May

29

Walkie TalkieThis past Decoration Day was a milestone for our family business. It was the first time that our year-to-date income from money and paper exceeded what we made from operations. Since business conditions in the equipment rental trade are terrible, the explanation could be that our income from dealing in wireless gear was negligible. It wasn't; we made as much this year as we did last year and the year before. What is different is that the capital that would have been spent on new equipment has been put into our investment accounts instead. So, for the first time since we started on this long, strange trip in California 35 years ago, we have money to lose that has nothing to do with our business.

I don't like it. Working to buy a house and set aside the money to send our daughter to college and beyond was much easier. In an operating business you have nothing but problems but you can fix them because you can, especially if you have a gifted partner, see what the problems are and what caused them. I don't find that to be the case in the world of money. There is endless speculation about this and that, but there is nothing that you can put your hands on. I continue to marvel at how the bond, stock and option traders who post on Dailyspeculations.com do their jobs. It seems to me even more wondrous than hitting a baseball 400 feet or throwing a split with a six inch break. Vic and Laurel could write a dozen books and we could study every one of them diligently, and none of us here in Nora-Jovanovich-Turner land would ever learn to be a speculator any more than we could give GM Nigel a game.

Not having the wit to speculate, we have tried instead to copy what we do in our business. We have treated our money as inventory and tried, however foolishly, to calculate the turns in the cycle. In our inventory-distribution businesses we buy more stuff for the shelves when times are bad but going to get better and sell some of our inventory when times are good but going to get worse. That is not, to our minds, the same thing as buy low, sell high. In an operating business Graham & Dodd's Never Land of buying new inventory for 10 cents on the dollar is just not found. As much as computer hardware prices may fall, the cost of necessary software to run the boxes competitively in our business will rise. You buy more equipment that has value when you think that you will have more customers, not when prices are "cheap."

The process of calling turns is entirely guess, but there are usually at least a couple of tells that reliably shorten the odds. What does not work is to study the psychology of your colleagues and competitors in the trade. Industry gossip is like Michigan's consumer sentiment expectation survey; it tells you where you are and have been, not where you are going. It is not a useful tell, even as a contrary indicator. There are three tells that seem to work in the wireless equipment rental business in Southern California. One of them just triggered: AFTRA settled its threatened strike with the producers, and it is more than likely SAG will follow. When the inmates decide they have taken over enough of the asylum, good things tend to follow. The second tell is advertising rates for spot commercials on TV. Usually, six to nine months after those rates have gone in the tank, volume in our trade increases. I don't know exactly why, but one credible explanation is that the networks and producers realize that they need to do something new and different to improve their ratings and more pilots go into production. The third tell is the one I am not divulging in case I have to go back to my day job.

For our investment inventory buying and selling, we have only found two tells that seemed to work: (1) the rate spread between the 5 and 30 year constant maturity Treasuries and (2) the rate spread between the Moody's seasoned AAA and BAA corporate bonds. These are reported each work day by the Fed, and their data go back decades. You can plot the widening and narrowing of the spreads over time over the past two business cycles and find a fairly consistent correlation to the future customer demand for U.S. common stocks.

John BogleThat still leaves the question of deciding what inventory to buy. We could avoid the problem of what to buy if we simply used an Index, but having exactly the same inventory as anyone else goes against the grain. John Bogle may be right, but we prefer to pick our own stocks. We also find that the actual expenses of our buying and selling are far less than the fees from even the least expensive S&P 500 Index Fund. Still, choosing what to own is a headache. In our three decades of owning distribution businesses, deciding what inventory to carry is one of the two issues that have caused more squabbles, arguments and partnership divorces than any other ten issues combined. You and your partners can agree that we need inventory on the shelves because business is going to get better and, at the same time, you want to strangle the idiots because they want to buy Motorola's new improved toy instead of what you want. Usually, you and the idiot partner are both wrong.

If you can't ever guess exactly what the customers will want, you can figure out what equipment will work. Since wireless devices are tools and not fashion statements, over time the better equipment wins. To pick that equipment, we developed our own test bench model that analyzes radios, batteries and accessories for reliability. It took several years to develop, but it was worth the effort because it works. Now, we receive fewer than a dozen emergency calls a year about our equipment. When we started the business, after hours and weekend customer problems were so common that we had regular shift assignments like a duty roster in the military. To pick our financial inventory we have tried to develop a similar analytical model that would weigh and compare known financial variables. We wanted to use data that, like the Fed's interest rate numbers, was so broadly available that it would at least be accurate. The other issue in an operating inventory business — besides deciding what to buy — that causes partnership divorces is the accuracy of the accounting. If the numbers are not real, you have problems.

I have no idea whether our financial test bench model does any better than chance. We have made money so far this year, but that could be nothing but luck. Common stocks are not wireless equipment; there is nothing you can put your hands on. There is no transmission test you can run to see if the thing actually works. What the model does give us is the comfort of knowing that decisions are being made with consistency. We know that its decisions tomorrow and next month will use the same logic that was applied this time last year. That is the best we can do. I can only hope that it is enough to help us keep at least some of the money.

"How do you make a small fortune in the stock market?" asked the straight man.

"That's easy," replied the top banana. "Start with a large one."

Go Big Brown.


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