TIP802: When Genius Was Just Luck: The Go-Go Years w/ Kyle Grieve

You're listening to TIP.

Did you know that during the 1960s,

some of America's greatest companies

traded at over 90 times earnings,

shattering current meg seven numbers,

simply because investors believe

there is no price too high to pay.

In today's episode,

we're gonna discuss one of the most fascinating bubbles

in American history, the Go Go years.

We're gonna unpack some of the most entertaining narratives

through this entire euphoric period.

You'll hear how legendary investors

and companies rose to fame.

Why momentum-based strategies made people

into geniuses in the moment,

and how entire fortunes were built seemingly overnight?

We'll also explore what happens

when valuation discipline just completely disappears.

How leverage can turn the smallest mistakes

into catastrophic losses,

and why rapid growth can sometimes be a red flag,

rather than an opportunity.

We'll also look at why stock prices can enable businesses

to pursue short-term strategies

and harm long-term investors.

And along the way,

we'll break down the impacts of misaligned incentives,

the dangers of financial engineering,

and how even the most sophisticated investors

can fall victim to fraud.

Now, if you've ever wondered

about the details of how a bubble is formed,

why they can feel so convincing when you're in them,

and what lessons you can take

to become a more disciplined, long-term focus investor,

then this episode is just for you.

So, let's dive right into this week's episode

on the Go Go years.

Since 2014, and through more than 190 million downloads,

we break down the principles of value investing

and sit down with some of the world's best asset managers.

We uncover potential opportunities in the market

and explore the intersection between money, happiness,

and the art of living a good life.

This show is not investment advice,

it's intended for informational

and entertainment purposes only.

All opinions expressed by hosts and guests

are solely their own,

and they may have investments in the securities discussed.

Now, for your host, Kyle Greve.

[♪ OUTRO MUSIC PLAYING [♪

Welcome to The Investors Podcast.

I'm your host, Kyle Greve, and today,

we're going to discuss a very well-written

and highly informative book

about one of America's greatest periods of euphoria,

the Go Go years of the 1960s.

So we'll be looking deeply at the book

called The Go Go Years by John Brooks

to discuss several investing stories

and extract a bunch of lessons from each of them.

Now, when I first heard of The Go Go Years,

I tended to think of just one thing, the nifty 50,

and this was probably through hearing about it

from people like Howard Marx.

So in one of his memos, he wrote,

investor interest in rapid growth

led to the anointment of the so-called nifty 50 stocks,

which became the investment focus of many

of the money center banks, including my employer,

which were the leading institutional investors of the day.

This group comprised the 50 companies believed to be the best

and fastest growing in America.

Companies that were considered just so good

that nothing bad could happen to them

and there was no price too high for their shares.

Like the objects of most manias,

the nifty 50 stocks showed phenomenal performance

for the first three years as the company's earnings grew

and their valuations rose to just nosebleed levels

before declining precipitously between 1972 and 1974.

Now the nifty 50 have always captured my attention

and I think that's because I'm very fond

of investments in high quality businesses.

Now if you look at the nifty 50, there are still

many high quality businesses from back in the 1960s

that are still around today trading as public companies.

Businesses like Amix and Howzerbush, Coca-Cola, PepsiCo,

Philip Morris, McDonald's, IBM, Disney, Walmart,

and many others still exist today.

The problem with the nifty 50 wasn't because

when you bought these businesses,

they were likely to disappear after a short period of time

due to the competitive nature of capitalism.

The risk was actually present in the insane prices

and investors were willing to pay for them.

So look at what Mark said there again.

Companies that were considered so good

that nothing bad could happen to them

and that there was no price too high for their shares.

Now I found this fascinating for multiple years

because as an investor, I fully realize

that no business is worth an infinite price

just like Charlie Mungo was sure to mention.

But the really good businesses,

businesses like Costco that Charlie owned

for a long period of time,

with ever-increasing earnings multiples

were businesses that he felt he could hold even

while they looked optically expensive.

So my brain got to work on exactly why

Charlie was able to make that Costco bet work

when it looked pretty much really expensive

over the last 10 years or so.

So over that time, it's traded north of 30 times earnings

since 2016.

And since that time, it's offered shareholders still

a 22% kegger in share price excluding dividends.

But when you get to looking a little deeper at the Nifty 50,

I think the answer becomes a little more clear.

So in 1972, McDonald's traded at a PE of 71 times,

Polaroid 95 times, and Disney 71 times.

If you own businesses that have nonsensical multiples,

it's just really hard to make any money.

You would still have made money in businesses like McDonald's

or Disney if you chose to hold them for decades,

but that's a pretty tough proposition

because it's really hard to know if those businesses

would have been around over a multi decade time period.

Now, all this talk of high PE ratios

is a great intro for the first story of the book,

which covers Ross Perot and the business

that really built his fortune,

Electronic Data Systems or EDS.

So Perot began his career after the Navy,

working as a computer drummer for IBM in Dallas.

He was such an incredible salesman

that his commission had to be cut by four digits.

And if he had annual sales pass a specific benchmark,

he just received no commission after that.

So in 1962, he made his annual quote by January 19th,

basically just putting himself out of business

for the rest of the year.

So he ended up quitting IBM at June

and incorporated his own company,

Electronic Data Systems Core.

Now, this business specialized in the early design,

installations and operations of computer systems.

Polaro invested $1,000 of his own money

as that was what was required to incorporate under Texas law.

So the company scaled well.

It sold contracts to 11 states,

and EDS specialized specifically

in providing its computerized systems

for the medical industry,

helping to pay things like Medicare and Medicaid bills.

By 1971, the business had grown to 23 contracts,

323 employees, $10 million in assets,

and 1.5 million in earnings.

The growth curve was attracting many investors.

So 17 investment bankers pitched Perot

to go with them to help take his company public.

He refused 16 of them, but the 17th banker

seemed like a very good fit.

And this banker was Ken Langone,

who helped found Home Depot.

One of the biggest attractors for Perot to Langone

was that Langone wanted to chase pretty high prices

for EDS's IPO.

Whereas many of the other investment bankers

suggested going for more normalized earnings

like 30 times, Langone wanted 100 times.

Once Langone was chosen,

he worked with Perot to improve EDS's standing

with the public.

First came the board.

The EDS board was typical of even a pre-listed

microcap today.

So you just have a bunch of family members on your board.

So Perot's board consisted at that time

of his wife, his mother, and his sister.

That just unfortunately wouldn't work for Wall Street.

So Langone suggested a few current employees

and other principles take board seats.

So the IPO price would be about $16.50 per share,

which was a 118 times earnings multiple.

Now keep in mind, 1971 was near peak euphoria

when this business had its IPO.

But this euphoria had been built over the 1960s.

It was a time when the bubble was just about to pop.

So for a tech business growing quite quickly,

you can probably see how a business like this

might fetch a very premium multiple.

Now just to give you an idea of EDS's growth,

by 1975, the business surpassed $100 million in revenue.

