Frank Thoughts: Tesla, Still Cheap?
Dave Canal
February 11, 2020

With half the stock market’s total capitalization represented in index and ETF funds, it could almost be called a “passive” stock market. But that will never happen. The impact of an individual stock on a portfolio’s performance is too great. Peter Lynch expressed this reality best when he said, “It is not the number of times you are right, but the magnitude of when you are right.” I had learned that lesson years ago working for Merrill Lynch as a young order clerk.

One day an oil delivery man came into the Merrill office wearing heavy duty work clothes with Sterling Oil embroidered on his jacket. He was assigned a broker and produced a check for $10,000. At the time, the early 1960s, it was an enormous amount of money. Hyman Adelman would turn out to be an aggressive investor who used leverage. Adelman bought $20,000 of Syntex on margin.

It was not a normal stock. It was an “animal.” By comparison, today’s Tesla trades like a utility. The specialist would have to halt trading several times a day. Massive order imbalances would develop. It was not unusual for the stock to reopen $20 or $30, up or down, from the previous halt. Only once did I see Hyman Adelman show any emotion. And I saw him every day after the market closed. 

If the stock had moved higher, he would use his increased buying power to purchase more. If it had gone lower, he would sell just enough to stay ahead of a margin call. It was living on the edge, but Adelman was mentally prepared to lose the original $10,000. He never allowed himself to become – as they say today in behavioral economics – “anchored” to what had been the high price of the stock. As time went by, and the stock traded higher, he would always use the increase in equity to buy more.

This experience came to mind the other day as I reflected on the past 12 years of the debt crisis and its negative impact on active portfolio management. As I thought about Adelman’s experience, it occurred to me his debt to equity ratio was just one to one. In the mortgage crisis it was typically twenty to one. That five percent - or less - down payment in real estate was the same margin which had caused the stock market crash of 1929. Too much debt to equity is always the cause of misery.

The crash of 2008/2009 had real estate, and the Collateral Debt Obligations (packaged mortgages) behind it, with an unknowable market value. This was finally recognized when two bond traders at a Bear Stearns hedge fund couldn’t get a bid for CDOs they were trying to sell.  It was the start of the debt crisis. The similarity between the two major stock market crashes of 1929 and 2008/2009 was that they were both caused by low 5% margin. Both crashes had a major impact on active portfolio management with correlation (stocks trading as a group) running as high as 70%. Fear causes correlation that can last for years. Following 1929, it was 12 years. This month it is also 12 years!

In a low-correlated market, the reward of individual stock selection can be breathtaking. Correlation in the early 1960s was below 10%. A record low. At the time of Adelman, there was a young stock analyst at The Old Colony Trust Company in Boston. I didn’t know him then, but we subsequently became friends. He convinced the bank to buy one million shares of Syntex at $17. Six months later they sold it at $600!  As for Adelman, he turned his leveraged $10,000 into one million, closed the account and walked out. Syntex was the pharmaceutical firm that created the birth control pill.

-Francis Patrick Boland

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