Investors aren't the only people who fall prey to the delusion that hyper-growth can go on forever. In February 2000, chief executive John Roth of Nortel Networks was asked how much bigger his giant fiber-optics company could get. "The industry is growing 14% to 15% a year," Roth replied, "and we're going to grow six points faster than that. For a company our size, that's pretty heady stuff." Nortel's stock, up nearly 51% annually over the previous six years, was then trading at 87 times what Wall Street was guessing it might earn in 2000. Was the stock overpriced? "It's getting up there," shrugged Roth, "but there's still plenty of room to grow our valuation as we execute on the wireless strategy." (After all, he added, Cisco Systems was trading at 121 times its projected earnings!)1
As for Cisco, in November 2000, its chief executive, John Chambers, insisted that his company could keep growing at least 50% annually. "Logic," he declared, "would indicate this is a breakaway." Cisco's stock had come way down-it was then trading at a mere 98 times its earnings over the previous year-and Chambers urged investors to buy. "So who you going to bet on?" he asked. "Now may be the opportunity."2
Instead, these growth companies shrank-and their overpriced stocks shriveled. Nortel's revenues fell by 37% in 2001, and the company lost more than $26 billion that year. Cisco's revenues did rise by 18% in 2001, but the company ended up with a net loss of more than $1 billion. Nortel's stock, at $113.50 when Roth spoke, finished 2002 at $1.65. Cisco's shares, at $52 when Chambers called his company a "breakaway," crumbled to $13.
Both companies have since become more circumspect about forecasting the future.
1 Lisa Gibbs, "Optic Uptick," Money, April, 2000, pp. 54-55.
2 Brooke Southall, "Cisco's Endgame Strategy," InvestmentNews, November 30, 2000, pp. 1, 23.
SHOULD YOU PUT ALL YOUR EGGS IN ONE BAS KET?
"Put all your eggs into one basket and then watch that basket," proclaimed Andrew Carnegie a century ago. "Do not scatter your shot. . . . The great successes of life are made by concentration." As Graham points out, "the really big fortunes from common stocks" have been made by people who packed all their money into one investment they knew supremely well.
Nearly all the richest people in America trace their wealth to a concentrated investment in a single industry or even a single company (think Bill Gates and Microsoft, Sam Walton and Wal-Mart, or the Rockefellers and Standard Oil). The Forbes 400 list of the richest Americans, for example, has been dominated by undiversified fortunes ever since it was first compiled in 1982.
However, almost no small fortunes have been made this way—and not many big fortunes have been kept this way. What Carnegie neglected to mention is that concentration also makes most of the great failures of life. Look again at the Forbes "Rich List." Back in 1982, the average net worth of a Forbes 400 member was $230 million. To make it onto the 2002 Forbes 400, the average 1982 member needed to earn only a 4.5% average annual return on his wealth— during a period when even bank accounts yielded far more than that and the stock market gained an annual average of 13.2%.
So how many of the Forbes 400 fortunes from 1982 remained on the list 20 years later? Only 64 of the original members—a measly 16%—were still on the list in 2002. By keeping all their eggs in the one basket that had gotten them onto the list in the first place—once-booming industries like oil and gas, or computer hardware, or basic manufacturing—all the other original members fell away. When hard times hit, none of these people—despite all the huge advantages that great wealth can bring—were properly prepared. They could only stand by and wince at the sickening crunch as the constantly changing economy crushed their only basket and all their eggs.10
10 For the observation that it is amazingly difficult to remain on the Forbes 400, I am indebted to investment manager Kenneth Fisher (himself a Forbes columnist).
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