By 1979, revenue exploded to $270 million with no debt.

I couldn't find a date for its IPO,

but my guess is that the growth then would have probably

far exceeded that growth that was happening

into the mid to late 1970s.

So you could have been looking at a business

doubling its intrinsic value every one to three years or so.

And those businesses tend to fetch a premium,

especially to growth or momentum investors.

And since this was the time that the nifty 50 was so popular,

it just wasn't that unusual for investors

to pay up for growth.

But as with both growth stories,

things tend not to end well.

And here's where the major lesson from Perot comes in.

So on April 22nd of 1969, the market decided

it didn't like EDS's stock, punishing its stock price

by 50 to 60% in just one day.

The bookstates up Perot said regarding the event

that he felt nothing at all.

The event had felt purely abstract for him.

Now, I absolutely love this way of thinking

because it clearly shows that Perot had his business owner's hat

and knew that he should stay away from the mistake

of thinking purely as a stock picker.

He had additional reasons not to be overly concerned.

So his status as a billionaire,

even after this gigantic drop was still intact,

and he'd simply gone from a paperwork

of about a billion and a half to just a billion.

So to me, as an owner, I would have thought

much along the lines of Perot here as well.

And the reason was simple.

Even though EDS stock had been punished severely,

the business was still firing on all cylinders.

So in 1969, Perot's share earnings doubled.

And knowing this, what could have possibly

precipitated a dip of that magnitude?

So the thesis was at a large part of EDS's stock

was weekly held by mutual funds who would flee

at the first sign of any type of weakness.

And since one EDS comp, a business in the same industry

had just had its stock price cut by 80% of its peak

while EDS continued to trade at its peak,

the market clearly felt that it was just time

for a massive re-rating of EDS.

So this is a classic example where re-rating

has a massive impact on the risk of a business.

And it's why expensive businesses are generally avoided

by most intelligent investors.

The risk of multiple re-rating downwards

is simply a risk that they want to avoid.

And by investing in businesses with single-digit PE multiples,

you can simply run a lower risk of re-rating

being as painful as those businesses

that are trading at a PE of 100.

Now, another problem with multiple re-ratings

is if you are using leverage.

If a business goes down substantially

and price while you're leveraged,

it's no good because you're gonna be forced to sell

when the best possible action,

if the business is still doing really well

and growing is actually to buy it.

So one great story of this exact scenario

discussed a gambler named Edward Gilbert.

So Edward Gilbert lived an interesting life.

His chapter is called the last Gatsby

because he appeared to attempt to live a life

similar to the great Gatsby.

So his life was full of posh parties,

expensive artwork, and high levels of ostentatiousness.

Gilbert started out working for his father,

Harry Gilbert, and his company called Empire Mill Work.

Now, Harry wasn't a true operator,

but he owned a very substantial stake

in this business called Empire.

Once the company went public,

Harry's net worth exploded to north of $8 million.

Now, Edward had no shortage of ideas

to continue expanding Empire.

But his father wasn't on board with many of his ideas

using Empire as some sort of conglomerate.

Eddie once demanded to get a position as a director

to execute his grand vision, but his father refused him.

So as a result of this, Eddie just quit

and created a business of his own,

specializing specifically in hardwood flooring.

Now, there are two competing stories

of what happens next,

and I don't think anyone other than them

would know the truth.

So the first story was that the hardwood flooring business

was a raging success,

and seeing the success of the business,

Harry decided that Edward was worth being brought in

to add to Empire's value.

And the second story was that Edward's venture

went south incredibly fast,

and Harry had to bail him out as a result.

Either way, Edward now owned 20,000 shares of Empire

that were given to him from his father

in exchange for the flooring business.

Now, one of the businesses that Edward thought

would make a lot of sense for Empire Mill

were at conglomerate was another flooring business

called EL Bruce.

As part of his strategy to one day acquire Bruce,

he began socializing with the elite of Wall Street.

He'd made the right donations,

he got in the right people's good books,

and he would start offering stock tips to his friends.

And they presumably had some sort of success

as they kept coming back to him for more.

But this is when keeping up with the Jones'

is just kind of started to ruin him.

So he spent all of the money that he had,

even the money he didn't have,

just doing things like the Great Gatsby,

throwing these lavish parties and buying expensive artwork.

And unfortunately, he was also a gambling addict,

and tabooed he wasn't very good at gambling

in the first place.

So with his growing network of wealthy friends,

he began pushing Bruce more and more towards them.

So his thinking was that if he could eventually acquire

enough of these friendly shares,

he thought that a takeover might be possible.

Now, this is what's called cornering the market.

Gilbert and his friends have been buying the business

causing the price to go up.

And sensing a potential raider,

the family who owned Bruce began buying even more shares,

causing the price to continue to rise even further.

A third group of investors monitoring the rise

wanted to profit from the eventual fall,

and they began shorting it.

And then there was a short squeeze.

So the owners who were short desperately bought more stock

to cover their shorts,

creating more and more upward pricing pressure.

The stock went from $25 to $70 before the short squeeze.

Now after the short squeeze,

the price of rocketed to $188.

Edward was now a paper millionaire

and EL Bruce had merged with Empire.

Now to fund his lavish lifestyle

that he just couldn't afford,

he ended up using money from Empire,

which was now called Bruce as his personal piggy bank.

He borrowed money from the Treasury once,

but he ended up repaying it before the SEC

was notified of his illegal funding methods.

But with Edward's success with Bruce,

he now thought that he could execute on his plan

of growing empire national into a reality for him.

Next, he turned his attention to a manufacturer

of building installation materials,

a company called Cellotex Corporation.

So this business was even larger than EL Bruce.

To get a controlling stake in Cellotex,

he shared the name with his family and friends

and he used his share holdings in Bruce

as a collateral to borrow even more shares.

Edward's eventually got 10% of Cellotex's shares,

which were enough to get him a board seat.

But unfortunately at this time,

Edward's personal life was starting to unravel.

As part of a divorce,

he was required to live in Nevada

as a prerequisite for a Nevada divorce.

He moved his operations from New York to Nevada,

but pretended like he was in New York.

He did this to make sure that the market didn't get jittery

about Bruce and Cellotex

and his quick relocation from New York to Vegas.

Now, given his attraction to gambling,

while in Vegas, he basically wake up.

He'd take calls regarding Bruce and Cellotex

and he just hopped down to the casino

and spend the rest of the day gambling.

As a market worsened, Gilbert knew

that in order to stay afloat,

he'd eat even more funding.

Now, here's what Brooks wrote about this in the Google years.

Gilbert's Cellotex holdings now amounted to over 150,000 shares.

And for each further point that the stock dropped,

he had to find and deliver $150,000 in additional margin

or risk being sold out by his brokers.

Those of his friends holding Cellotex on his advice

now numbered around 50.

And they too, since most of them had held it on margin,

were being squeezed as the price continued to fall.

Many of them also had positions in Bruce.

