Beating the Street (17 page)

At the end of 1981, I'd taken my profit in Circle K Convenience Stores and Penn Central, a turnaround from bankruptcy. I sold Bally, the slot-machine company and casino operator, and bought two other gaming stocks, Elsinore and Resorts International. In early 1982, I bought back Circle K. My biggest holding was Mattel, the toy maker, which was 3 percent of the fund. Other companies in my top 10 at the time were Chemical Bank; Pic 'N' Save, a chain of discount stores in California; Verbatim, a manufacturer of floppy disks (once again, I'd fallen for a high-tech stock); Horn & Hardart, the owners of Bojangles restaurants and a mail-order gift business; and Pep Boys—Manny, Moe & Jack, not to be confused with the
Three Stooges. These were the Three Sages when it came to making money in auto parts.

Pep Boys, Seven Oaks, Chart House, Telecredit, Cooper Tire—now I was beginning to see that some of my favorite stocks did have something in common. These were companies with strong balance sheets and favorable prospects but most portfolio managers wouldn't dare buy them. As I've mentioned before, a portfolio manager who cares about job security tends to gravitate toward acceptable holdings such as IBM, and to avoid offbeat enterprises like Seven Oaks, the aforementioned servicer with a plant in Mexico. If Seven Oaks fails, the person who recommended putting it in the portfolio gets the blame, but if IBM fails, the blame is put on IBM itself, for “disappointing the Street.”

What made it possible for me to deviate from this stultifying norm? In a wide-open fund like Magellan, nobody was looking over my shoulder. In many firms there is a hierarchy of shoulders, with each person judging the work of the person directly in front of him, while worrying about how he's being judged from behind.

When you have to concern yourself with what the person behind you thinks about your work, it seems to me that you cease to be a professional. You are no longer responsible for what you do. This creates a doubt in your mind as to whether you are capable of succeeding at what you do—otherwise, why would they be monitoring your every move?

I was spared the indignity of being second-guessed by my superiors. I had the luxury of buying shares in companies that nobody had heard of, or of selling shares at $40 and changing my mind and buying them back at $50. (My superiors may have thought I was crazy for doing such things, but they didn't say so.) I didn't have to justify my stock picks at a daily or weekly meeting, or subject myself and my strategy to demoralizing critiques.

Fund managers have enough to worry about in trying to beat the market. We don't need the added burden of conforming to a plan or explaining our strategies every day. As long as we follow the mandate of the fund as described in the prospectus, we ought to be judged once a year on our results. Along the way, nobody should care if we buy Golden Nugget or Horn & Hardart instead of Reynolds Aluminum or Dow Chemical.

By 1981–82, I'd begun to work on Saturdays. I devoted the extra day to cleaning off my desk. I had to peruse a stack of mail, which
at one point reached a height of three feet a day. In February and March, I reviewed annual reports. I flipped through my notebooks of corporate contacts, looking for situations in which the stock prices had dropped (I always wrote down the price along with the date whenever I talked to a company) and the fundamentals either had improved or were unchanged. My goal was to see some wood at the end of the afternoon, but I didn't always achieve it.

The first half of 1982 was terrible for the stock market. The prime rate had hit the double digits, as had inflation and unemployment. People who lived in the suburbs were buying gold and shotguns and stocking up on canned soups. Businessmen who hadn't gone fishing in 20 years were oiling their reels and restocking their tackle boxes, preparing for the shutdown of the grocery stores.

Interest rates had gone so high that my biggest position in the fund for several months running was long-term Treasury bonds. Uncle Sam was paying 13–14 percent on these. I didn't buy bonds for defensive purposes because I was afraid of stocks, as many investors do. I bought them because the yields exceeded the returns one could normally expect to get from stocks.

This leads us to Peter's Principle #8, the only exception to the general rule that owning stocks is better than owning bonds:

When yields on long-term government bonds exceed the dividend yield of the S&P 500 by 6 percent or more, sell your stocks and buy bonds.

I couldn't imagine that interest rates could go much higher, or stay at these levels for long, without the economy collapsing and the worst nightmares of the backyard fishermen coming true. If that happened, I'd be out there casting in the surf with the rest of them, and Magellan's portfolio strategy would be the least of my worries. But if it didn't, I'd want to be fully invested in stocks and long-term bonds.

