Bubbles, Manias, and Other Nonsense Why Fools love Alan Abelson
Part 2

By Louis Corrigan (TMF Seymor)

(September 22, 1999) -- Again, Abelson's best guide to the future is always the past. In this July 1997 article, he notes some interesting research from Ed Hyman, one of Wall Street's most respected economists. Hyman found that on five occasions, the Dow had doubled over a stretch of 31 months. In four instances, the market traded lower a year later. "In the bad old days," Abelson confessed, "we would have gleefully seized on this slice of history as a dark omen." And that's what he's doing here in a sarcastic vein. This stuff is supposed to scare you.

History Lesson?

            31 Mo.                   DJIA
Date         Gain        DJIA     12 Mo. Later    Change
1906 June     110%        92.1        78.7         -15%
1929 August   133        361.0       230.9         -36%
1935 October  136        135.3       174.8         +29%
1956 April     95        511.0       485.4         - 5%
1987 August   114       2655.0      2051.3         -23%
1997 July     112       7975.7         ?             ?%
These stats make for swell chatter at a cocktail party, but they just don't tell you squat about what's likely to happen in the future because they don't say a thing about what makes the economy or the Dow 30 corporations unique today. Let me fill in the blanks.
1997 July        112%   7975.7      9234.5         +16%
Abelson's work is simply chock-full of such examples. My own read on this is that financial writers who regularly misuse history as Abelson does either don't know how to think about actual businesses in a way that's useful to investors, or they simply don't have the patience to do so.

Lest you think I'm holding all mainstream journalists up for scorn on this count, let me note that The Wall Street Journal's Greg Ip, for one, does a consistently excellent job of exploring what's potentially distinct about our historical epoch. That was again apparent in his fine September 13 article, "'New Paradigm' View For Stocks Is Bolstered."

Indeed, Ip's piece reads almost like a direct rebuttal of Abelson's recent column of August 30. For instance, Ip takes seriously the analysis done by CS First Boston's Michael Mauboussin on the attractive and unusual cash flow dynamics of "new economy" companies like Amazon.com and Yahoo! (Nasdaq: YHOO).

Ip also explores the implications of a new Federal Reserve study, mentioned recently by Fed Chair Alan Greenspan, which indicated that corporate earnings are understated due to heavy spending on intangible assets such as research and development (R&D), or what Greenspan called "idea-based value added." Increasingly, vital long-term corporate investments come in the form of technology that must be expensed rather than capitalized. That means these items hit the income statement all at once, cutting deeply into profits today rather than being depreciated over time based on their long-term utility.

Abelson didn't think much of this research. He noted that "earnings have been hoked up, in some instances by capitalizing expenses, but more insidiously by disguising labor costs through the use of options as compensation instead of traditional coin." In other words, he emphasized the negative aspect of these actually counterbalancing accounting distortions. He didn't bother to note that Greenspan himself had suggested that the net effect of these distortions was understated corporate earnings. That's no surprise given that such an interpretation might be cause for Abelson to reconsider whether high P/E stocks might to some extent be less expensive than they appear.

Moreover, Abelson dismissed the unnamed Mauboussin as one of the "professional diviners of trends" who coins new phrases "not from linguistic necessity but, rather, from marketing imperatives -- specifically, the need to impress everyone."

"We don't know what master of articulation first uttered the phrase 'new economy' and then quickly arrayed it in neat counterpoint to its antonym, 'old economy.' But it was a neat formulation and has gained widespread currency, particularly among apostles of high-tech and Internet stocks. For their writ, holey as it may be, holds that the Internet and technology are the creators of the new economy. So it follows ineluctably (to them, anyway) that the Internet and high-tech stocks fully merit their monster valuations.

"At the risk of revealing ourselves as decidedly unhip, if not a Luddite, we'll confess we don't think there's such a thing as a new economy -- or, for that matter, an old economy. There's simply a real economy, and it constantly undergoes changes, big and little, abrupt and subtle, overt and imperceptible."

What's interesting about this is that Abelson purports to counter talk of a new economy by focusing on the "real" economy. Yet, it's all talk. He never addresses Mauboussin's work in any detail, perhaps because that work deals in uncomfortably real matters like the actual cash flows of specific corporations and how that figures into valuing them.

In fact, it's not clear that Alan has even read the Mauboussin article he's clearly alluding to, or if he has, whether he understands it well enough to utter a syllable about it pro or con. After all, it would be hard to read Mauboussin on Amazon's cash flow dynamics and limit yourself, as Abelson does, to a discussion of Amazon's "anorexic profit margins even by the not-very-robust standards of booksellers" and the likelihood that competition means Amazon will "probably never show a profit." There's just some crucial stuff about Amazon's business model that Abelson isn't discussing much less rebutting. But this is no surprise given that he still believes Amazon is mainly a bookseller.

Moreover, he still thinks that price-to-book value is a meaningful metric to apply to Amazon and other high-tech companies. But with such businesses built on intangible assets like software, brand, and intellectual property, book value has become a less useful valuation tool, perhaps even a completely useless tool in many cases.

With Amazon, as well, the company's decision to issue convertible debt rather than equity effectively understates the company's (potential) reported book value since straight-up stock issuance would immediately show up as shareholder equity whereas debt does not. Yet, this was a smart financing decision. If all the notes convert to equity at the fixed price of $78 a share, then Amazon will issue around 16 million shares versus the minimum 20.3 million it would have been required to issue last January had it just sold stock in a follow-on offering. Amazon's high price-to-book value, then, results partly from a financing strategy intentionally adopted by the company's management team.

Abelson will never understand such things. It's exasperating only if you think Barron's lead columnist should be an astute judge of stocks and the market. Yet, that's probably not a fair expectation. The fact is, Abelson is a writer and entertainer, and a darn good one, even when he's wrong. His prose is full of avuncular charm, style, and wit. He's grumpy, but he's always good for a laugh or two on a Saturday morning. You gotta appreciate that. Indeed, that's ultimately why I honestly do love the guy and will miss him whenever he lays down his pen. And given his technophobia, I'm pretty sure it is a pen, not a keyboard!

That being said, the last thing you want to do is give his commentary any weight in your investment decisions -- unless you're looking for potential Rule Breakers getting slammed by major financial media outlets.

Related Links:
-- Eyes on the Wise Message Board
-- Eyes on the Press - 1/21/99
-- Eyes on the Wise: A Fund Czar, an Analyst, and a Broker - 12/9/98
-- Inside Business Week's "Inside Wall Street" - 10/15/98
-- Fools on Amazon.bomb - 6/8/99

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