So their alternatives were three.

They could either buy Cellotex,

they could sell Bruce shares to cover Cellotex,

which would depress the share prices of Bruce

and thus be equally disastrous for Gilbert

or just find more cash margin.

In other words, Gilbert and Bruce were in very bad shape here.

So Gilbert chose the last option

which was the least painful of all options.

He couldn't find anyone to lend them money

so he decided to try to break the law

to find the funds that he needed.

So he got Bruce to write checks

to two dummy corporations that he owned

in the amount of about $2 million committing larceny.

So his thought process was that if Bruce's share price rebounded,

he could just repay the checks while maintaining his position.

But if that didn't work out, he'd end up in prison.

Unfortunately, his timing couldn't have been any worse.

So an event later named Blue Monday,

which I'd never actually heard of,

occurred shortly after he committed the crime.

Now, Blue Monday was a second worst day

at publication of this book in the last century.

Gilbert's holdings in Bruce and Cellotex

went down precipitously.

Gilbert was now down to $7 million in debt,

$5 million to creditors,

and $2 million of the money that he stole from Bruce.

Gilbert then decided to just move to Brazil

before he was found out.

His father helped him by sending a money,

but he only actually lasted a few months

before just getting bored.

And for some reason,

he decided to return to New York

where he was immediately arrested.

At result, he ended up going to prison,

but just for two years.

So maybe that's why he returned.

Now, the story of Edward Gilbert,

I think, teaches several lessons.

The first is one that has been drilled to me for many years

by listening to most long-term investors,

which is simply just stay away from leverage.

While leverage can be alluring

as it simply boosts your results when you're right,

it's easy to forget the potential downside.

If you are leveraged and the market moves against you,

then you're basically forced to sell positions

that you probably otherwise keep

or even add to if you are unleveraged.

And if you're a value investor

who enjoys averaging down,

then leverage means a strategy

will simply cease to exist.

Another lesson here is in sharing ideas with your friends.

Now, I know it's fun to talk what ideas and talk your book.

But only I know, personally,

how I would deal with the business that I hold.

I cannot say the same thing for friends who may listen

to me, discuss a business that I might own.

They may take a giant position

where I might just have a tracking position

where I know I need to do more work.

Then when things go south,

I'm minimally affected while they may be taken

to the ringers and sell the exact wrong time.

Edward Gilbert, more or less,

used his friends to achieve his own financial goals.

I'm very much against this line of thinking.

Simply because it's not the right thing to do

to anyone let alone people that you actually like.

Now, one potential strategy here

is to just avoid discussing your stocks

with family and friends who have an itchy trigger finger.

That way, you avoid the risk

of having awkward conversations at future dinner parties.

But I think the biggest lesson from Gilbert

regards his classic gamblers mistake.

And that's to take riskier and riskier bets

when you're down just to recoup your losses.

This is a horrible mistake

in pretty much any area of life.

While it might work out for the odd person every now and then,

doing it repeatedly is simply just a recipe for failure.

Now, in poker terms, this is called being on tilt.

It's basically when you aren't playing your game properly

because you're being influenced

by certain misjudgments.

In the past, when I began feeling this way,

maybe I got upset about a bad beat.

The best course of action was really just a step away

and not dive headfirst into trying to make my money back.

And it's the exact same in investing.

In investing, you can't really step away

in the same sense as you can if you're playing poker,

but you can simply take a break from action.

Let's say you maybe have a position

that loses 50% of its price

and you determine that you made a big mistake on the thesis.

Let's say in this case,

there's just no reason to hold the business

as it's more likely to go bankrupt than rebound and price.

So you end up selling out

and now you have capital to put to work.

If you're Edward Gilbert, you go out

and find some sort of bet

that can maybe double in just a few months.

That way you recoup your money and you're no worse for it.

But what many investors actually do

when trying to replicate this strategy

is take incredibly, incredibly, incredibly risky bets.

Maybe you decide to bet on some junior mining company

that has just announced

that it's finished drilling a hole in the ground.

If gold is found,

the business could quickly multiply value,

but if nothing is found,

the business has a bunch of debt

and zero assets generating any money.

So let's look at this through the lens of expected value.

Let's suppose that you're offered a bet

with a 5% chance to triple your money

and a 10% chance to lose everything

and an 85% chance to just lose a little bit.

So most people are gonna fixate on that 3x.

It's exciting.

It feels like an opportunity.

But the arithmetic really just tells a different story.

In 95% of the outcomes you lose money

and in a meaningful number of cases,

you're completely wiped out.

So when you do the math,

the expected value is less than what you started with.

That is not an investment.

That is a transfer of wealth from you

to whoever is on the other side of the trade.

The lesson's quite simple here.

If you're gonna take the risk of permanent loss,

you should be paid for it.

And if you're not,

the game is working against you

no matter how attractive the upside appears.

The scariest part of investing, in my view,

is investing in a fraudulent company.

And public markets unfortunately are just right for it.

If you have a person in charge

who's able to spin a great lie,

then it's completely possible to fool

even the most sophisticated investor.

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All right, back to the show.

One great example covered in this book

was a business called Atlantic Acceptance Corporation.

Now, this was a Canadian business

that specialized in automobile and home lending.

So in 1964, it created a considerable amount of buzz

because it was just simply a product of its time.

It was a time when there was a cultural shift on Wall Street.

So you had younger investors that began proliferating,

taking over for some of the older generation.

And they were tending to take a much more daring approach

to investing compared to that prior generation.

They resonated more with speculation

and gambling over more boring and predictable routes

of compounding your money slowly.

So Atlantic was a product of its time.

It basically ended up telling a story to its investors

that didn't exist, but let's get into that.

So Atlantic was led by the gentleman

by the name of Campbell Morgan, a former accountant

who also enjoyed the cheap thrills of a badly placed bet.

So let's rewind to 1955 when Morgan realized

that he could tap into public markets, Wall Street,

to raise money for his company.

He signed on a number of investors

beginning with Lambert and Company

who supplied Atlantic with about $300,000.

By 1959, the business appeared to be aging very, very well.

And US Steel Fund decided to invest.

The Ford Foundation quickly followed suit.

After that, it was quite easy for him

to attract new investors and money just began pouring

into this Canadian domicile business on Wall Street.

Now, ironically, one of Atlantic's investors

was none other than Moody's, who specialized

in assessing the credit quality of corporations.

By the early 1960s, Atlantic was just crushing it.

Sales in 1960 were $25 million in 1961.

It was $46 million, and by 1962 was $81 million.

By 1963, it over doubled to $176 million.

So you were looking at just one of the cleanest

examples I've ever seen of a business

basically compounding at 100% a year.

But here's the thing, the business wasn't based

on some sort of pie in the sky technological marvel.

It was just a lending business.

And lending businesses just don't grow like this

for long period of time.

There has to be a reason it was growing parabolically.

And the reason it turns out was that it was making loans

and its competitors just didn't want to make

because they were just too risky.