Why investors attempt to prepare for total disaster by bailing out of their best investments is beyond me. If total disaster strikes, cash in the bank will be just as useless as a stock certificate. On the other hand, if total disaster does not strike (a more likely outcome, given the record), the “cautious” types become the reckless ones, selling their valuable assets for a pittance.

In early 1982, I went through my usual scare-proofing drill, concentrating
on the Even Bigger Picture, assuming that the worst wouldn't happen, and then asking myself, if it didn't, what then? I figured that interest rates had to come down sooner or later, and when they did, the owners of both stocks and long-term bonds would make big profits.

(In fact, the S&P 500 had a fourfold gain from 1982 to 1990 and 30-year government bonds did slightly better. Then in 1991, when stocks were up another 31 percent, bonds did poorly, proving once again that in the long run stocks will outperform bonds.)

In the gloom and doom of the era, financial commentators continued to harp on slumping auto sales, as if slumping auto sales were a permanent affliction. It seemed to me that recession or no recession, people were going to have to return to the showrooms. If there's anything as certain as death and the collapse of the Red Sox, it's that Americans have to buy cars.

It was this sort of thinking that led me to Chrysler in March 1982. Actually, I stumbled onto Chrysler indirectly. I got interested in Ford as a beneficiary of the rebound in autos, and in talking to Ford I became convinced that Chrysler would benefit even more. As usual, my research into one opportunity led me to another, the way a prospector follows the gold flakes upstream.

Chrysler stock was selling for $2 at the time, because Wall Street expected the number-three automaker to go bankrupt and become the next Penn Central. A quick check of the balance sheet showed me that Chrysler had more than $1 billion in cash—mostly thanks to its sale of a tank division to General Dynamics—so its imminent demise was greatly exaggerated. Chrysler had the capacity to go bankrupt, but not for at least a couple of years. The U.S. government had guaranteed enough loans to Chrysler to ensure its short-term survival.

If auto sales had been robust in general and Chrysler had managed not to sell cars, I would have been more pessimistic about its future. But the entire industry had been in a slump and was due for a rebound. Since Chrysler had reduced its debt and was hovering near the breakeven point when sales were slow, it had the potential to do jumbo numbers when sales picked up.

In June I visited corporate headquarters, where I saw the new cars and talked with several top executives in a meeting arranged by investor relations officer Bob Johnson. This was probably the most important day in my 21-year investment career.

The interviews that were supposed to last three hours stretched into
seven, and a brief chat with Lee Iacocca turned into another two-hour session. In the end, I was convinced not only that Chrysler had the wherewithal to stay in business for a while, but also that the company was putting some pizzazz into its products.

The Dodge Daytona, Chrysler Laser, and the G-124 Turbo Car were all coming off the assembly lines. The G-124 could accelerate from 0 to 60 faster than a Porsche. There were convertibles for the younger crowd and a sportier New Yorker with front-wheel drive. Mr. Iacocca was most excited about what he called “the first new thing in the auto industry in twenty years,” a vehicle that had been given a code name: T-115. This was the Chrysler minivan, which sold over three million copies in the next nine years.

I was more impressed with the cars than with the minivan, but the minivan turned out to be the product that saved the company. No matter how well you think you understand a business, something can always happen that will surprise you. Here was a breakthrough in automotive design and engineering that came not from Japan or Germany or Sweden, but from Detroit. The Chrysler minivan outsold all the Volvos in the U.S. by five to one!

Chrysler was a large company with millions of shares outstanding, which made it possible for Magellan to acquire a large position. The company was so disparaged on Wall Street that the institutions had given up and had stopped following it. In the spring of 1982 and into the summer, I was buying the stock in earnest. By the end of June, it was my number-one holding. By the end of July, 5 percent of Magellan's assets were invested in Chrysler, the maximum percentage allowed by the SEC.

