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The Speculator
On Wall Street, pride signals a fall
Beware companies with oodles of hubris. Those pumped up by magazine cover stories or that slap their own names on stadiums suffer for it later, our studies show.
By Victor Niederhoffer and Laurel Kenner

Hubris: Presumption, originally toward the gods; pride, excessive self-confidence.
-- Old English Dictionary

Hubris is much on our minds lately. It seems like only yesterday (it was mid-1999) that Enron Chairman Kenneth Lay boasted to a group of oil and gas executives impressed by the company's ninefold growth in market value to $40 billion during the 1990s, "We will do it again this coming decade."
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Greek tragedies, as Aristotle explained, rely on the punishment of successful but flawed heroes who reach for godly heights. The hero's downfall brings catharsis, letting audiences purge themselves of pity and fear without becoming paralyzed by those emotions.

We'd all prefer to find catharsis in plays rather than our portfolios. The best strategy, therefore, is to keep away from hubristic executives. How to read the signs? We tested two indicators and will report the results below.

First, however, we'll declare that we are second to none in our admiration for high aspirations. We disagree with Warren Buffett, the "just plain folks" Nebraskan sage who finds it more virtuous to invest in slow-growing carpet, shoe and paint companies than technology enterprises. The question is whether there is a way to distinguish companies with grand ambitions that will go on to reach the stars from those destined to suffer the denouement deemed necessary by the Greek tragedians. How do we separate the Long-Term Capitals, the Scott Papers, the Winstars and the Lucent Technologies (LU, news, msgs), from winners like Genentech (DNA, news, msgs), once ridiculed for having the hubris to believe it could use biotechnology to develop a profitable drug? Note that Genentech was acquired by Roche at prices up to seven times the original 1986 offering price. And even with the 2000-2001 tech collapse, 18 stocks in the Nasdaq 100 are up more than 500% over the past five years, led by a 2,079% gain in Immunex (IMNX, news, msgs).

Hubris is by no means a new fault of corporate executives. Yet the late historian Robert Sobel, surveying the past century of business downfalls in his 1999 book "When Giants Stumble", prominently featured hubris in his list of 15 deadly sins that destroyed such leading companies as Osborne Computer, LTV, Schwinn and Packard Motor Car. (Sobel's list also included nepotism, non-strategic expansion, cutting corners, isolation and dependency.)

The hubristic chief executive of Enron (ENE, news, msgs) was merely treading in the footsteps of Cisco Systems (CSCO, news, msgs) Chairman John Chambers. The Cisco leader's prediction one year ago of a continued 30%-50% growth rate was promptly followed by three straight quarters of 70% profit declines. A similar drop is expected this quarter.

Chambers and Lay shared an outspoken disdain for Old Economy rivals. In 1998, when Cisco was at the top of the hill, Chambers remarked of traditional telephone companies, "As the majority of load on the network becomes data and video, voice will become free." Similarly, Lay said he characterized Enron as a New Economy company "before it became cool to be one."

The sense of being above the world, illustrated nicely by the story of Icarus, seems basic to corporate hubris. Enron employed ingenious mechanisms to banish debt from the corporate books. Chambers, warning Silicon Valley on Feb. 28, 2000, against "hired gun" options that vested after only three years, omitted to mention that he had made $142.9 million 17 days earlier by exercising 1.15 million Cisco shares at what turned out to be close to the peak.

Boasting seems to be another classic hubris "tell." In the official biography of Chambers on the corporate Web site, we learn that Network World called Cisco "the most powerful company." Our trader friend Ed Gross, a 20-something blackjack player whose adept card-counting led to his banishment from casinos, says he can predict failure in even skillful card players who enter the casino bouncing with confident talk of how easy it will be to win.

Unfortunately, boasting is hard to quantify. As our readers know, we believe that a scientific theory is one that suggests predictions that can lead to results that differentiate between competing theories. We therefore ran comprehensive tests on two bits of Wall Street folklore for which concrete measures are available: magazine covers and sports stadiums.

The magazine cover indicator
As one of our readers, lawyer William Harrell, points out, "Hubris goes out of its way to let you know of its existence, while humility does not." As media organizations depend on loudmouths, we considered the question of the performance of companies featured on business magazine covers. "Whom the gods would destroy, they first put on the cover of Business Week," wrote Paul Krugman of Enron's Kenneth Lay, in a recent New York Times article.

Krugman gave no data to support his conclusion, and in typical fashion, used the anecdote to argue for decreased reliance on markets and increased reliance on government intervention. In fact, the example of failure is only one blade of the scissors, leaving out the many CEOs featured by Business Week who went on to great heights. What is needed to shed light on the subject is a complete enumeration of all companies featured on magazine covers during a reasonably representative period with a comparison of the performance of these companies to the market during relevant subsequent periods.