But Atlantic took them on allowing them

to capture more and more premium

while just throwing caution to the wind.

But here was what Morgan was really doing.

So he was basically running a typical Ponzi scheme

relying on fraudulent accounting to just do investors.

Atlantic would use new capital inflows it raised

to make these new risky loans.

But that risk was hidden from investors

because Atlantic hired complicit accounts

that were willing to commit fraud.

And these loans obviously made their growth

continue to look more and more impressive,

which brought in more and more capital.

So on their books, they actually overstated assets

and they understated their allowance for bad debts.

So in 1964, Atlantic published profits of $1.4 million.

But in reality, they actually incurred a loss of $16.6 million.

By 1965, investors were starting to wonder

about their investment.

Morgan, who was very fond of gambling,

also owned through Atlantic a hotel

with an attached casino in the Bahamas.

This, predictably, did not turn out well either.

Eventually, TD Bank refused to honor

five million in Atlantic checks for notes

that had been matured.

The same day, 41 different brokers

received buy orders for Atlantic stock

using checks from the same bank account.

But the certification was actually fake.

And oddly enough, this wasn't even done by Morgan,

but by one of his unsavory associates.

As a result, even more notes were called

for a total of $25 million.

But now the scheme was up as Atlantic

just didn't have the funds to pay.

As a result, owners of his debt and equity

were completely obliterated.

In bankruptcy proceedings, it was found

that there is a paucity of credit information

and as far as we were able to ascertain

no real financial control.

There appears to be no reporting procedure

for real estate, machinery, and other types

of fixed asset loans.

Apparently, no appraisals were obtained

and there was no evidence on file

of the value of loan collateral.

In some, procedures considered necessary

in the conduct of financial business were just missing.

Now, this was a big moment in Canadian history

as a repercussions from the Atlantic deal

had systematic effects on the Canadian economy.

The first two months after the default,

the central bank of Canada increased the money supply

to avoid a credit panic.

Foreign investment into Canada from the US all

but dried up as well as a result of Atlantic's Ponzi scheme.

Now, even on his deathbed, Morgan would never admit

that he was complicit in the fraud.

After Morgan passed away, there was a commission

that found he was very well aware of the fraud

and he had acted in a highly, highly dishonest way.

So here's a great quote from Brooks

about Morgan and Atlantic.

A smooth operator with a streak of a gambler,

a company more interested in attracting investors

than in making real profits.

The resort to tricky accounting,

the eager complicity of long established,

supposedly conservative investing institutions,

the desperation plunged into a gambling casino

at the last minute, the need for a massive central bank

action to localize a disaster

and finally reform measures that were instituted too late.

Now, the hard part about scams

is that investors are supposed to be protected from them.

But in reality, all we can really rely on is ourselves.

And if well-respected investment firms can be duped,

what stop in the retail investor from also being fooled?

In Atlantic story, it seems odd

that nobody would have caught on earlier.

There's just plenty of insurance underwriters

and lenders that had been operating for a very long time

and it's kind of hard to find out exactly

what differentiated Atlantic from its competitors.

This is the main lesson from the story.

If a company is producing incredible results

versus its peers and isn't really doing anything differently,

you just have to ask yourself why that is.

Either they have some sort of hidden moat, maybe,

that's not easily discovered

or they're taking part in some form of fraud

that's deliberately hidden from investors.

A more modern example is luck in coffee,

a Chinese coffee shop.

This business exploded from zero stores in 2017

to over 2,000 by the time at IPO just two years later.

By 2021, they claimed to have over 4,500 stores

and just like Atlantic, they had exceptional growth

but it was kind of left unchecked

and I think that was probably some sort of a yellow flag.

Now in April of 2020,

Luckin disclosed that over 300 million of its 2019 revenue

had been completely fabricated.

So executives had created fake transactions, fake sales,

all with the aim of inflating revenue

to meet their lofty growth expectations.

They were eventually uncovered by a short seller report

from Muddy Waters back in 2020.

While I'm a huge fan of growth businesses,

it's very important to remember that growth

can become its own kind of self-fulfill in prophecy.

And when management owns things like options

or warrants that gain in value,

they're actually incentivized to continue growing

the stock price.

And unfortunately if they do it in illegal ways,

that's something that you have to try

to pay very close attention to

to try to avoid at all costs.

Now I think with businesses that are growing fast,

you must inject some degree of skepticism

and you have to ask yourself

if this growth is actually feasible.

Are there margins realistic?

When you go into their store, do they appear

to be busier than their competitors?

In the Muddy Waters short report on Luckin,

they spent a lot of time, money and effort

trying to figure out if Luckin was being truthful

on its growth KPIs.

Muddy Waters reportedly reviewed over 11,000 hours

of video footage while hiring 92 full-time

and 1,418 part-time staff to run surveillance at stores.

And what they found was simply that the growth numbers

at Luckin was presented to investors

just didn't align with reality.

Their surveillance covered things like foot traffic,

a number of cups sold per store

and the average order size.

As a result of the research,

they claimed that Luckin overinflated numbers

of KPIs like number of items per store per day

and net selling price per item.

Now this is all great, but certainly it's a very hard task

to do if you have limited resources in time.

Now let's get back here to the inception of the Google year.

So I already mentioned with the Atlantic example

that there was this new breed of investors

who were willing to take on certain risks

that the previous generation may have just skipped.

But there were other changes happening as well

that are very easy to overlook.

So in Boston, the vocation of managing money

was one that was taken very seriously.

The art of managing money was first

by just managing a trust.

And when you manage the trust historically,

especially in Boston,

it was to basically generate profit

for the beneficiaries of that trust.

But this notion began to change in the 1960s

with the formation of the hedge fund.

But let's first look here,

a little more closely at a gentleman named Edward Johnson.

So Edward Johnson owned fidelity,

which probably many of you,

all of you are going to be familiar with us.

It was there that Peter Lynch would go on

to post his legendary investing returns.

But interestingly,

when Edward Johnson assumed control of fidelity,

the organization refused to take a dime for it.

They were the typical Bostonians

who did not believe in profiting from their trustees.

Now, I wondered here for a second,

Buffett was inspired by this when he was offered money

for his Buffett partnerships.

Because I know he decided to skip it too,

because he simply just didn't want to benefit

or profit from his partners.

But back to Edward Johnson.

So Johnson wasn't a typical manager of a trustee

who tended to be highly conservative.

He was more interested in things like speculation

and his investing idol was a master speculator,

Jesse Livermore.

So here's what he wrote about the fidelity fund.

We didn't feel that we were married to a stock

when we bought it.

You might say that we preferred to think of our relationship

to it as a companion at marriage,

but that doesn't go far enough either.

Possibly now and again,

we'd like to have a liaison

or very occasionally a couple of night together.

Essentially, he was using relationship as a mental model

for his holding periods.

And he admitted that he wasn't really willing

to have a long-term relationship with his stocks.

