Why Do I Hate Wall Street So Much? - DOW?!?!

The long holiday weekend always leaves me in a reflective mood. This weekend I was thinking of the influences that made me a value investor. Let’s tell a few stories about my journey, and then tie them into an analysis of Dow - DOW - $44.

I left my undergraduate studies as an agnostic in the battle between growth and value. I had a great undergraduate course in security analysis taught by a professor that also ran a growth stock firm. I did a 30 page analysis of McDonald’s and concluded it was a buy despite the stock having a well above average Price/Earnings ratio. This was 1980, and the market was near a multi-year low. Only one investment manager even came to campus to interview students. It was the Bank of Sheboygan. I handed the guy my McDonald’s report. He read it carefully. He said he could not hire me. He told me “you will be running your own shop by the time you are 30, you will never be happy in Sheboygan”. He was right, I started JKE Equity Research when I was 29.

The only job available in 1980 was being and internal auditor for Beatrice Foods. With my first check I invested in the T Rowe Price Growth Stock Fund. While doing an audit in New York, I discovered the McGraw Hill bookstore. I remember distinctly carrying home a suitcase filled with investment books. Included were a copy of Graham’s opus Security Analysis, and a book of academic studies including Basu’s low P/E paper (that included the footnote that stocks with negative earnings did the best).

When I went looking for graduate schools, I came across a strange professor at TCU that was doing a paper on Ben Graham. He was looking for a graduate assistant to look through over 100 S&P Stock Guides to find all the “Net Asset Value” stocks. At about 3 hours per guide, this was a lot of work. The magnificent Dr. Henry Oppenheimer also convinced me to sell my growth stock fund, and buy John Neff’s Windsor Fund.

While at TCU “Dr. O” also taught the Educational Investment Fund (a $1 million dollar fund donated to TCU by the Alcon Labs co-founder, the great William Conner). Dr. O insisted the student do their own work, and never use an Wall Street reports. My first report for the Conner Foundation was on a “net asset value” stock that made pneumatic tools. The company was acquired two years later at a 140% premium. I was was hooked on value investing, but I did really not hate Wall Street. In fact, I did not even know Wall Street.

All I knew about Wall Street was watching Louis Rukeyser’s Wall Street Week every single Friday night since I was 15 years old. I was fascinated that someone could earn a good living analyzing natural gas pipeline stocks (including my dad’s favorite, El Paso Natural Gas). I built up great respect for the guys from Merrill Lynch, Kidder Peabody, EF Hutton, and especially Goldman Sachs. I could not wait to read their research.

My work on the Conner Foundation landed me an analyst job at the biggest bank in Dallas, Interfirst Bank. They managed $4 billion using a growth stock strategy. We were covered by at least 30 Wall Street firms. The prior analyst for nice enough to leave me a five foot stack of Wall Street research. I dove in. I went right for the blue Goldman Sachs envelope. I could not wait to see the Goldman Sachs recommended list. It would be the guide to eternal wealth. The smartest guys in the world, telling me which stocks to buy. I had waited 10+ years to see the magic.

Wow, what a soul crushing disappointment.

The list was horrible. It was completely unusable. Of the 30 stocks, 27 were near their 52 week highs. Only a few had PE’s under 12 (remember this is 1984). There was not a single value stock on the list. Goldman was not unique, but I expected better. The entire stack of research had very few useable ideas. There were some great industry reports, but none recommended stocks near their lows. In about 8 hours of reading that stack of research I became a value investor forever. In a few weeks I knew I had to start my own firm. There was plenty of great information in the reports. I totally consumed the research for two years. But over 95% of the time Wall Street’s conclusions were silly. The conclusions were designed to make you feel good about owning growth stocks, and thereby generate MAXIMUM COMMISSIONS. As the brilliant analyst next door very perceptively asked a leading drug analyst one day. “How much higher did Merck have to go before you will have to recommend it”. The analyst paused for a long moment, and then said that was the best question he had ever been asked. He then admitted he would have to put Merck on the “buy list” if the stock went higher.

When I look at Dow -DOW - $44 - today (it is no longer Dow Chemical), I know it is exactly the type of stock that was never on on the Goldman Sachs recommended list (or any other big Wall Street firm, sorry to pick on GS but they have earned a special place in hell). Please pull up a DOW one year chart. The market is up 25% this year, yet DOW has plunged from $60 to $44. The stock has a 6%+ yield, and sells for 5x what they earned in 2021 and 2022. There are 5 buy recommendations, and 16 hold/sell recommendations. I will bet you a pile of Krispy Kreme doughnuts that the firms with buy recommendations have done investment banking for Dow in the last two years.

I am not convinced yet that DOW is a Top 20 Model Portfolio stock. They are presenting at a conference on December 3rd. I will listen to the replay if the company puts it on their website. I hate DOW’s exposure to housing starts, and China, and especially their exposure to housing starts in China. But the stock is very cheap. It is exactly the type of stock that every real value investor has to at least consider. The balance sheet in is good shape, they are selling underperforming businesses, and low natural gas prices help exports.

Good security analysis is necessary for the functioning of the capitalist system. The sewage produced by Wall Street is a significant hinderance to the proper allocation of capital. Aren’t the holidays fun?