Chapter 3. My First Crisis

From my reading I knew that stocks —like herds, indeed—form groups according to the industry they represent and that stocks belonging to the same industry have the tendency to move together in the market, either up or down.

It seemed only logical to me that I should try to find through fundamental analysis:

  1. The strongest industry group;
  2. The strongest company within that industry group.

Then I should buy the stock of that company and hold on to it, for such an ideal stock must rise.

I started studying the personality of a stock in relation to its industry group. When I read the quotations of general motors I automatically looked at those of Chrysler, studebaker and American motors. If I looked at kaiser aluminum, my eye automatically glanced afterwards at Reynolds metals, alcoa, and aluminium ltd. Instead of reading the stock tables in A.. B.. C.. order, I always read them in industry groups.

Whenever a stock started to behave better than the market generally I immediately looked at the behavior of its brothers— stocks of the same industry group. If I found that its brothers also behaved well, I looked for the head of the family—the stock that was acting best, the leader. I figured if I could not make money with the leader, I would certainly not make money with the others.

How delighted and important I felt doing all this! This serious, scientific approach made me feel like a soon-graduating expert in finance. Besides, I felt this was more than mere theory. I was going to put all this into practice and make a lot of money.

I started by compiling earnings of whole industry groups like oils, motors, aircraft, steel. I compared their past earnings with their present earnings. Then I compared these earnings with the earnings of other industry groups. I carefully evaluated their profit margins, their price-earnings ratios, their capitalizations.

Finally, after a tremendous amount of sifting and concentrating, I decided that the steel industry was the vehicle, which would make me rich.

Having made this decision, I then examined the industry in the minutest detail. Once again I delved into my rating service.

I was determined to play safe, so I figured the stock to buy should be in the "A" range and should pay a high dividend. But I received a surprise. As I went into this I discovered that "A" ratings were extremely rare and were almost always for preferred stocks. They were relatively stable price-wise and rarely rose spectacularly. Obviously these were not for me.

I decided to have a look at the "B" range. Here the stocks looked fine and they were numerous. I selected the five best known of them and started to compare them with each other. I did this with the utmost thoroughness. I set up my comparison table like this:

Company

Rat-ing

Price: End of June 1955

Price-earnings ratio

Earnings per share

Estimated 1955

1952

1953

1954

Earnings

Dividend

Bethlehem Steel

BB

142⅜

7.9

8.80

13.30

13.18

18.00

7.25

Inland Steel

BB

79⅜

8.3

4.85

6.90

7.92

9.50

4.25

U.S.   Steel

BB

54⅜

8.4

2.27

3.78

3.23

6.50

2.15

Jones & Laughlin

B

41½

5.4

2.91

4.77

3.80

7.75

2.25

Republic Steel

B

47¼

8.5

3.61

4.63

3.55

5.50

2.50

As I looked at my table I began to feel a wave of excitement. My table, like a pointer on a scale, clearly pointed to one stock: jones & laughlin. I could not imagine why no one had noticed it before. Everything about it was perfect.

  • It belonged to a strong industry group.
  • It had a strong B rating.
  • It paid almost 6% dividend.
  • Its price-earnings ratio was better than that of any other stock in the group.

A tremendous enthusiasm came over me. This undoubtedly was the golden key. I felt fortune within my grasp like a ripe apple. This was the stock to make me wealthy. This was a gilt-edge scientific certainty, a newer and greater brilund. It was sure to jump 20 to 30 points any moment.

I had only one great worry. That was to buy a large amount of it, quickly, before others discovered it. I was so sure of my judgment, based on my detailed study that I decided to raise money from every possible soubce.

I had some property in Las Vegas, bought out of many years of work as a dancer. I mortgaged it. I had an insurance policy. I took a loan on it. I had a long-term contract with the "Latin Quarter" in New York. I asked for an advance.

I did not hesitate for a moment. I had no doubts. According to my most scientific and careful researches, nothing could go wrong.

The 23rd of September, 1955,1 bought 1,000 shares of jones & laughlin at 52¼ on margin, which at that time was 70%. The cost was $52,652.30 and I had to deposit $36,856.61 in cash. To raise this amount I had put up all my possessions as a guarantee.