Now, this is very vital because Edward Johnson

would bring on the very highly talented Gerald Psy

who also shared in the sentiment.

Now, Jerry Psy absolutely crushed

in a Wall Street in his early years.

He was one of the first investor celebrities.

He gained popularity simply with large amounts of success,

but his success wasn't your, you know,

uber-long-term buffet type of success.

His success was more based on short-term high turnover

that resonated with the average investor.

And I would say that probably still resonates

with the average investor today.

Now, what Jerry Psy was able to do

was pick stocks that quickly appreciated in value.

And his trading patterns of getting in

and out of stocks relatively quickly

was what just put him over the top.

He was the epitome of a garbage quick.

One thing that Jerry mentioned when he spoke

about his time with Edward Johnson

was that Edward was willing to hand off

a lot of responsibility to his key employees.

So he called it handing them the rope,

meaning they could either succeed

or they would grievously injure themselves with the rope.

Size rope would be known as a fidelity capital fund.

Now, his strategy here was kind of simple.

Make a few concentrated bets on more speculative businesses

like Polaroid, Xerox, and Litton Industries.

But the parameters of entering the positions

was also key to his strategy.

Since he was making these concentrated bets,

he'd require his brokers to buy shares

and maybe 10,000 share increments.

He basically did this intending to move the share price

by one or two percent after his order was filled.

And if he talked to the brokers

and they couldn't make the share price move,

then he just wouldn't use them.

It was not simple.

And since obviously Jerry was bringing a lot of business

to these brokers, if one broker refused to do it,

then he could go to the next one

to find someone who could fulfill his parameters.

Now, next thing he would do when he had these companies

was, as I've already discussed,

he wasn't really a long-term holder of business

looking for these compounders.

His turnover rate was apparently well over 100%.

Meaning he was unlikely to hold a position

for longer than a year.

Now, due to the fact that he was able to enter

an exit large blocks of stock,

the companies that he invested in also took note

of his presence.

So they wanted to be on the good side of this investor

who wielded the ability to just move markets

with their stock picking abilities.

In mid 1962, Si had his first hiccup.

The market crashed and his strategy of investing

in high growth companies with concentrated positions

was severely punished.

But a rally ended the year increasing fidelity

gross funds assets by 68% of the end of the year.

So after this, the bull market was in full action

and Jerry's size strategy was highly successful.

In 1965, the fund gained a 50% in net asset value

on 120% turnover.

But at the same time, fidelity had come

to a sort of crossroads.

Its owner, Edward Johnson was now 65

and he was set to retire.

Since Si had so much success with fidelity,

he figured that he was kind of a shoe

and to take over leadership.

But it was just not to be.

Edward Johnson informed Jerry that his son

would be the one who eventually would succeed him.

This painful event caused Jerry to quit

and just go on on his own.

So he ended up selling his stock in fidelity

for about $2.2 million and he established

the Manhattan fund.

As with most success stories and investing,

investors tend to time things all wrong.

They invest in successful managers

at the apex of their success

and they ignore the unsuccessful ones

at the apex of their weakness.

And this is exactly unfortunately

what happened with Jerry's size.

So he sold his shares of mutual funds for $10 each.

He figured he might be able to raise

somewhere in the region of $150 million.

But once the funding had been complete,

Si was actually had to check for $247 million.

Now at the standard 1% management fee at the time,

Si's firms are with about $2.5 million in revenue.

But the problems that come with early success

are quite simple.

If you set unrealistic return expectations,

you run a very high risk of redemption

if you fail to meet them.

And as we know, 50% returns are just not feasible

over a multi-time frame.

Si's strategy worked incredibly well in bull markets

but take the bull market away

and the entire strategy is no longer viable.

Now the first two years that he opened his fund were okay.

But by 1968, his fund had taken an absolute beating

declining in value by about 6.6% in play

seeing 299 that of a possible 305 other mutual funds.

Now even with this poor performance,

especially the comparative basis

Manhattan fund had actually grown

by accumulating more and more AUM to over $500 million.

When it became clear to Si that he was no longer able

to generate outsize returns for his partners,

he decided to sell the business.

He alone made somewhere around $30 million in that sale

in 1968, which equates to approximately $280 million

in today's dollars.

So clearly the original standard of not profiting

from trust structure no longer existed,

at least in Jerry's eyes.

Now what does Jerry's size experience

managing money teach us about investing?

Hell of a lot.

First, momentum can look like genius.

I remember following a lot of funds

in 2020 and pretty much all of the most successful ones

own stocks that I had basically no interest in.

And the reason being that they were obviously overpriced.

These fund managers took a similar strategy to Si.

They bought these businesses that were growing really fast,

but they were all growing fast in a raging bull market.

That strategy just works until the bull market reverses course

in which case we get pretty catastrophic results.

So in the short term, this obviously results in high returns.

These high returns attract more and more AUM

from you and existing investors.

But then things inevitably go self.

If you own a portfolio of businesses that are going to suffer

from a massive multiple compression

and earnings compression,

once the economic environment no longer supports them,

you're going to be in for a large amount of pain.

Now it's important to balance aggression with defensiveness.

Yes, you can take advantage of the times

to become somewhat imbalanced for short periods,

but don't make the mistake of going completely imbalanced

to such an extent that you leave no space

for any defensiveness.

The second point here is that liquidity

can disappear much faster than you expect.

When you have a strategy that requires large volumes,

then attracting competitors is not the best feature.

When other intelligent investors saw what Si was doing

and that it was working,

they would have piled into the exact same stocks

that he was buying,

which would make it harder and harder for him

to make large concentrated bets

while also paying a fairly reasonable price.

And the other problem with liquidity

is that it can be fatal when the market moves against you.

When you have an ownership basis

made largely of momentum investors, when they leave,

you're going to lose a lot of money

if you don't have the conviction in the business

to ride the correction.

Now, since Si was looking to get in and out pretty quickly,

if he wasn't ahead of the selling,

he exposed himself to a lot of downside risk.

The third lesson here is that incentives shape behavior.

When Jerry Tsai first started working at Fidelity,

Edward Johnson was taking 20% of just the profits.

He didn't even have a management fee,

but the times were changing and with larger staff sizes

and increased reliance on technology,

management fees are being justified

by a number of different funds.

As a result, Tsai took a 1% management fee.

Now, when you have management fees,

the incentive structure just really changes.

The business makes money by simply gathering assets.

The result of what happens to your investor's money

matters a lot less.

In size case, he was able to continue to attract AUM

despite the fact that he just wasn't creating

that much value for the fund.

The lesson here is for investors looking

to invest in other managers.

So I would highly recommend finding a manager

who makes a lion's share of their money

when you are also making money.

And when you aren't making a reasonable return

or even if you're losing money,

the manager should also feel the pain

of that underperformance as well.

Fourth year is to just look at how performance chasing

is in relation to where you are in the cycle.

So size experience clearly illustrate

the cyclicality of markets.

You had strong performance, you had massive capital inflows,

concentrated bets, then the market conditions change

and you had a rapid reversal.

