Bernard Baruch lived a dual financial life early in his career. He remained cautious and ever-watchful over his client’s money but that conservative nature ended where his own portfolio began.
Baruch tended to overtrade. He also ran a margin account and never left money in reserve. In other words, he liked to bet it all. But since he had little capital, he always put up the smallest margin possible.
In those days, margin accounts allowed anywhere from 10% to 20% margin. So Baruch could buy a stock using his own money to cover as little as 10% of a stock’s price and borrow the other 90%. Which is exactly what he did. Except, having no money in reserve meant a tiny change in price would quickly wipe him out. And so it went.
Anytime Baruch came across a stock or bond he felt sure of, he bet everything he had. Almost like clockwork, the market fluctuated in the wrong direction, and he was broke again. It didn’t help that most of his ideas came from gossip and tips. This process repeated numerous times before he finally realized he needed a little bit in reserve in case the market moved against him.
His big turning point, however, came in the spring of 1897. It was the first time Baruch changed his investment approach. He set his eyes on American Sugar Refining. He could afford to buy shares but before doing so he actually studied the company.
American Sugar was a near-monopoly. It controlled 75% of the sugar production in the U.S. The company’s success was helped by a tariff on raw sugar. Except, the status of the tariff was in question. The uncertainty around American Sugar, caused its stock to drop.
Baruch saw an opportunity. Dropping the tariff, would let foreign competition into the country and put U.S. farmers’ livelihoods at risk. Baruch didn’t believe Congress would follow through with it. Which is exactly what happened.
After Congress passed a bill that kept the tariff intact, American Sugar’s stock soared. Baruch parlayed his winnings to buy more stock. When he finally sold out, he had a $60,000 profit on his hand.
Baruch followed that major success with another. The firm he worked for was slowly gaining recognition when Thomas Fortune Ryan came calling. Ryan was a Wall Street giant with his eyes set on the tobacco industry.
Four major tobacco companies existed at the time. The biggest was the American Tobacco Company controlled by James Duke. Ryan wanted to combine the other three into a company called Union Tobacco and he wanted Baruch’s help to do it. Baruch was tasked with convincing Colonel Moses Wetmore, the president of Liggett & Myers, to get on board.
A few weeks of playing cards and being generally agreeable with the Colonel did the trick. Baruch and the Colonel agreed to an option on over half the stock for $6.6 million. Not long after, Union Tobacco and American Tobacco merged to create a monopoly.
For his part, Baruch’s firm earned $150,000, which pushed its profits up to $501,000 on the year. A third of that profit went to Baruch!
Flush with more cash than he ever had, and more confident than ever, Baruch fell back to his old ways and committed an amateur mistake. Rumor was that American Spirits Manufacturing was worth buying. It was the largest whiskey maker in the country at the time. Word on the Street was four liquor companies, including American Spirits, wanted to merge.
Baruch gave the rumors a little more weight because Ryan agreed it was a good buy. Or so he was told by someone other than Ryan. He put everything he had — his payday from the firm and the American Sugar profits — into American Spirits stock.
The market took the news of the merger with disappointment as the stock price dropped. Again, Baruch left no reserves to work with. He was forced to sell other positions to cover his margin.
In a matter of weeks, he closed the biggest deal of his career, collected a huge payday, then bet it all and lost it on a tip! It was his quickest loss ever. As a percentage of total net worth, it was his largest loss too. To add insult to injury, Baruch later learned from Ryan that he never believed American Spirits was worth buying.
It took months before Baruch built up the courage to get back into the market. He also began studying his losses to see where he went wrong. The goal was not to make the same mistake twice. In this case, it didn’t take much effort to figure it out.
I learned a great deal from this misadventure in whiskey. It taught me one thing about tips, mainly, people sometimes drop remarks calculated to bring the little minnows into the net to served up for the big fish. I had been a little minnow…
It is not simply that inside information often is manufactured to mislead the gullible. Even when insiders know what their companies are doing, they are likely to make serious blunders just because they are in the know.
There is something about inside information which seems to paralyze a man’s reasoning powers. For one thing, people place a great store on knowing something other people do not know, even if it is not true. A man with no special pipelines of information will study the economic facts of a situation and will act coldly on that basis. Give the same man inside information and he feels himself so much smarter than other people that he will disregard the most evident facts. I have seen insiders hold on to their stocks when it was obvious to nearly everyone else that they should be sold.
Over the long run, I have found it better to rely on one’s own cold detached judgment of the economic facts… My course violated every sound rule of speculation. I acted on unverified information after superficial investigation and, like thousands of others before and since, got just what my conduct deserved.
In a time where social media lets everyone blast their opinions to the world, you’re likely to come across stock “tips.” But why are they sharing it? What do they get out of it?
One reason, as Baruch points out, is to drum up demand. Higher demand lifts the stock price and makes it easier to off-load their shares on someone else. Once demand dries up, as Baruch learned, the stock price falls and you lose a lot of money.
That’s why studying the company is so important. When you know little about a company, you don’t know if there is a reason for further upside. You don’t know if you overpaid for the stock or not. And not knowing makes it that much harder to be confident in a position that goes south.
To prevent repeating the mistake again, Baruch’s solution was simple. He went to great lengths to not be biased by other people’s “opinions” on companies. In some cases, he literally shut people down. He cut them off and told them to stop. The best way for Baruch to limit undue influence on his investment decisions was to cut it out of his life.
Baruch: My Own Story
- Are Value Stocks Cheap for a Fundamental Reason? – C. Asness
- Rational at Night, Irrational at Day? – Klement on Investing
- An Essay on Investing in Small Stocks – MicroCapClub
- The Simple Tricks that Turned One Investor’s $70,000 Retirement Account into a $264 Million Fortune – Washington Post
- Speculation Is Necessary. Governments Can Help – Investor Amnesia
- Why the Bezzle Matters to the Economy – Carnegie Endowment
- Learning From John D. Rockefeller – Investment Master Class
- From Homeless to Head of a Sneaker Empire – Undefeated
- Darwin’s Sweet Spot – The Better Letter
- 40 Ways Things Are Getting Better – Reason