Throughout the fall, Chrysler remained my top position, just ahead of Horn & Hardart, Stop & Shop, IBM, and Ford. If I'd been allowed to, I would have made Chrysler 10 or even 20 percent of my fund. This in spite of the fact that most of my friends and professional colleagues told me I was crazy, and that Chrysler was going bankrupt.

By October, my bond position was whittled down to 5 percent of Magellan's assets. The great bull market had begun in earnest. Interest rates had started to come down, and the economy showed signs of revival. Cyclical stocks were leading the market higher, as they usually do at the end of a recession. I responded by selling some bank and insurance stocks. Eleven percent of the fund was now in the autos, and 10 percent in the retailers.

This shift in allocation was not a policy derived from the headlines,
or from remarks made by the chairman of the Federal Reserve Board. My decisions were made on a case-by-case basis, as one company after another told me that business was getting better.

During this period, Genentech came public at $25 and promptly soared to $75 in one day. This was one of the new issues that I bought.

The weekend before Halloween, I made my first appearance on “Wall Street Week.” I didn't meet the host, Louis Rukeyser, until about a minute before the cameras rolled. He walked onto the set, leaned over, and said: “Don't worry, you'll do fine, only about eight million people are watching you.”

Rukeyser opened the show with a Halloween joke about how politicians scare Wall Street much more than goblins do. Then the three panelists (Dan Dorfman, Carter Randall, and Julia Walsh) did some weekend thinking. As usual there was plenty to be worried about, beginning with the fact that the Dow had fallen 36 points on the prior Friday. The newspapers had made a big deal of this “worst one-day drop since 1929,” even though the comparison was absurd. A 36-point drop with the Dow at 990 was not the same thing as a 36-point drop with the Dow at 280, which is where it stood before the Crash.

How frequently today's mountains turn out to be tomorrow's molehills, and vice versa. Asked what might be spooking the market, the three experts mentioned the indictment against automaker John De Lorean, the Tylenol scare, and the large number of members of Congress who might lose their seats in the upcoming election. Mr. Rukeyser read a letter from a viewer who was concerned about a possible bank and S&L crisis that might deplete the resources of the Federal Deposit Insurance Corporation. The panelists thought there was little chance that such a thing could happen. Rukeyser ended the discussion by suggesting that the government could always “print a few more bucks if it had to,” a jocularity that may turn out to be prophetic.

For my part of the show, I was ushered in from the wings as I was kindly introduced as the “best mutual-fund stockpicker of the last five years,” tops on the Lipper list with a 305 percent gain over that period. I wore a plain brown suit and a blue shirt, the kind you are supposed to wear on television, and I was nervous. Getting on the Rukeyser show was the financial equivalent of opening the envelopes at the Academy Awards.

Rukeyser lobbed me a few easy questions, beginning with the “secret to my success.” I said I visited more than 200 companies a year and read 700 annual reports, and that I subscribed to Edison's theory that
“investing is ninety-nine percent perspiration”—something I was doing a lot of at the time. “That was Edison's theory of genius, not of investing,” Rukeyser corrected. I said nothing. The witty comebacks were trapped in butterflies.

Rukeyser wanted to know more about my modus operandi. What was I going to say? “Well, Lou, I buy what I like”? I didn't. Instead, I said that I divided the Magellan portfolio into two parts: the small-growth and cyclical stocks, and the conservative stocks. “When the market heads lower, I sell the conservative stocks and add to the others. When the market picks up, I sell some of the winners from the growth stocks and cyclical stocks and add to the conservative stocks.” Any resemblance between my actual strategy and this attempt to explain it to 8 million viewers on the spur of the moment is purely coincidental.

Asked about my favorite picks, I listed Bassett Furniture, Stop & Shop, and the autos in general, especially Chrysler. The autos had been depressed two straight years, I said, and Chrysler was well positioned to benefit from a comeback. Expressing the popular Wall Street view, Dorfman wondered if Chrysler wasn't too risky. “I'm willing to take risks,” I countered.

Things lightened up when somebody asked a question about a technology company. I confessed not only that was I ignorant of technology, but that “I never really understood how electricity works.” This got a laugh, and Rukeyser wanted to know if it had ever occurred to me that I was a “very old-fashioned fellow.” My brilliant reply to that question was “No, it hasn't.”