Performance Investing

Performance Investing

Performance investing took hold of Wall Street in the late 1960s. The commandments for fund managers were simple: Concentrate your holdings in a relatively few stocks and don’t hesitate to switch the portfolio around if a more desirable investment appears. And because near-term performance was especially important (investment services began to publish monthly records of mutual-fund performance) it would be best to buy stocks with an exiting concept and a compelling story. You had to be sure the market would recognize the beauty of your stock now – not far into the future. Hence, the birth of the so-called concept stock.

Xerox was a classic example of a concept stock. The concept was that of a new industry where machines would make dry copies by electrostatic transference. The company, Xerox, with its parent protection and its running head start, could look forward to several years of increased earnings. It was a true story – a believable story, one that would quicken the pulse of any good performance manager.

But even if the story were not totally believable, as long as the investment manager was convinced that the average opinion would think that the average opinion would believe the story, that’s all that was needed. The youthful gunslingers became disenchanted with normal security analysts who could tell you how many railroad ties Penn Central had, but couldn’t tell you when the company was about to go bankrupt. “I don’t want to listen to that kind of security analyst,” one of Wall Street’s gunslingers told the author. “I just want a good story or a good concept.” The author Martin Mayer quoted one fund manager as saying, “Since we hear stories early, we can figure enough people will be hearing it in the next few days to give the stock a bounce, even if the story doesn’t prove out.” Many Wall Streeters looked on this as a radical new investment strategy, but Lord Keynes had it all spotted in 1936.

Eventually, it reached a point where any concept would do. Enters Cortess W. Randell. His concept was a youth company for the youth market. He became founder, president, and major stockholder of National Student Marketing. Randell’s motto, if he had one, appears to have been borrowed fro Shakespeare: “Nothing can seem foul to those that win.” First, he sold an image – one of affluence and success. He owned a personal white Learjet named Snoopy, an apartment in New York’s Waldorf Towers, a castle with a mock dungeon in Virginia, and a yacht that slept twelve. Adding to his image was an expensive set of golf clubs propped up by his office door. Apparently the only time the clubs were used was at night when the office cleanup crew drove wads of paper along the carpet.

He spent most of his time visiting the financial community or calling the on the sky phone from his Lear, and sold the concept of NSM in the tradition of a South Sea Bubble promoter. Randell’s real métier was evangelism. When he told meetings of security analysts that NSM was well on its way toward becoming a $700 million marketing organization, they listened with faith, respect and awe.

Performance Investing. Apartments on Manhaten. Photo by Elena

The concept that Wall Street bought from Randell was that a single company could specialize in servicing the needs of young people. NSM built its early growth via the merger route, just as the ordinary conglomerates of the 1960s had done. The difference was that each of the constituent companies had something to do with the college-age youth market. Subsidiary companies sold magazine subscriptions, books and records, posters, paper dresses, guidebooks for summer jobs, student directories, a computer dating service, youth air fare cards, sweatshirts, live entertainment programs, and a variety of consumer staples. What could be more appealing to a youthful gunslinger than a youth-oriented concept stock – a full-service company to exploit the youth subculture? Youth was in – this one couldn’t miss.

Randell kept up his whirlwind promotional pace, making new converts as he went along. Glowing press releases issued forth from company headquarters and Randell’s earnings projections for the company became increasingly optimistic.

While there were some thistles among such roses (the earnings growth was produced by the old conglomerate gambit with the generous support of some creative accounting), “concept” investors bought heavily in the company and blithely ignored all questions. When Gerry Thai’s Manhattan Fund bought 120,000 shares for $5 million, it became clear that Randell had obtained the imprimatur of Wall Street’s performance investors. Even some of the most august and conservative firms, including Bankers Trust, Morgan Guaranty, and Boston’s venerable State Street Fund, bought stock. Pension funds, including General Mills, bought heavily; and United States Trust Company (the country’s largest trust company) bought the stock for many of its accounts. University endowment-fund in the mad scramble for performance. Blocks of NSM were bought by Harvard, Cornell, and the University of Chicago. Bundy himself practiced what he preached, and the previously conservatively managed Ford Foundation Fund also bought a large block.