This is a cycle that constantly repeats in the market.

Instead of eventually playing the victim to the cycle,

try and position yourself best to deal with it.

For instance, in the cycle above,

if you see the first four attributes in the market,

just simply don't partake.

Yes, you'll probably miss out on some of the short-term returns

that other investors are making,

but you'll also take a much smaller part

in the rapid reversal that will take place

at some point in the future.

Now this doesn't mean selling everything

and going to 100% cash.

After all, we never know when a reversal will happen,

but it might mean maybe taking some profits

and adding to your cash position.

If you're still working like me and regularly add cash

to your brokerage account,

it might mean taking a break on adding to new

and existing positions and just allowing your cash

to pile up and take advantage of a reversal

whenever it happens.

Now one of Jerry's size highly successful investments

was a business called Litten Industries.

Now Litten was a new form of business

that was exploding in popularity during the Gogo years.

This business is now known as a conglomerate.

Today we might loosely compare them to zero acquires

like Berkshire Hathaway,

but the similarity mostly ends at the idea

of buying more and more businesses.

Berkshire buys wonderful businesses

at sensible prices and holds them indefinitely.

Most conglomerates of the Gogo years

were exploiting financial engineering

rather than building operating excellence.

Now, part of the reason the conglomerates were able

to get a foothold into Wall Street

was due to several very early successes.

For instance, in mid 1966,

the New York Stock Exchange declined by over 20%.

But one group of businesses had been shielded

from this decline.

So you had Ling Temco Vaught, which was up 70%.

City investing was up 50%.

Litten and textile were each up 15%.

So clearly, there was a market for businesses

that were following this conglomerate structure.

So what exactly is a conglomerate?

It's a business that diversifies through mergers

and other lines of business.

Now, this is different from, say, a roll-up

that is buying businesses in one line of a business

such as HVAC.

A true conglomerate buys businesses

in completely separate industries.

Perhaps the businesses started selling machine tools.

They systematically add businesses

such as ice cream, helicopters, or eyeglass frames.

Only enough, the word conglomerate was actually frowned upon

by conglomerate operators in their early years.

The CEO of Litten Industries thought conglomerate

implied a large mess and instead used

the term multi-company industry when describing Litten.

Textron felt similar, referring to itself

as engaging in non-related diversification.

I find it kind of strange that all these great businesses

that were conglomerates look down upon the term,

but that's the way it was.

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All right, back to the show.

Now there are three major forces

that help build the rise of the conglomerate structure.

The first was antitrust loss.

With new laws enacted that made M&A

within the industry more challenging,

these businesses become targets for businesses

that are lacking in synergies.

A cable operator owned by a conglomerate

just didn't have the same monopoly advantages.

If it were acquired by another cable operator

that could pool additional resources

and then leverage a larger customer base.

The second was that there was a changing ideology

by educational institutions.

So Brooks writes graduate business schools taught

that management's ability was an absolute quality

not limited by the type of business being managed.

This meant new managers were going into businesses

not only to specialize in a single business line

but could also use their managerial skills

in a more diverse way.

Conglomerates were a great structure

to test your absolute quality as a manager.

And third here was just rising evaluations.

Since businesses had risen in price

it reduced the cost of equity for many businesses.

If your business was now growing at a PE of 30

versus a previous PE of let's say 15

it opened up the ability to acquire

a much larger base of acquisitions

that you just wouldn't want to have acquired

if your shares were trading at a major discount.

Now let's go over a point three here in some detail

because it's very vital to understand

why the conglomerate structure at this time worked so well.

So let's create a hypothetical case study

to show why these deals worked

and how they could easily fail.

Let's say we have a business called Grass Tron

which sells law and equipment and turf services

and has a PE of about 20 times.

They want to diversify away from their core business

and to do so they start buying businesses

that sell car parts.

They find a business called car parts ink

which sells side and rear view mirrors.

The sellers are willing to part with the business

at a PE of just five

as it's a low growth business with very steady earnings.

Let's say car parts generates 10 million in profits.

Grass Tron is already doing about 50 million in profits.

Now Grass Tron buys car parts for $50 million

using pure equity to purchase it.

And this is because they understand

the benefits of merger arbitrage.

So once they add the earnings to Grass Tron

they are now doing 60 million in profits.

But the arbitrage comes in the difference in the PE ratios.

Grass Tron isn't just worth $50 million more.

Given its higher PE ratio,

it's now worth $200 million more

but it only paid $50 million for that increase in value.

Now let's imagine that Grass Tron begins getting more

and more excited about making deals.

After all, they had a super successful deal

with car parts and maybe they may add some other deals

that were really successful.

So they're very high on their ability to do M&A.

They're so high on that ability

that they begin making errors.

They know that making acquisitions are very key

but they begin to lose discipline on their purchase price.

Instead of creating shareholder value

by exploiting arbitrage,

they begin focusing on just building a larger

and larger empire at the expense of their shareholders.

They begin looking for large acquisitions.

This time it's in chemical manufacturing.

So Grass Tron now has $200 million in profits.

One chemical business they find is also

doing $200 million in profit.

But the times in the markets aren't nearly as good

as they once were and Grass Tron has been a victim

and its PE ratio has now dropped to 10 times.

The chemical manufacturer that I was looking at

trades at 15 times.

Grass Tron just says screw it.

Let's get this deal over with double our profits

then the market's gonna love it.

Now unlike the first deal,

they're not paying 15 times for Chem Core

to double their profits.

Once Chem Core is inside Grass Tron,

its earnings are now valued less than before.

So this deal basically ends up actually

destroying shareholder value rather than adding to it.

They added $2 billion in value

but they actually paid $3 billion to do so.

Now let's look at James Ling

who is one of the pioneers of this structure.

James started an electrical service company in 1946

with about $2,000 of his own savings.

He eventually scaled up to an annual revenue

of about $1.5 million.

In 1955, he went public at an evaluation

of about a million dollars,

selling shares in a booth at the Texas State Fair.

Now going public was really a light ball moment for Ling.

He realized that he could generate cash

in exchange for basically paper

and that paper was equity.

With his million dollars in cash,

he used it to acquire a business called LM Electronics.

Now here's what Brooks said about Ling's strategy.

In essence though,

they are all geared to the crucial discovery

that Ling had made of the Texas Fair

that people like to buy stocks

and that their overpaying for stocks

can be capitalized by the issuer to his advantage.

His basic tool was leverage,

capitalizing on long-term debt

to increase current earnings.

He built his business substantially

then switched course in 1964.

His new initiative called Project Redepoint Reverse Course.

Instead of adding new businesses,

he decided to spin out certain businesses

from his conglomerate and sell them to the public.

Essentially Ling was taking advantage of the public's yearning

to buy stocks by spinning out parts of his business

to generate shareholder value.

And it worked.

He'd sell off 25% of a share in a business

and 75% was kept by Ling's company

now named Ling TemcoVot

and doing so would make their 75% share worth a lot more

than it had been worth weeks before.

