FOOL ON THE HILL
An Investment Opinion
Wise Journalist Confesses He Blew It Louis Corrigan (TMF Seymor)
September 15, 1999
Stop the presses! We've got breaking news.....
Major Wise Journalist Admits He Was Wrong,
Responds to Fool's Criticisms
Woaaah! Mark your calendars. The Age of Accountability has arrived. Viva la revolution! Viva l'Internet!
Okay, I must admit to some giddiness when I realized that Joseph Nocera, Fortune's editor-at-large, was talking about little ole me in his latest column in Money magazine (October, 1999). It's not every day that I pound a major financial journalist for dumb market commentary and then have the guy confess, "I was wrong."
Sure, it took him a few months, and he added a half dozen caveats. But there's something truly touching about this. It's like we've almost got a dialogue going. Try as I might to be glib about it, I think it's a positive development.
A brief history
But first some background. The Fool has tussled with Nocera in the past -- mostly because he's never been particularly nice to us. In a 1996 PBS special about how the Internet was changing investing, Nocera gave the Fool lengthy though highly skeptical coverage. And Nocera had penned the April '96 cover story in Fortune -- headlined "Market Mania?" -- which highlighted the heated online discussion in Fooldom about Iomega (NYSE: IOM), the Zip drive company whose stock soared throughout 1995 and the first half of 1996 before collapsing.
In retrospect, Nocera was right. Sure, Iomega did have an awesome growth story. There's also no question that the frequently terrific discussion on the Fool message board highlighted the striking power of the Internet to bring together people from diverse backgrounds to share information and learn from each other about investing.
But the Iomega saga would prove to be one of enthusiasm run amuck, of too many herd-like investors throwing money at a stock mainly because it kept rising
Truth be told, I don't think any of us Fools writing about Iomega at the time were sufficiently alert to these dangers. We recognized them, sure, and the Gardners and others tried to head them off in various ways. Yet, we surely could have done more.
Though operating with the best of intentions, the Fool found itself riding a monster partly of its own making, a mania it had fed, however innocently. And at least as Iomega was concerned, it did all end badly, just as Fortune's cover had predicted. It was, to say the least, a learning experience.
Yet, we were not charlatans, quite the contrary. As The Economist once wrote, the Fool was an "ethical oasis," one of the relatively civilized outposts amidst the anything-goes Wild West that is the 'Net. Nocera could not bring himself to emphasize that. He was simply too skeptical about the medium to pay due respect to its constructive power or to the Fool's role in trying to channel that power in a responsible way. For that, we naturally concluded that he wasn't as smart as he thought he was.
We were right.
Requiem for the bull -- Ooops, he's not dead
A year ago, amidst perilous times for financial markets, Nocera composed a provocative cover story for Fortune entitled "Requiem for the Bull." He argued that the market would not recover quickly from its correction and that stocks could head significantly lower. In January, I reviewed the major magazine coverage of the market's meltdown and chided Nocera -- and nearly everyone else -- for lame analysis. (Money, incidentally, got a gold star.) Yet, I wasn't just picking on Nocera after the fact because he was wrong. Even last September, David Gardner expressed dismay at Fortune's coverage.
In his October Money column, Nocera confesses that he blew it with the market call, and he accepts my criticisms, if only implicitly. Yet he adds that "what's taking place on Internet stock sites involves a level of invective, of contempt, of raw hostility that goes beyond anything I've ever experienced." And so he asks, "What is it about financial journalism that so inflames the Internet stock community? Why has it become us vs. them?" He argues that the online sites cherish bullishness above all else whereas traditional financial journalists think caution best serves their readers.
Us vs. them?
Since the only examples of "invective" he cites come from my articles, let me respond. First, I think Joe is simply exaggerating. Print journalists have never been made to feel accountable to their readers. A few screened letters to the editor don't amount to much. So this new experience no doubt seems particularly unpleasant.
Second, it's not like this is a one-way street. Mainstream journalists have ragged on the Fool repeatedly. Money ran its own August screed from Jason Zweig blasting the Foolish Four investing approach. No doubt, Money has finally figured out that there's a huge market of smart individual investors on the Web and that lots of them check in with the Fool to discuss and research stocks, and to get their bearings. So Joe's actually complaining about his competition: Why are they being so mean to me? Well, competitors compete. That's kind of the way capitalism works.