The follwing table shows the high prices and and enormous price-earnings multiples for National Student Marketing and for a small group of other concept stocks. The number of institutional holders (probably understated) for each security is also shown. Clearly, institutional investors are at least as adept as the general public at building castles in the air.

There were other concepts. Health care, fr example, attracted quite a few adherents. Given the increasing numbers of older people and the spread of federal and private health insurance plans, someone was bound to make lots of money. Four Seasons Nursing Centers of America looked just like that someone. The biggest and most aggressive mutual funds bought in. At one point in 1969, institutions owned close to 50 percent of the company’s stock.

Security, High Price (1968-69), Price Earnings Multiple at High, Number of Institutional Holders Year-end 1969, Low price 1970, Percentage Decline.

Four Seasons Nursing Centers of America – 90 3/4; 113,4; 24; 0,20; 99.

National Student Marketing – 35 3/4; 111.7; 21; 7/8; 98.

Performance Systems 23; – ; 13; 1/4; 99.

The company expanded at a feverish pace, financing itself largely through the issuance of debt. These borrowings were sweetened, however, with so-called equity kickers. This meant that attached to each bond were warrants to buy common stock of Four Seasons at fixed prices. Thus, if the stock price continued to go up, the bondholders could exercise their warrants and make additional profits.

The institutional buyers who flocked in were not only Americans – even the « shrewd » European bankers bought heavily. European purchasers included such illustriuos names as Banque Rotchild, Kreditbank Luxembourgeoise, Crédit Commercial de France, and the European operations of such U.S. Firms as American Express Securities, S.A.; Bache & Co.; Burnah, & Co.; and Merrill Lynch, Ltd. Four Seasons president Jack L. Clark boasted, “without the institutions, we couldn’t have grown nearly this fast.”

As the debt mounted up no one seemed to worry much about the old ideas of prudent debt rations, for this was a new concept and the rules of the game had changed. On June 26, 1970, the company filed a petition for reorganization under Chapter X of the Bankruptcy Act.

Minnie Pearl’s concept is our last example of the period. Minnie Pear was a fast-food franchising firm that was as accommodating as all get-out. To please the financial community, Minnie Pearl’s chickens became Performance Systems. After all, what better name could be chosen for performance-oriented investors? On Wall Street a rose by any other nae does not smell as sweet. The “-” shown in the table under “price-earnings multiple” indicates that the multiple was infinity. Performance System had no earnings at all to divide into the stock’s price at the time it reached its high in 1968. As the table indicates, Minnie Pearl laid an egg – and a bad one at that. The subsequent performance for this and the other stocks listed was indeed truly remarkable. Although not quite what their buyers had anticipated.

Why did the stocks actually perform so badly? One general answer was that their price-earnings multiple were inflated beyond reason. If a multiple of 100 drops to the more normal multiple of 15 for the market as a whole, you have lost 85 percent of your investment right their their. But in addition most of the concept companies of the time ran into severe operation difficulties. The reasons were varied: too rapid expansion, too much debt, loss of management control, etc. These companies were run by men who were primarily promoters, not sharp-penciled operating managers. In addition, fraudulent practices were common. For example, Performance Systems reported profits of $3.2 million in 1969. The SEC claimed that this report was “false and misleading.” In 1972 Performance Systems issued a revision of the 1969 report. Apparently a loss of $1.3 million more accurately reflected 1969 operations. Similarly, the management of National Student Marketing was accused of fraud. NSM’s Cortess Randell eventually pleaded guilty to stock fraud; he served eight months in prison and was fined.

And so when the 1969-71 bear market came, these concept stocks went down just as fast as they went up. In the end it was the pros who were conned most of all. While there is nothing wrong with seeking good performance, the mad rush to outgun the competition week by week had disastrous consequences. The cult of performance and the concept of “concept” stocks were henceforth greeted with disdain when mentioned in Wall Street.