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February 22, 1999

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Subject: Re: The Flow Ratio...
Author: TomGardner

Eric,

I see that you are fired up as well out there, and I don't want to raise a ruckus here. Again, I support the right and responsibility of individuals to make up their own minds, when investing. And I hope and trust that you are doing as much. We probably don't agree on the best way to generate long-term investment rewards, but I hope we can keep things civil in our disagreement.

Perhaps we can settle this with a question. When Merrill Lynch brought Schering public in 1952, when was the best time to flip out of your shares based on valuation? Dig back into the numbers and you'll find a stretch of non-performance from the stock, but which investor could have timed that perfectly, what would the commission and capital-gains tax costs amounted to, and which investor would have known just when to get back in?

Schering Plough has compounded 19% annual growth since 1952, turning $5,000 into $17.7 million over that period. Is this not enough wealth accumulation for a single family?

My final question is -- were you, using traditional valuation techniques, able to justify investing in America Online in 1992-1994? The stock is up anywhere from 100-300 times in value since then. I remember hearing just how badly overvalued it was in 1994. Now that rant has moved to other stocks. Do we think AOL is now reasonably priced, overpriced, or underpriced, relative to its business prospects going forward -- and were you able to dig it up as a wonderful value five years back?

Tom Gardner, Fool


Subject: Re: The Flow Ratio...
Author: newtopos

Tom Gardner, a Fool, wrote:
I see that you are fired up as well out there, and I don't want to raise a ruckus here.

I doubt it'll be a ruckus. On the Rule Maker board you likened it to a boxing match or duel.

We probably don't agree on the best way to generate long-term investment rewards, but I hope we can keep things civil in our disagreement.

Civil -- absolutely. I think one of my points however is that The Motley Fools' actions point to one thing while your rhetoric points to another.

Perhaps we can settle this with a question. When Merrill Lynch brought Schering public in 1952, when was the best time to flip out of your shares based on valuation? Dig back into the numbers and you'll find a stretch of non-performance from the stock, but which investor could have timed that perfectly, what would the commission and capital-gains tax costs amounted to, and which investor would have known just when to get back in?

Here you extol the wonders of buying and holding great stocks over very long stretches of time. No disagreement here.

"I have shown that the Fool Portfolio, the one that has been around for more than a couple years, has shuffled stocks on a regular basis. The average holding period is maybe 12-18 months. Yes, it's nice to hear rhetoric about five and ten year holding periods (or 40!), but that's not the way it has happened."

Let's see.

In 1994, the Fool portfolio bought Boston Technology and Sonic Solutions.

It sold Boston Technology ten months later.

It sold Sonic Solutions almost fifteen months after buying it.

In 1995, the Fool portfolio bought The Gap. This is interesting because the Gap is a great company. Yet the Fool portfolio sold it sixteen months after the purchase. Hmmmm.

It also bought Iomega, Ride Snowboards, Applied Materials, and KLA-Tencor.

Ride was held for six months.

Applied Materials was held for less than nine months.

KLA-Tencor was held for over three years (!).

Iomega was pared back around the two year mark.

In 1996, the Fool Portfolio bought Medicis, 3Com and ATC Communications.

It held Medicis for less than eight months.

ATC Communications lasted less than a year.

3Com lasted almost two and a half years.

In 1997, the Fool Portfolio bought Innovex and Amazon (as you can tell, I'm not mentioning the shorts - no one expects you to maintain a short for years and years).

Innovex lasted a year and a half.
Amazon was pared back fifteen months later.

Now, that's a great story about Schering. And the way you talk about flipping sure riles me up to hate those market-timers and people with short time horizons. I'm all for holding those great stock for forty years. In fact, Schering's the kind of stock I'd talk about if I ever wrote a book.

But look at the trades.

My final question is -- were you, using traditional valuation techniques, able to justify investing in America Online in 1992-1994? The stock is up anywhere from 100-300 times in value since then. I remember hearing just how badly overvalued it was in 1994. Now that rant has moved to other stocks. Do we think AOL is now reasonably priced, overpriced, or underpriced, relative to its business prospects going forward -- and were you able to dig it up as a wonderful value five years back?

Okay, Tom, I have to call you on this. You're a very smart guy (and I mean that), so you know that you're committing at least two fallacies in this attack.

One, you're arguing that one example invalidates a general rule. Since you're very well-read, you'll remember the argument from The Republic. Should you return what your friend lends you? The answer is yes. But what if your friend lent you a gun and he comes back demanding it when he is drunk and incensed? Do you give him the gun? Absolutely not. So, I suppose, since we shouldn't give back what our friends lend us in this one case, we should never give back what our friends lend us?

Secondly, you commit the straw man fallacy. You put up something that we never suggested as the target, and then attack it as if it were our suggestion. You say that using "traditional valuational techniques" would never have allowed the purchase of AOL in 1992-1994. No argument here. In fact, I never suggested the use of "traditional" valuational techniques. Neither did IFindKarma. We simply pointed out that there are no valuational criteria anymore. Should AOL be given a premium to all the companies out there that aren't growing? Absolutely. Should AOL be worth half the total market cap of all American equities (it's not right now, by the way) at this time? I'd say no. It gets murkier in between, and all I'm suggesting is that perhaps some attempt should be made to consider what insanely great companies should be worth.

"...when does a Fool become Wise? How many employees must he have? Must he be a public company? How many books must he sell? How many people must listen to him? When does the outsider become the new establishment?"

It seems that whenever we have a discussion, it's like the carnival game where heads come up from random places all the time. To fend off that feeling of aiming at a moving target, I'm going to reiterate a couple points.

The original posts stated that the current Rule Breaker/Rule Maker methods of picking stocks have throw out all valuation guidelines. I don't think that has been disproven, or even disputed.

But your response makes two arguments. The first is that over the long, long term (40 years in the case of Schering-Plough), it doesn't make sense to try to time the market. Thus, long term buy and hold is the key.

I have shown that the Fool Portfolio, the one that has been around for more than a couple years, has shuffled stocks on a regular basis. The average holding period is maybe 12-18 months. Yes, it's nice to hear rhetoric about five and ten year holding periods (or 40!), but that's not the way it has happened.

Secondly, you said that traditional valuation techniques would have precluded buying into AOL in 1992-1994. Granted. I challenge you to find a place where I have suggested that old-time valuation techniques must be rigidly adhered to. But I do think that consideration of value should at least enter a buyer's mind, lest they get into Iomega at its peak and see 75% of their money vanish over the next two and a half years. To me, that would be foolish and sad.

It might surprise you to learn that I think your position of completely disregarding valuation is actually not that bad. I take exception, however, to intellectual dishonesty. Preaching the long, long term while holding most stocks for a year doesn't fit. Mocking the momentum players while making relative strength a key criterion for your stock picks doesn't fit.

My question to you: when does a Fool become Wise? How many employees must he have? Must he be a public company? How many books must he sell? How many people must listen to him? When does the outsider become the new establishment?

Eric, a gadfly

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