So in 1965, Ling TemcoVot ranked number 204

on the Forkton directory of largest US industrial businesses.

But by 1969, it was ranked 14th.

Net income before dilution,

which would have been large, I would have assumed here,

tripled in 1966 and went up 75% in 1967.

Between 1965 and 1967,

the stock price increased by 10X.

Now as with most bubbles,

the newness of a new paradigm shift,

in this case conglomerates, wears off over time.

And what is usually left over

is a bunch of angry bag holders kicking themselves

for making the investment in the first place.

While some conglomerates gave the illusion

of infinite growth,

most were pretty unable to make that a reality.

Inventors believe that conglomerates

had this diversification in which predicted their downside.

And also that a lot of these conglomerates

were run by superstar managers

that were able to make acquisitions

that basically guarantee growth.

But unfortunately, they are in for a very rude awakening.

As these businesses scaled,

their biggest flaws began to be exposed.

The businesses had become large and unwieldy

and it became nearly impossible

for just one man to run the show

without a significant amount of help and decentralization.

In the case of Litton Industries,

management had been so disconnected from a subsidiary

that it didn't actually even realize

that there was a problem with them until it was too late.

Several Litton's divisions were in a very serious trouble,

and management discovered

that they could actually not even contain the problem.

This event caused investors to challenge the premise

that the conglomerate was built on.

If a superstar management couldn't control

his subsidiaries, what was the value in diversification?

Once Litton reported the quarter,

its stock was crushed.

Earnings came in at 21 cents per share

versus 63 cents for the same quarter in the previous year.

Litton lost about 18% of its price in one week.

A month after earnings had gone down 50%.

The drop in Litton dragged down all conglomerates with it

just as the rising conglomerates allowed for them all

to take advantage of them or draw a crush.

Now my first big lesson from this chapter

was that high stock prices can create

the illusion of business skill.

The conglomerate operators looked like geniuses

because their strategies made shareholders money.

But the actual success of the strategy

came from areas that were outside of their control

and that was from the stock price itself.

The high evaluations that euphoric market assigned to them

allowed them to have a high evaluation,

which gave them access to acquisition currency

which further fueled EPS growth

leading to an even higher prices.

This is what Howard Marx likes to refer to

as the virtuous cycle of rising multiples.

Now the problem is like all cycles they eventually reverse.

And if you were holding on during the reversal

then it becomes this vicious cycle

as you must prepare to either back up a truck on weakness

or just sell at a large loss.

But even if the business is improving

there are other attributes that now change

which will affect their acquisition strategy.

If they no longer have a share price

then they can't continue acquiring businesses

that would have made sense before.

And when you have to reduce your acquisition pace

EPS growth is gonna slow down considerably.

And when this happens you lose the faith

of a lot of your investors causing painful multiple compression.

And this unfortunately is exactly what happened

to many conglomerates during this time.

The second lesson is that financial engineering

can masquerade itself as operational excellence.

In the case of Linden

it was eventually proven out that the conglomerate

simply just wasn't improving its acquisitions

after they bought them.

They are more focused on simply relabeling earning streams.

Now taking advantage of merger arbitrage works very well

when you own businesses that will either maintain

or organically grow its earnings power.

When it weakens you obviously expose yourself

to a lot of potential risk.

One business that I own I think would be considered

a modern form of conglomerate

is a business called terabest industries.

So in its early days

a large portion of its revenues came from kind of cyclical areas

related to the oil and gas industry.

Now realizing that depending so much on the cyclical gas industry

was too risky they decided to kind of pivot

because they wanted to make sure

that their business was protected from cyclicality

so they ended up diversifying into other areas

such as compressed gas vessels and HVAC equipment.

Additionally terabest does a really good job

of creating value for its subsidiaries

once they're part of the terabest family.

It's not unusual for post acquisition EBITDA multiples

to drop to maybe two times a year after being acquired.

So when you're actually creating value

like the way I think terabest is doing

then the financial engineering plays very well in your favor

and you protect your downside.

But if you're looking at a business that can create value

strictly through financial engineering

then you must consider what happens

if the business declines in earnings power.

The third lesson here is in humility.

The best modern conglomerates tend to run

a pretty decentralized business model.

This takes responsibility from upper management

and it spreads it out across the company.

Berkshire, Constellation Software, and Lyftgo

are great examples.

If all the power was centralized in their leaders

there's probably no chance

as these business would have had the success they had today.

The early conglomerates had a lot of key man risk

but the modern equivalent have created business models

and cultures where a key man risk

is a lot less impactful.

The fourth lesson regards something

you probably noticed that I love to speak about

which is incentives.

The book doesn't divulge what the incentives were

for these CEOs that were evaluated

but one thing they were most likely not incentivized on

was long-term metrics.

When you're incentivized to perform in the next year

then making endless acquisitions,

empire-building and dilution are actually highly encouraged.

When you have to focus on things like cap efficiency,

per share metrics or organic growth

your strategy has obviously changed.

Instead of focusing on what you can do

to increase profits this year

you're more focused on creating profits

maybe three to five years from now.

And there's a major difference in strategy

between these two objectives.

I prefer the long-term strategy simply

because it just doesn't incentivize nearly

as much risk-taking.

Brooks had one incredible story that I have to share

and I never knew this but for a time during the Gogo years

Wall Street was actually shut down from trading

on each Wednesday.

This is a pretty strange event

to shut down trading during a raging bull market

but let's dive into why this happened.

As the Gogo years progressed

the markets euphoria continued to rise

at a very rapid pace.

But the technology stack back then

was obviously a lot different than it is now.

Back in those days when you bought a stock

your broker had to do the back end paperwork on your behalf.

Much of this was done manually.

The broker's back office would be inundated

with ever increasing paperwork

having a mail-out share certificates

based on each individual trade.

Now as euphoria rises

second order effects emerge

and one second order effect is that volume obviously goes up.

More and more stocks are changing hands

which increases the burden on these back offices.

And the people doing the back office

weren't even the brokers.

They had people who specialize in the back office

and it was basically an entry-level job.

Now as Wall Street became more chaotic

due to increasing volumes

the infrastructure needed to keep up

with the growing demand from new entrants to the market

just wasn't increasing at the same rate.

They were very far behind in processing trades

and not just days behind

but actually months behind.

As a result the back offices

were a decreased substantially in quality.

Share certificates that were supposed to be mailed out

to their new owners were lost, misplaced or stolen.

And it was so prevalent

that it was given its own name, a fail.

Now a fail occurs when on a normal settlement date

for any stock trade five days after the transaction itself.

The seller's broker for some reason

does not physically deliver

the actual sold stock certificates

to the buyer's broker

or the buyer's broker for some reason fails to receive it.

In January of 1968

the New York stock exchange allowed

for a certain number of fails

as just a regular part of business.

So at the time it amounted to a billion dollars.

