The Investor and Market Fluctuations: The story of the Great Atlantic & Pacific Tea Company Shares (1)

The A. & P. Example

At this point we shall introduce one of our original examples, which dates back many years but which has a certain fascination for us because it combines so many aspects of corporate and investment experience. It involves the Great Atlantic & Pacific Tea Co. Here is the story:

A. & P. shares  were introduced to trading on the “Curb” market, now the American Stock Exchange, in 1929 and sold as high as 494.  

• By 1932 they had declined to 104, although the company’s earnings were nearly as large in that generally catastrophic year as previously. 
• In 1936 the range was between 111 and 131. 
• Then in the business recession and bear market of 1938 the shares fell to a new low of 36.

That price was extraordinary.

• It meant that the preferred and common were together selling for $126 million, although the company had just reported that it held $85 million in cash alone and a working capital (or net current assets) of $134 million. 
• A. & P. was the largest retail enterprise in America, if not in the world, with a continuous and impressive record of large earnings for many years. 
• Yet in 1938 this outstanding business was considered on Wall Street to be worth less than its current assets alone—which means less as a going concern than if it were liquidated. 

Why? 

• First, because there were threats of special taxes on chain stores; 
• second, because net profits had fallen off in the previous year; and, 
• third, because the general market was depressed. 
• The first of these reasons was an exaggerated and eventually groundless fear; the other two were typical of temporary influences.

Let us assume that the investor had bought A. & P. common in 1937 at, say, 12 times its five-year average earnings, or about 80.  We are far from asserting that the ensuing decline to 36 was of no importance to him.

• He would have been well advised to scrutinize the picture with some care, to see whether he had made any miscalculations. 
• But if the results of his study were reassuring—as they should have been—he was entitled then to disregard the market decline as a temporary vagary of finance, unless he had the funds and the courage to take advantage of it by buying more on the bargain basis offered.

Ref; Intelligent Investor by Benjamin Graham

The most realistic distinction between the investor and the speculator is found in their attitude toward stock-market movements.

The most realistic distinction between the investor and the speculator is found in their attitude toward stock-market movements.  

The speculator’s primary interest lies in anticipating and profiting from market fluctuations. 

The investor’s primary interest lies in acquiring and holding suitable securities at suitable prices.

Market movements are important to him in a practical sense, because they alternately create 

• low price levels at which he would be wise to buy and 
• high price levels at which he certainly should refrain from buying and probably would be wise to sell.

Explanations for the Erratic Price Behaviour of some of the Most Successful and Impressive Enterprises

Growth Stock Paradox: The more successful the company, the greater are likely to be the fluctuations in the price of its shares.

The argument made above should explain the often erratic price behavior of our most successful and impressive enterprises. 

• Our favorite example is the monarch of them all—International Business Machines. The price of its shares fell from 607 to 300 in seven months in 1962–63; after two splits its price fell from 387 to 219 in 1970. 
• Similarly, Xerox—an even more impressive earnings gainer in recent decades—fell from 171 to 87 in 1962–63, and from 116 to 65 in 1970. 

These striking losses 

• did not indicate any doubt about the future long-term growth of IBM or Xerox; 
• they reflected instead a lack of confidence in the premium valuation that the stock market itself had placed on these excellent prospects.

Every investor who owns common stocks must expect to see them fluctuate in value over the years.

Market Fluctuations of the Investor’s Portfolio

Every investor who owns common stocks must expect to see them fluctuate in value over the years. 

The behavior of the DJIA since our last edition was written in 1964 probably reflects pretty well what has happened to the stock portfolio of a conservative investor who limited his stock holdings to those of large, prominent, and conservatively financed corporations.

• The overall value advanced from an average level of about 890 to a high of 995 in 1966 (and 985 again in 1968), fell to 631 in 1970, and made an almost full recovery to 940 in early 1971. 
• (Since the individual issues set their high and low marks at different times, the fluctuations in the Dow Jones group as a whole are less severe than those in the separate components.) 
• We have traced through the price fluctuations of other types of diversified and conservative common-stock portfolios and we find that the overall results are not likely to be markedly different from the above. 
• In general, the shares of second-line companies* fluctuate more widely than the major ones, but this does not necessarily mean that a group of well established but smaller companies will make a poorer showing over a fairly long period. 

In any case the investor may as well resign himself in advance to the probability rather than the mere possibility that most of his holdings will advance, say, 50% or more from their low point and decline the equivalent one-third or more from their high point at various periods in the next five years.†




* Today’s equivalent of what Graham calls “second-line companies” would be any of the thousands of stocks not included in the Standard & Poor’s 500-stock index. A regularly revised list of the 500 stocks in the S & P index is available at www.standardandpoors.com.

† Note carefully what Graham is saying here. It is not just possible, but probable, that most of the stocks you own will gain at least 50% from their lowest price and lose at least 33% from their highest price—regardless of which stocks you own or whether the market as a whole goes up or down. 

• If you can’t live with that—or you think your portfolio is somehow magically exempt from it—then you are not yet entitled to call yourself an investor. 
• (Graham refers to a 33% decline as the “equivalent one-third” because a 50% gain takes a $10 stock to $15. From $15, a 33% loss [or $5 drop] takes it right back to $10, where it started.

Ref:  Intelligent Investor by Benjamin Graham

The Investor and Market Fluctuations

To the extent that the investor’s funds are placed

• in high-grade bonds of relatively short maturity—say, of seven years or less—he will not be affected significantly by changes in market prices and need not take them into account. 
• (This applies also to his holdings of U.S. savings bonds, which he can always turn in at his cost price or more.) 
• His longer-term bonds may have relatively wide price swings during their lifetimes, and 
• his common-stock portfolio is almost certain to fluctuate in value over any period of several years.

The investor should know about these possibilities and should be prepared for them both financially and psychologically.  He will want to benefit from changes in market levels—

• certainly through an advance in the value of his stock holdings as time goes on, and 
• perhaps also by making purchases and sales at advantageous prices. 

This interest on his part is inevitable, and legitimate enough. But it involves the very real danger that it will lead him into speculative attitudes and activities. 

• It is easy for us to tell you not to speculate; the hard thing will be for you to follow this advice. 
• Let us repeat what we said at the outset: If you want to speculate do so with your eyes open, knowing that you will probably lose money in the end; be sure to limit the amount at risk and to separate it completely from your investment program.

What can the past record of the market actions promises the investor—

• in either the form of long-term appreciation of a portfolio held relatively unchanged through successive rises and declines, 
• or in the possibilities of buying near bear-market lows and selling not too far below bull-market highs?

Ref:  Intelligent Investor by Benjamin Graham.