The Intelligent Investor_ The Definitive Book on Value Investing - Benjamin Graham [143]
What about Exodus the business? Graham wouldn’t have touched it with a 10-foot pole and a haz-mat suit. Exodus’s revenues were exploding—growing from $52.7 million in 1998 to $242.1 million in 1999—but it lost $130.3 million on those revenues in 1999, nearly double its loss the year before. Exodus had $2.6 billion in total debt—and was so starved for cash that it borrowed $971 million in the month of December alone. According to Exodus’s annual report, that new borrowing would add more than $50 million to its interest payments in the coming year. The company started 1999 with $156 million in cash and, even after raising $1.3 billion in new financing, finished the year with a cash balance of $1 billion—meaning that its businesses had devoured more than $400 million in cash during 1999. How could such a company ever pay its debts?
But, of course, online traders were fixated on how far and fast the stock had risen, not on whether the company was healthy. “This stock,” bragged a trader using the screen name of “Launch_Pad 1999,” “will just continue climbing to infinity and beyond.”6
The absurdity of Launch_Pad’s prediction—what is “beyond” infinity?—is the perfect reminder of one of Graham’s classic warnings. “Today’s investor,” Graham tells us,
is so concerned with anticipating the future that he is already paying handsomely for it in advance. Thus what he has projected with so much study and care may actually happen and still not bring him any profit. If it should fail to materialize to the degree expected he may in fact be faced with a serious temporary and perhaps even permanent loss.”7
Where the Es Ended Up
How did these four stocks perform after 1999?
Emerson Electric went on to gain 40.7% in 2000. Although the shares lost money in both 2001 and 2002, they nevertheless ended 2002 less than 4% below their final price of 1999.
EMC also rose in 2000, gaining 21.7%. But then the shares lost 79.4% in 2001 and another 54.3% in 2002. That left them 88% below their level at year-end 1999. What about the forecast of $10 billion in revenues by 2001? EMC finished that year with revenues of just $7.1 billion (and a net loss of $508 million).
Meanwhile, as if the bear market did not even exist, Expeditors International’s shares went on to gain 22.9% in 2000, 6.5% in 2001, and another 15.1% in 2002—finishing that year nearly 51% higher than their price at the end of 1999.
Exodus’s stock lost 55% in 2000 and 99.8% in 2001. On September 26, 2001, Exodus filed for Chapter 11 bankruptcy protection. Most of the company’s assets were bought by Cable & Wireless, the British telecommunications giant. Instead of delivering its shareholders to the promised land, Exodus left them exiled in the wilderness. As of early 2003, the last trade in Exodus’s stock was at one penny a share.
Chapter 14
Stock Selection for the Defensive Investor
It is time to turn to some broader applications of the techniques of security analysis. Since we have already described in general terms the investment policies recommended for our two categories of investors,* it would be logical for us now to indicate how security analysis comes into play in order to implement these policies. The defensive investor who follows our suggestions will purchase only high-grade bonds plus a diversified list of leading common stocks. He is to make sure that the price at which he bought the latter is not unduly high as judged by applicable standards.
In setting up this diversified list he has a choice of two approaches, the DJIA-type of portfolio and the quantitatively-tested portfolio. In the first he acquires a true cross-section sample of the leading issues, which will include both some favored growth companies, whose shares sell at especially high multipliers, and also less popular and less expensive enterprises. This could be done, most simply perhaps, by buying the same amounts of all thirty of the issues in the DowJones Industrial