TMF Interview With
Author Kevin Hassett
With David Gardner and Tom Gardner
December 7, 2000
Though the market's been blue, there's still optimism out there -- just ask Kevin Hassett, resident scholar at the American Enterprise Institute and former senior economist at the Federal Reserve Board, who along with Jim Glassman wrote a book bearing the words "Dow 36,000" on the cover. Hoping to get a better sense of how the stock market might make such a move possible, Tom and David Gardner spoke with Hassett during the Dec. 2 broadcast of The Motley Fool Radio Show. Here is an edited transcript of that interview.
Tom: Kevin, the book Dow 36,000: The New Strategy for Profiting from the Coming Rise in the Stock Market is now coming out in paperback. Did you guys think about changing the title?
Hassett: You know, it was kind of funny. Certainly it did just come out in paperback. When we were really in the middle of all the news reports about the market last year, a lot of folks were writing stories about how our book was being disproved by the huge increase in Nasdaq, because our book is sort of about how firms that make money are a great buy at today's prices -- or last year's prices, too -- so when Nasdaq started soaring they said, "Well, you said it's the guys who make money who should be soaring."
Now it's on the other side. It just sort of shows how illogical bears can be. They're saying we're wrong because Nasdaq's going down, and so we're wrong because they were going up and we're wrong because they're going down, too. Jim and I stick to our theory, which is that firms that make money and grow that money over time are still really cheap.
Tom: When you said Dow 36,000, did you have a particular time-frame in mind for when the index would hit that mark?
Hassett: It's such that we don't know when that's going to happen. We don't claim to be crystal ball gazers. What Jim and I do is work through a simple rational logical valuation procedure and see what a reasonable, rational person ought to be willing to pay for the Dow today. I think that at each step of the way we make pretty conservative assumptions and the really startling thing is that if you're a reader, you sort of go through conservative assumption after conservative assumption and then at the end, we give you a Dow of 36,000.
|"I've started to look at a lot of Nasdaq companies because there are companies out there that are sitting on cash and making money... that have really been crushed." |
Now, we don't know that it's going to go to 36,000 this year or next year, but we do believe at today's prices that it's okay to run in and buy stocks because they're still cheap.
David: You guys are obviously focused on the Dow in your book, but what about the Nasdaq? It has had a rough few months. It's lost nearly half its value since March. I've got to figure even though it's not the Dow, that you have some thoughts about the Nasdaq -- like could we get the Nasdaq 3,600?
Hassett: I am a big fan of a lot of the Nasdaq companies, especially the companies that make money. I think that what we're going to see now is a test of the kind of things you guys have been preaching for years, which is that the new economy firms are great businesses. We're going to now really put that to the test.
You know, I've started to look at a lot of Nasdaq companies because there are companies out there that are sitting on cash and making money and growing that money at pretty remarkable rates that have really been crushed. I mean there are a lot of price earnings to growth ratio firms out there like in the point one range right now. I mean very good companies, like a company -- I don't own this company -- called ViaSat (Nasdaq: VSAT). Have you guys ever thought about this company?
David: Have not.
Hassett: Well, it's a company that makes the stuff that satellite companies use and if you just look at the growth of their revenues and the amount of money they have coming in, they look like they are a pretty good company, but they are selling at a P/E that's kind of about what you'd get for a blue-chip, old-economy firm right now, like in the 20's.
Tom: Kevin, you're talking about some of these technology companies possibly rebounding and being values now -- a lot of them made of the dot-com shakeout -- and you have companies like Priceline (Nasdaq: PCLN) that have virtually disappeared now over the last six months. Do you have a beat on which of the dot-coms actually have the potential to be around and successful 10 years from now?