As a result the exchange cut trading hours

and closed at 2 p.m. to slow down the system

with the intention of allowing the back offices

to catch up with their missed transactions.

By April though,

fails had actually reached 2.67 billion.

May was 3.47 billion and by June it was just a touch

under 4 billion.

As a result the exchange basically closed

the New York stock exchange every single Wednesday.

This was the first midweek closure since 1929.

And the break actually didn't even work

as most brokers just took Wednesday off

rather than doing the necessary work to catch up.

What eventually fixed this problem

was the market just turning bearish

and because of that volume dried up

and so did the fails.

Now I'm not sure there are many modern lessons

we can learn from this but I found the story fascinating.

Perhaps it's a lesson in understanding

the complexity of seemingly simple things

like you know back office paperwork.

Even today nearly 60 years later

we still have manual back office events.

My wife who works in an accounting firm

still manually enters data.

Another lesson is a second order effect on the market.

There are never any shortage of second order effects

and unfortunately many of them remain completely hidden

until it's too late.

And this is a good reminder to ponder the unknowns

that could be happening in the background

during the next bull or bear market.

Now the next way I wanna discuss

concerns mental models that I find crucial

not only in investing but in life

and that's incentives,

particularly in conflicts of interest.

Now in the go-go years with so many new investors

coming to place their first trade

there wasn't a lot of education on how the brokerage industry

inside Wall Street really operated.

Back then just like today

brokerage firms earned revenue through commissions

and the fees were insanely high back then.

The SEC continuously had to fight with brokerages

just to get them to cut their fees.

Now bull markets are great for brokerages.

This is why online brokerages today

tend to be a pretty good place to invest

if you believe that volume will continue to rise.

I agree that that's probably

the most likely scenario

but I don't think profiting from others

needs to gamble on stocks is right for me.

Now in 1966 Francis Huntington was a clergyman

at Trinity Church on Wall Street.

The church is still there today

as you walk uptown from Wall Street.

Francis began having conversations with people

like brokers, lawyers and bankers

about what was just bugging the most about their jobs.

One finding that Francis had was at brokers

especially were much more open

about divulging their deeper problems

that they had in their own jobs.

And most of the things that were bugging them

about their job concerned being written with guilt

and frustration.

Now one big question that Francis focused on

with his brokers was where to draw the line

between investment and speculation.

The problem with the brokerage industry

is that incentives are just misaligned.

A broker who puts his needs above the customers

can rake in large fees

but there's a good chance he's also encouraging

his customers to speculate and quickly move in

out of stocks because doing so fans is wallet.

Now in one conversation,

Francis had a broker tell him,

if you really wanna know what bugs me,

it's the fact that I can take client

out of general motors and put him in Chrysler

when in my heart I feel that he probably shouldn't be

in any motors at all.

Now this simple sentence tells you the fine line

that brokers are walking.

This broker felt that it was in his customer's best interest

not to invest in an entire industry

but instead of admitting this to his customer,

he basically just had to shuffle him

from one automotive company to another

just to make a living.

Now we reached the apex of the Gogo years.

In 1970, the Dow started at around 800,

already down 15% from the start of the year in 1969.

By April, the Dow was at 750, a few days later, 728.

President Nixon went ask for a quote on the market

at this time so that if he had any spare cash

he would be buying in the market as well.

Now Brooks here was clearly trying to draw a few parallels

between the crash of the Gogo years

and the great depression.

So after a black Thursday of 1929,

President Hoover said, and I quote,

the fundamental business of the country

is on the sound and prosperous basis.

John D. Rockefeller told the press that he and his son

had been buying stocks just to try

and reduce the fear in the market as well.

So by the end of May, the Dow had dropped to below 700

and this prompted the Fed to reduce margin requirement

on stock purchases from 80% to 65%

to try to get more liquidity back into the market.

Investors overseas services,

one of the largest mutual funds in the world

which operated as a fund of funds was hit very hard.

They lost about 75 million in value

in bad investments in poor loans.

It had sold out about $20 in late 1969

and was now selling for just $2.

This would have been bad news for mutual fund investors

that would have obviously had far-reaching consequences

to other mutual funds.

Then, look at what happened to James Ling's Ling Temco Vot.

The business was now suffering from antitrust suits

and had dangerously high levels of debt.

They were now at a point where their cash flow

just couldn't service their interest payments.

The business model obviously once thrived on a high price

that could be used as a currency to buy cheaper businesses.

But now that the price have been punished

from a peak of 170 to a depressing $16,

that strategy was completely out of the window.

Under pressure from the company's creditors,

Ling stepped down as a chairman and CEO.

Brook's rights, thus and hardly more than a week,

the king of the conglomerates

and the king of the mutual fund operators

were boast forced from their throats.

By the end of May, the Dow was now at 640.

Doomsayers were now talking about a 500 point Dow,

but by the end of 1970, the Dow was back up past 840.

Now, I'd like to finish this episode

by speaking a little bit about Brook's comparison

of the 1970 crash to the Great Depression.

So from 1929 to the deepest low of the depression in 1932,

the Dow dropped 90%, and in the 1970s crash, it dropped 36%.

So from the looks of it, it didn't look very comparable to me.

The problem with comparing the Dow

between both time periods is that the businesses

inside of the Dow in the 1970s

wasn't a great representation of the best businesses

in America as they had been in 1929.

So Brook's decided to use a different yardstick.

He looked at a proxy index

that a financial consultant named Max Shapiro had discussed.

This index consisted of many of America's greatest winners

of that time.

Businesses that were in the portfolio

of many average Americans.

So the portfolio had 10 leading conglomerates,

including Litton, LintemcoVot, 10 computer companies,

such as IBM, Lisco, and Sparry Rand,

and then 10 technology stocks, including Polaroid,

Xerox, and Fairchild camera.

The average decline of these 30 companies

from 1969 until 1970 was 81%.

But I tend to disagree with some of Brook's takes

on comparing the two.

For one thing, while this one index didn't fare so well,

it seems a little like cherry picking data

to fit your narrative.

Of course, the 30 most hyped up expensive stocks

are gonna get killed during a bear market.

I'm sure if you looked at the 30 most expensive stocks

trading during the .com bubble after it popped,

you could probably also create an index

that would have suffered a very similar drawdown.

Now, Brook's goes on to talk about how the crash of 1970

affected a lot more people

because more Americans were invested in stocks

in the 1970 versus 1929.

So in 1929 estimates were that about four

to five million Americans own stocks,

and by 1970, that number swelled to just 31.

On this point, I think he was correct

as the total percent of Americans owning stocks

during the Great Depression was just four percent,

and in 1970, it was over 15%.

Now, that's all I have for you for today.

Wanna keep the conversation going?

And please follow me on Twitter at our rational MR,

KTS, or connect with me on LinkedIn,

just search for Kyle Grief.

I'm always open to feedback, so please feel free

to share with me how I can make this podcast

even better for you.

Thanks for listening, and see you next time.

Thanks for listening to TI-P.

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