the property value of the casino skyrocketed, the price of the stock languished for year after year. Eventually, I sold my shares for an extremely modest gain. However, Mario Gabelli and other resolute value investors never wavered, holding their positions in the casino for over a decade. Gabelli and other patient investors were finally rewarded when a bidding war for Aztar broke out in early 2006.

Pinnacle initially bid $38 a share for the common stock of Aztar, subsequently raising the offer to $51 a share. But that figure was not good enough; in May of 2006 Columbia Sussex won the right to purchase Aztar for the whopping sum of $54 a share. I could only watch from the sidelines as I had sold my shares years before, giving up on what would have been an 800 to 900 percent gain if I had only possessed the proper patience.

The next edition of Reflections from Twenty Years of Investing will cover the period from 2001 to 2008. I will spend the majority of the article detailing the stocks which provided me with much of my profits. I will also document my greatest investment failure which ultimately did extensive damage to the long term ROI of my portfolios. Indeed, that investment blunder cost me severely in monetary terms; however, it profoundly changed my investment strategy in terms of future investing.

About the author:

John Emerson
I have been of student of value investing since the mid 1990s. I have continued to read and study value theory on an ongoing basis. My investment philosophy most closely resembles Walter Schloss although I employ considerably less diversification. I also pattern my style after Buffett's early investment career when he was able to purchase shares of tiny companies.

Rating: 4.3/5 (34 votes)

Comments

achitpatel
Achitpatel - 1 year ago
Excellent read. The recount of the Aztar investment is definitely a lesson for all value investors!
AlbertaSunwapta
AlbertaSunwapta - 1 year ago
Yes, value will out but the longer it takes the lower return you may realize. The hidden value needs to be able to compound it's growth while you wait for a catalyst, otherwise it's dead money - much like gold. The value may be more in creating a floor under the asset than a profit opportunity. I'd say realizing gains on 'hidden' real estate value is particularly tricky. Just look at Sears Holdings'.

I started investing in the 1970s and was fortunate to read the Intelligent Investor in the 1980s after the early 80s recession having held strong through the recession, so between the book and a positive buy and hold position the experience was self-reinforcing.

Still, that hasn't helped me avoid making many investing mistakes. Over diversification, selling too soon, buying concept stocks knowing full well that the odds of great outcomes are remote... I even bought one of the first Internet stocks ever to hit the market (online advertising, jobs, real estate and auto listings). How could I loose!

I, like you, also owned PM back then. Took my profits and donated them to an anti-smoking group.

:-)
superguru
Superguru - 1 year ago
"Observation over many has taught us that the chief losses to investors come from the purchase of low-quality securities at times of favorable business conditions".

Would cyclical business in downtrend considered low quality?

Would we consider miners and material companies like MT and BHP low quality or just beaten down?
John Emerson
John Emerson - 1 year ago
I appreciate all the comments from the first two articles in the series.

Albert, I concur with your comments although I always felt that Aztar had a catalyst in place after their corner started to populate. It seems that many of Gabelli's asset plays take longer that anticipated to play out, still the margin of safety exists in the discount to the underlying assets which they hold. That said, the Aztar property value was tremendously inflated by the time they sold the casino in 2006. By 2008 the bubble had burst and casino projects on the far north side of the strip were abandoned uncompleted. The price that was paid for Aztar was outrageously high and had it not sold at the time it did Gabelli would never have made anything close to the wind fall that he did. Still, at 4-7 bucks a share it was outrageously undervalued. The real value certainly lied somewhere in the middle.

Super, Certainly many cyclical companies have held durable competitive advantages and could be considered to be quality businesses, Microsoft and Intel would come to mind. I would say the same about mining and material companies which are the low cost producers of their products. Buffett has a history of buying building material companies and housing related businesses which are definitely cylical. Shaw and Acme Bricks are two such examples.
Adib Motiwala
Adib Motiwala - 1 year ago
thanks for sharing. retrospectives are always great.
mtommasiello
Mtommasiello - 1 year ago
Looking forward to the next article
aguaplumb
Aguaplumb - 1 year ago
Absolutely spot on the money pal. I started investing 2005 and your story is so familiar. Lost the shirt and got it back. Lost it again and got it back again. 2013 the rudder is now pointing north and the boat is in shipshape. Good article.
boutch2fr
Boutch2fr - 1 year ago
what about Intel actually? it would have been -retrospectivel- quite an interesting stock to buy and hold and hold and hold...

It's a really interesting series. Like aguaplumb, it makes me reflect on the past 7 years.

I have also 10% in gold, I've owned Intel for many years...

and I've seen quite a few companies being bought out a few months after selling / giving up on them...

looking forward to the last 2 parts!
kartikey1
Kartikey1 - 1 year ago
Great read. Looking forward to 2001-08... Thank you for sharing...
jasonmbaxter
Jasonmbaxter premium member - 1 year ago


I love this series of articles. Can't wait for your next!

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