What's key, though, is that we honestly believe that we're right and that guys like Joe are way too often wrong. We think we've got a product that often serves customers better. If you doubt this for a second, survey those September '98 cover stories and compare them to what was published by the Fool. Frankly, we couldn't care less if a savvy market call (like a Money cover two years ago: "Don't just sit there. Sell stocks now.") saves investors from a three month slide of 10%. If you start caring about stuff like that then you've lost your focus as a long-term investor.
What I will grant Joe is that all the dangers that eventually became obvious in the Iomega affair are real and widespread dangers. Many stock message boards -- including some on the Fool -- are filled with bulls addicted to their own wishful thinking. These are situations where skepticism should be welcome. Short-sellers or crusty journalists can save you a ton of money if they can get you to step back and analyze a situation. Of course, the Fool has warned investors about hypesters, about story stocks and penny stock scams, for years.
But why am I so mean to Joe?
Still, Nocera's work has personally bugged me because it's so high profile and yet sometimes so poorly reasoned at the pivot points. That's been a shocker because he's clearly a smart guy and a talented writer.
Consider his June 7 Fortune cover story on Yahoo! (Nasdaq: YHOO), subheaded: "A tale of how Wall Street and the rest of us learned to stop worrying about valuation and love an insanely valued Internet stock." My problem with this piece wasn't that Joe was saying skeptical things about an Internet stock. The problem was that he wasn't saying sufficiently skeptical things even though he should have been given everything else he uncovered in his reporting.
Nocera talked to numerous professionals who should know how to value Yahoo! None of them had a good reason for thinking that Yahoo! should trade where it did at the time ($158) rather than 50% lower or 100% higher. Instead of calling everyone's bluff, he decided to go with the flow. The article was filled with excellent reporting, but what really fascinated me is that it showed that Nocera and Fortune were willing to chuck their supposed intellectual compass (valuation matters) for no apparent reason -- though I bet that Yahoo! cover didn't hurt newsstand sales.
This speaks to a certain intellectual superficiality that mars Nocera's work along with the work of many other financial journalists who don't think like actual investors. Joe talks about how we online investors "think it's different this time" yet are really just part of the excess of the system contributing to the "eye-popping valuations." He's worried by folks (like me, no doubt) who seem smug about these good times, who don't seem to understand that the market can go down and stay down.
I appreciate his warnings -- really, I do. But these warnings are worse than useless if they aren't rooted in rigorous financial analysis.
Why historical P/Es don't mean much
Let's focus on my pet peeve: the historical mean price-to-earnings ratio. When I read "eye-popping valuations," I want to shake Nocera: How do we know whether a stock or the market overall is overvalued?
This question can be answered, and the right answer may be that the market is way overvalued. But the high P/Es that Nocera and his compatriots fall back on don't provide a meaningful answer. Think how far stocks could fall if the market reverts to the historical mean P/E level, they say. Dow 5,300, Nocera said a year ago. But this is a dopey argument.
It assumes, first off, that reported earnings are an adequate reflection of a company's free cash flow rather than a construct of GAAP accounting. It assumes that earnings alone satisfactorily capture economic value, despite the fact that brands, research, and other intellectual property don't necessarily get reflected in today's earnings. It assumes that the world is not dynamic, that variables like technological innovation, low inflation, low interest rates, improved corporate governance, better corporate disclosure, transparent real-time capital markets, better information technology for inventory management, and a hundred other things are immaterial to valuation. It assumes that managing a business to maximize return on invested capital is no different than managing it to become as big as possible.
This reversion to the mean argument assumes that capitalism does not evolve, that the conditions of corporate performance are fixed. There are no new eras. The range of possible valuations is set so that the mean cannot be raised by a period of prolonged growth. Most profoundly, Nocera assumes that the historical data he can readily access is relevant for thinking about the future free cash flows of hundreds of corporations and the market's ability to discount those cash flows properly.
These are all misguided assumptions.
Nocera counsels caution, but caution by itself is a pale virtue. If he thinks we should worry about stocks being overvalued, then he needs to really explain why. To do that, he must look at the actual businesses. The only obvious thing that historically high P/E multiples tell us is that the market is forecasting substantial growth for America's dominant companies. To figure out whether that forecast is right or wrong requires some pretty interesting analysis, which I'd love to see Joe tackle.