Novel Investor

Some people happily pay a premium for quality. If you think a product — like iPhones, designer bags, or shoes — is higher quality, it might be worth paying more. Sometimes you actually get more than your money’s worth. Other times, the premium is the cost of being associated with the logo.

It’s no different with stocks.

Investors pay a premium for stocks labeled “quality” or “excellent.” Sometimes, it’s worth it.

In 1987, Michelle Clayman tested the performance of so-called “excellent” companies based on fundamentals relayed in the book In Search of Excellence.

The book labeled 36 publicly traded companies as “excellent” based on specific fundamental criteria: asset growth, equity growth, return on capital, return on equity, return on sales, and price to book. Clayman looked at the performance of 29 companies (of the 36 still in existence) to see how well “excellence” performed. Over a five year period (1981-1985), an equal-weighted portfolio of the 29 “excellent” stocks beat the S&P 500 by 1.1% per year. Continue Reading…

Every bull market bust comes with lessons. One is that bull markets offer the illusion of permanence.

For example, the longer a bull market drags on, returns are more likely to be normalized and expected. When double-digit returns are all you know, the easy assumption is to expect more of the same.

It’s a repeated lesson because there’s always a new crop of investors experiencing their first bull market and some of the old crop forgets what the last bear market was like.

But some market busts are so impactful it creates a sea change. The hardest taught lesson was felt at the depths of 1932. Continue Reading…

And one cloudy day somebody asked for a dollar, and not getting it promptly enough, very promptly squealed. That squeal was the signal to the chorus of the entire world, which also wanted Money! Money! Money! It is sad to want money and not get it. But to ask for your own money and not get it is the civilized man’s hell.

Thus the 1907 bank run began.

The Panic of 1907 is a story of the stupidity of a few greedy rich men attempting to corner United Copper, the failure of the Knickerbocker Trust Company, and one J.P. Morgan.

Augustus Heinze, his brother Otto, and Charles Morse cooked up a scheme to corner the market in United Copper stock. The plan was a short squeeze, that ultimately failed and took a brokerage house down with it.

A dip in confidence is all it takes to set off a bank run and the Heinze brother’s failure was enough catalyst for the distrust. The bank run began at the banks controlled by Augustus Heinze and quickly spilled over to banks merely associated with him, including the third-largest trust in New York, The Knickerbocker Trust Company.

Once the Knickerbocker Trust was hit, it failed a day later. The run spilled over to other banks, lending dried up, and the panic reached the stock market.

It was Morgan who stepped in at the last minute to provide the much-needed liquidity to quell the panic because no one else could do it.

Edwin Lefevre, of Reminiscences of a Stock Operator fame, retold the story of the Panic of 1907 four months after the event: Continue Reading…

Fred Schwed had a front-row seat to the Great Crash. He worked at a trading desk of a brokerage house since he left college. A week earlier — on October 24 — was the first moment he realized something was off.

October 24th started out like any normal day…until 11 am. The time is important because that was the deadline for margin calls.

The day before, in the final hour of trading “someone had pulled the plug, and an avalanche of common stock had descended on the reluctant and retreating buyers.” That selling triggered margin calls.

If you borrow money to buy stocks, you must meet certain minimum margin requirements. Falling below the minimum triggers a margin call and sticks you with two choices: add cash to your account or sell stocks.

In the booming market of 1929, how many investors using margin had extra cash lying around? Practically none is my guess. Continue Reading…