Our study of the Time Person of the Year awards, which go back to 1926, does indicate a hubristic curse. The first company to receive the honor was Chrysler in 1928. This was followed by General Electric Chairman Owen Young in 1929. Both companies declined about 70% in the next two years. The most recent executive to receive the award was Jeffrey Bezos, founder of Amazon.com (AMZN, news, msgs), in 1999. The online bookseller has declined some 80% since the time of the award.

Only in bull markets, it seems, do companies and businessmen make the cover of Time. The only others we found were GM Chairman Harlow Herbert Curtice in 1955, Cable News Network founder Ted Turner in 1991 and Intel (INTC, news, msgs) Chairman and CEO Andy Grove in 1997. On average, the six companies to receive the award declined an average of 10% in the next two years, vs. an average gain of 20% in the S&P 500 for the same two-year periods.

Because neither Business Week covers nor the Time awards were numerous enough to permit statistically valid conclusions, we studied every company featured on the cover of Forbes from 1997 to the present. The results show that companies perform about 5 percentage points worse than the market in the month after making the cover of Forbes, and in line with the market over the subsequent five months.

The results for the one-month period appear to be rather unlikely to have occurred by chance variation alone -- say one in 20. Our study thus supports the theory that companies perform worse than the market in the month after appearing on the cover of Forbes.

The stadium indicator
The Wall Street Journal recently documented the inordinate tendency of companies that bought the rights to name stadiums after themselves to fall into bankruptcy, financial difficulties or drastic declines in market value. Examples of bankruptcies include Enron, TWA, PSINet and Fruit of the Loom, while CMGI Inc . (CMGI, news, msgs), Savvis Communications (SVVS, news, msgs), 3Com (COMS, news, msgs) and Conseco (CNC, news, msgs) merely showed stock price declines ranging from 85% to 92%.

True, some stadium namesakes have suffered no ill effects. The stadium named for General Motors (GM, news, msgs) houses the Vancouver Canucks; PepsiCo (PEP, news, msgs) helps house the Denver Nuggets and Compaq Computer (CPQ, news, msgs) put its name on the Houston Rockets' base. All three companies are still very much alive and kicking.

However, after completing a comprehensive study of every company that named a stadium after itself, beginning with RCA in 1984, we can confirm the gist of the Journal's article.

Other indicators
In a classic 1986 study, "The Hubris Hypothesis of Corporate Takeovers," Richard Roll found that acquiring companies often perform worse than the market after a deal, and that the motivation for the purchase thus could not rationally be stock price appreciation. He posits that the main motivation would have to be...hubris. Is there anyone among our readers (assuming he does not own the stock in question), after witnessing some of the landmark takeovers in the banking, energy and pharmaceuticals industries, who has not had similar thoughts?

We suspect that acquisition overpayment, corporate golf courses (Lucent), opulent offices (RJR Nabisco), moves to Florida (Scott Paper), sex scandals (Bendix) and executive pay exceeding $100 million a year might be profitable areas for future hubris tests.

We encourage our readers to share their own tells, hubris candidates and ideas on testing for this fatal flaw. Write to us at dciocca@bloomberg.net. We will send the complete results of our tests on stadiums and magazine covers to all who request them.

The Greeks believed that the stately and portentous language of iambic pentameter, which corresponds to the emotional heights of human speech, enhances the impact of tragedy. (An iamb is a weak syllable followed by a strong syllable, and iambic pentameter contains five weak-strongs to a line, with many artistic liberties taken.) We'll therefore close with some heroic verses by Victor's daughter, the producer and writer Galt Niederhoffer, whose forthcoming coming-of-age novel "American Thighs" is written in iambic pentameter.

Hubris is on everybody's mind of late
Humility seems like a memory.
It seems that only yesterday that
Enron's chairman, Kenneth Lay
Did boast of feats unmatched in a decade:
"We've grown nine-fold to $40 billion
And we'll do it again before too long."
A messenger from the Economist
Was witness to his grandiosity
Reporting on the New Economy
He found in Enron the epitome


So often history repeats itself
And so was Cisco twinning over times
Referring to its staunch predecessors
As relics of the Old Economy
Behold, not more than 12 months ago,
Cisco offered its own grand prophecy
Predicting 30 percent to 50
Though such growth occurs mainly in tragedy
So diminished is the growth of tech firms now
The media now calls them shriveled men.




At the time of publication, Victor Niederhoffer and Laurel Kenner did not own or control shares of any of the equities mentioned in this column.





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