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Those Who Cannot Remember the Past are Condemned to Repeat it

Tuesday, Feb 6th, 2018

We all recall the old saying, "Those who cannot remember the past are condemned to repeat it." The problem is, when it comes to investing we seem to often shy away from prior mistakes. The mistakes I am referring to, is the idea of overpaying for not just companies, but all asset classes. The mistakes do not always occur in the same manner, but they follow the principle of overpaying for inflated assets. Over the course of time we have seen investors driven by the fear of missing out, which leads them to pile into popular, but expensive assets. This rapid increase in price is then followed by a bursting of the bubble and a collapse in that asset class.

The Dutch Tulip Bulb Crisis: As silly as this may sound, this is a perfect example of the craziness which overtakes some investors. Tulip bulbs became a novelty in Holland in the 1630’s and became traded on stock exchanges in numerous Dutch towns and cities. Tulip prices at one point increased 20-fold from November 1636 to February 1637. There were no earnings or sales driving this increase in tulip bulbs. Instead, people were consumed by the rising prices and a fear they were missing out on easy money. This period of time became known as Tulipmania, as investors were willing to pay at one point 6 times the average person’s salary for the rarest tulip bulbs. Investors did not think this mania was going to end, but reality set in and in May of 1637, tulip bulbs plunged 99%.

1920’s Florida Real Estate Bubble: We should all be familiar with the Great Depression which began in 1929. Many however are much less versed on the collapse of the Florida real estate market before the Great Depression. The country was booming during the 1920’s and vacationing in Florida became a desirable activity. As the tourism industry grew, land prices rose. At its peak year in 1925, property prices quadrupled in less than one year. Cheap credit helped fuel the bubble as it became plentiful and investors could buy Florida real estate regardless of their net worth. Even people in the northern states of New York, Massachusetts, and others heard of the rapid increases and wanted a piece of the action. Making money in real estate became so easy that it seemed all you had to do was buy a Florida property and watch your investment grow at rapid rates. Like all other asset bubbles, Florida real estate did not go to the moon. Instead prices plunged, and, in many cases, investors went bankrupt as there were no new buyers and crushing mortgage debt became too much to handle.

The Nifty Fifty: In the late 1960’s and early 1970’s, 50 stocks with promising prospects captivated investors. These 50 companies became known as one decision stocks as they were meant to be bought and held. Names included in the 50 companies were McDonald’s, IBM, Coca-Cola, Polaroid, Disney, and Avon Products. Investors became enamored by the growth of these companies and began to pay steep prices, without an understanding of the true value. In 1972, the Nifty-Fifty had a P/E of 42 which was more than double the S&P’s average of 19. Some companies with the highest P/E’s were Polaroid at 91, McDonald’s at 86, and Avon at 65. The Nifty-Fifty rose for several years, until the stock market collapsed in 1973 and 1974. The Dow fell 45% in just two years and many of the companies in the Nifty-Fifty experienced larger declines. Some examples included Xerox which fell 71%, Avon declined 86%, and Polaroid had a loss of 91%.

The Dot Com Bubble: This period of time presented a lot of excitement as the internet became a part of our lives. This triggered massive speculation as investors tried to find the companies which would be the most successful in a digital age. The problem was speculation fueled buying of companies with no earnings or cash flow, but rather companies that were technologically based. The NASDAQ soared from approximately 500 in 1990 to over $5,000 in March 2000. Many investors placed heavy bets on technology and lacked a diversified portfolio. This was a profitable strategy until the music stopped, and the NASDAQ crashed by nearly 80% in October 2002. Many investors witnessed massive wipeouts of the gains they accumulated during the tech boom. It took 15 years for the NASDAQ to set a new high after the peak in March 2000. Many popular companies during this period are no longer around, and many still reside below their all-time highs. This includes companies such as Intel, Qualcomm, and Cisco. Microsoft was another hot name during the tech boom. After it peaked in 1999, it took over 15 years to get back to breakeven. The lack of earnings to support the growth in stock prices fueled all-time highs in P/E multiples and overvaluation caused the meltdown during the tech bust.

These are just 4 examples of asset classes which became over inflated. There are other instances throughout history, but investors still look for that quick investment tip to make a quick dollar. That type of decision making is what leads to the massive bubbles we have seen. No matter the asset class it is best to understand the true intrinsic value based on actual fundamentals. If you don’t know what it is truly worth, then it is best to stay away from that investment. In today’s world of cryptocurrencies, high flying cloud companies, and other overpriced assets the next bursting of a bubble is around the corner. Be cautious with your investments and don’t get sucked into the hype. It is part of our human nature to chase returns, but in investing you don’t make money following the crowd.

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