Hassett: You know that obviously is the hard question. One of the things I think we've learned in the process is that the incumbents -- like Toys 'R' Us (NYSE: TOY) versus eToys (Nasdaq: ETYS) -- can mimic the new guys if they have to in order to survive. You should look for the dot-coms that can't have their business plans stolen very easily, so I would expect, for example, that Amazon.com (Nasdaq: AMZN) is here to stay and if they are here to stay, then you should buy that stock right now. I mean, they are really cheap.
They really ought to be able to start making money, but you know it's ultimately going to be a test of management and business plan. If the guys don't start making money, then their value shouldn't go up and so for me, I'm still sitting on the sidelines with the Internet firms that don't make money and trying to wait to see who has the management that can start making money. When I start seeing that, then I'm going to be buying like crazy.
David: Earlier in our interview, you mentioned some of the conservative assumptions in your book that lead to a natural conclusion for you and for Jim Glassman of Dow 36,000. Can you just toss out a couple of those conservative assumptions so that we can figure out what you base your optimism on?
Hassett: The idea is first of all that when you are buying a stock, you are buying a share in a business. I've heard you guys say this: All you have to do to figure out if you want to buy is just add up the money and see if you are buying more than a dollar for a dollar. And to add up the money, you just add up the cash that the firm's throwing off and then make a present value calculation or add it all up from now off into the future sometime.
Then you just need to make growth assumptions because the cash isn't going to stay the same, it's going to grow over time to close the loop. When you do that and you look at the growth that the firms have produced for their profit, you get really, really high valuation numbers very easily because in the aggregate, for example, over the last 10 years, firms have been growing their profits about 12% a year and when they are growing their profits 12% a year, then, shucks, that thing doubles in six years.
|"I'm still sitting on the sidelines with the Internet firms that don't make money and trying to wait to see who has the management that can start making money."
If the profit doubles in six years and the price doesn't move, then the P/E is going to get cut in half and that's the kind of logic that gives you a really high Dow. But the assumption of profit growth that gives you a 36,000 [Dow] is only about 5.5% a year which is half the long-run average. If you think profits are going to grow 5.5% a year in the future, and you discount the cash flows for firms, then you can get a Dow of 36,000. That's what I mean by conservative assumptions.
Tom: Okay. Let me create a scenario for you, Kevin, of an investor who began investing, let's say, 30 months ago and is now looking at having made decisions that have led to his or her retirement plan being actually 15 percent in the hole from where they began.
Let's put this person in their late forties and say they are beginning to feel the pressure of the decisions that they're making affecting clearly what year they believe they can retire comfortably. What do you say to the person who is sitting there right now looking down at their portfolio in their den listening to the program and thinking, "What the heck should I do given the environment today?"
Hassett: I think the most important thing to remember is when you make money in the stock market, it's hard work. It's not free money, and the reason it's hard work is there are times like right now when it's hard to keep holding stocks. It's easy to panic and sell and if you look at the series of events that we've seen over the last 12 months, there's been a bunch of really crazy news like an old-economy Federal Reserve raising interest rates 6 times, more than doubling the price of oil, and now we've even got a constitutional crisis, for gosh sakes.
All this bad news is the kind of thing that temporarily -- and historically this has always been true -- moves the market down, but the market has always come back very strongly after that and I don't see why this time should be any different. Indeed, if you look at the fundamentals of valuation like the profits that firms are making, they're still pretty good, and so that person should rest assured that the market's going to come back -- probably soon -- and it's going to do so for good, solid fundamental reasons.
Tom: And let me close with this question, Kevin. What is it that makes profits dry up and what is it that make profits expand here in the U.S.?
Hassett: Basically, the thing is the world is a changing place and if you've got a cool product and the ability to make cool products, then even if the world changes, you can find some other thing to make to sell to people to make money. In Japan, they basically decided they were going to make a thousand widgets no matter what and when people didn't want widgets any more, they kept making the widgets and losing money doing so. They didn't decide to look for some kind of new product besides widgets. I think that in the U.S. we are always going to be in the front of the wave of new product creation and if you are out there, you ought to be making money.
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