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FOOL ON THE HILL
Valuing Stocks by the Market

Bill Barker reviews the year's big news, and notes that problematic voting machines weren't restricted to Florida, but have a metaphorical place in the current market as well. The confidence of some to entrust any or much of their money to the market long-term may well have been shaken by the recent unpleasantness, and the undeniable reminder that over the short term the market is defined more by risk than reward.

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By Bill Barker (TMF Max)
December 28, 2000

Now that we're at that time of the year where we're bombarded with lists of the biggest news stories of the year, we're likely to be reminded (as if we could forget) that two of the biggest stories of the year were the Presidential election fiasco, and the end of the uninterrupted bull market of the 1990s, both of which were united by the imperfections of voting machines.

At this particular moment of this particular year, a well-known quote comes to mind, that being Benjamin Graham's famous observation that, "In the short run, the market is a voting machine, but in the long run it is a weighing machine."

Of course, when Graham first uttered his famous words, back in the 1930s I imagine, he wasn't talking about the imperfections with literal voting machines. (It's interesting to note, however, that the imperfections of actual voting machines have been known for at least that period of time, and that as a society he have largely been willing to ignore the potential consequences.) No, Graham was referring to the willingness of stocks in the short-term to move wildly up or down on the basis not of the intrinsic value of the underlying business, but because of the popularity of the idea behind them. Or, perhaps, and as we have just seen this year, the popularity of the idea that since the stock prices had been moving up -- and quickly -- that direction (and speed) would continue.

But, as we have seen this year -- and as we will surely see over and over again in our lifetimes -- the market in the long term will, as it must, end up weighing stocks. Once having done so, the prices of the stocks will better represent the true value of the underlying businesses, and it now appears perfectly obvious that many stocks which were wildly popular as measured by the market's voting machine, had precious little weight underneath them. Oh, it would be easy to name a bunch of companies that best fit that description, and end up offending numerous owners of the stocks, but I'm sure that anyone reading this can fill in the blanks as they see fit.

To return to the analogy of the voting machines, if you watched as much post-election talking head coverage as I did, you were surely confronted by a number of hours of chatter devoted to whether "we" were or could soon be facing a constitutional crisis as a product of our reliance on those darned voting machines to tell us who we had voted for. (A brief interlude. I beg you, I plead you, not to construe anything written here as involving political analysis in any way. I have seen the email that comes in from our readers whenever anybody engages in anything involving politics. For the record, you all voted for the right guy. All of you. There.)

As it turns out, though there was enough of our political and judicial system exposed to provide pretty much everybody with something to disagree with, there appears to have been no constitutional crisis. (Again, please, no emails.) While the democratic system we have in place, voting machines and all, is not perfect, it is, in the words of Churchill, the worst form of government except for all the other ones ever tried.

So, too, is our market similarly afflicted with being about the worst valuation machine around -- except for all the other ones ever tried. Hey -- how many stocks can you look at that today go for less than a dollar a piece, that fetched $40, $50, $60 or $100 a share less than a year ago? Far, far too many to have any great faith that the market is much of a system for valuing its merchandise. In the short term. And it was an awfully short term that any of the companies sported such lofty valuations.

The confidence of some to entrust any or much of their money to the market long-term may well have been shaken by the recent unpleasantness, and the undeniable reminder that over the short term the market is defined more by risk than reward. This understandable reaction is, moreover, abetted by the mainstream media's willingness to phrase the type of questions that investors are and should now be asking themselves in fairly dark terms, much like the post-election media sought out constitutional crises to worry about.

While it might be entertaining every once in a while to think about just how bad things could get in the short term, either electorally or economically, I'm not sure how productive it is, or at least how productive it is in comparison to the amount of time that seems to be devoted to it. Instead, in an attempt to end with something more cheerful for the holiday season, I hearken back to a quote from another famous investor, this one Warren Buffett, who in his 1997 letter to shareholders advised,

"If you expect to be a net saver during the next 5 years, should you hope for a higher or lower stock market during that period? Many investors get this one wrong. Even though they are going to be net buyers of stocks for many years to come, they are elated when stock prices rise and depressed when they fall. This reaction makes no sense. Only those who will be sellers of equities in the near future should be happy at seeing stocks rise. Prospective purchasers should much prefer sinking prices."

By that definition, it's been a pretty good year in the market. Have a happy New Year, all.



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