All this I had done with the greatest confidence. Now there was nothing to do but sit back and wait until I would begin to reap the harvest of my foolproof theory.

On September 26th the lightning struck, jones & laughlin began to drop.

I could not believe it. How could it be? This was the new brilund. This was going to make my fortune. It was no gamble; it was a completely detached operation, based on infallible statistics. Still the stock continued to drop.

I saw it fall and yet I refused to face reality. I was paralyzed. I simply did not know what to do. Should I sell? How could I? In my projection, based on my exhaustive studies, jones & laughlin was worth at least $75 per share. It was just a temporary setback, I said to myself. There is no reason for the drop. It is a good sound stock; it will come back. I must hold on. And I held on and I held on.

As the days went by I became afraid to look at the quotations. I trembled when I telephoned my broker. I was scared when I opened my newspaper.

When after a three-point drop the stock rose a half-point, my hopes started to rise with it. This is the start of recovery, I said. My fears temporarily calmed. But the following day the stock resumed its downward slide. On October 10th, when it hit 44, blind panic set in. How much further would it drop? What should I do? My paralysis turned to terror. Every point the stock dropped meant another $1,000 loss to me. This was too much for my nerves. I decided to sell, and my account was credited with $43,583.12. My net loss was $9,069.18.

I was crushed, finished, destroyed. All my smug ideas about myself as the scientific Wall Street operator crumbled. I felt as though a great bear had shambled up to me and mauled me just when I was preparing to shoot it. Where was the science? What was the use of research? What had happened to my statistics?

It would be difficult for anyone to conceive the shattering effects of the blow. If I had been a wild gambler, I could have expected such a position. But I had done my best not to be one. I had labored long and hard. I had done everything possible to avoid a mistake. I had researched, analyzed, compared. I had based my decision on the most trustworthy fundamental information. And yet, the only result was that I was wrecked to the tune of $9,000.

Black despair filled me when I realized I would probably lose my Las Vegas property. The horror of bankruptcy stared me in the face. All my confidence, built up by a benevolent bull market and by my first quick success with brilund, deserted me. Everything had been proved wrong. Gambling, tips, information, research, investigation, whatever method I tried to be successful in the stock market, had not worked out. I was desperate. I did not know what to do. I felt I could not go on.

Yet I had to go on. I must save my property. I must find a way to recoup my losses.

For hours every day I studied the stock tables, feverishly searching for some solution. Like a condemned man in a cell, I watched all the active stocks to see if they offered any escape.

Finally my eye noticed something. It was a stock I had never heard of, called texas gulf producing. It appeared to be rising. I knew nothing about its fundamentals and had heard no rumors about it. All I knew was that it was rising steadily, day after day. Would it be my salvation? I did not know, but I had to try. Much more in despair than in hope, as a last wild attempt to recoup my losses, I gave an order to buy 1,000 shares at prices ranging between 57 1/8and 37½. The total cost was $37,586.26.

I held my breath as I anxiously watched its continued rise. When it hit 40, I had a compelling temptation to sell. But I hung on. For the first time in my stock-market career I refused to take a quick profit. I dared not—I had that $9,000 loss to make up.

I telephoned my broker every hour, sometimes every fifteen minutes. I literally lived with my stock. I followed its every movement, every fluctuation. I was watching it the way an anxious parent watches over his newborn child.

For five weeks I held it, tensely watching it all the time.

Then one day, when it was standing at 43¼, I decided not to stretch my luck any further. I sold it and received $42,840.43. I had not got my $9,000 back, but I had recovered more than half of it. When I sold texas gulf producing I felt as if I had just passed the crisis in a long, critical illness. I was exhausted, empty, spent. And yet, something began to shine through. It came in the form of a question.

What, I asked myself, was the value of examining company reports, studying the industry outlook, the ratings, the price-earnings ratios? The stock that saved me from disaster was one about which I knew nothing. I picked it for one reason only— it seemed to be rising.

Was this the answer? It could be.

So the unfortunate experience with jones & laughlin had its significance. It was not wasted. It led me toward the glimmering of my theory.

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