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"Sardines" are to Trade, not Eat

February 10, 1999

One of the smartest businessmen I know, a highly successful wine importer, has done well in the stock market over the last five years.

He has doubled or tripled his stake in a few issues, and his portfolio overall has produced a higher rate of return than the family-run business for which he has slaved 60 to 70 hours per week since 1971.

So why has he been pruning his shareholdings recently and shunning hot tips from his stockbroker?

The answer, in a word, is value. Even under the most bullish assumptions share prices are currently too high relative to companies' foreseeable earnings, he says.

Indeed, the statistics should be sobering to anyone with a business of his or her own who has been trying to eke out a decent living after paying taxes.The average share of an S&P 500 company now sells for more than 30 times earnings and for Nasdaq-listed firms the figure is closer to 90.

I doubt that any of those companies are run more aggressively or efficiently than my friend's. He does brisk business with vintners in a dozen countries, including France, Italy, Germany, Chile, Australia and Israel.

Moreover, it is often they who seek him out and not the other way around, so formidable is his firm's reputation for securing premium shelf space at high-volume retail outlets and prominent placement on the wine lists of top restaurants and casinos.

Even so, my friend readily concedes that if a corporate behemoth like Seagram's or Diageo offered to buy his company for a relatively modest fifteen times earnings, he would take the money and run. So, I am certain, would many other successful business owners.

Yet most of the small-businessmen I know are on the phone with their brokers nearly every day, bidding for shares in companies that often sport outlandish earnings multiples or that have no earnings at all.

In neglecting to apply the same hard-headed logic to the stock market that they bring each day to their own companies, are these investors succumbing to the mania that has swept up millions of shareholders who can't even read a balance sheet?

Probably, yes. In fact, businessmen are probably even more susceptible than the rest of us to the lure of easy money in the stock market.

After all, they are ardent capitalists and therefore firm believers in the principle of letting their money work for them. They are also entrepreneurs with an abiding faith in the economy and a pragmatic optimism about the business of America.

So why is my friend, who shares these traits and has prospered enviably by them, inclined to view the stock market as a crapshoot at current levels?

The answer may lie in the wine business itself and the way that inventories are handled.

As it happens, there is currently some speculative froth in high-quality wines, particularly estate-bottled vintages from California, France and Italy. It is not quite such a mania as we have witnessed in Internet stocks, but prices have nonetheless risen faster and higher than at any other time in the history of the wine business.

For example, at the importer level, a case of Puligny Montrachet has doubled to $200 in just 18 months. Chianti Classico Riserva that once sold for about $75 a case is now $150.

Some of the rarest wines have appreciated even more spectacularly. Chateau Clinet Pomerol 1966 vintage, for one, has gone from $66 a case in 1968 to a current $2,000.

At current prices, importers are beginning to smell a bust. They reason that any downturn in the economy of the United States, where wine demand is strongest, would strand sellers with pricey bottles that they could not sell for a profit.

It happened in the early 1970s, when the market for Bordeaux and Burgundy wines collapsed. At the time, marketing research had convinced French vineyard owners that Americans were about to increase their wine consumption significantly.

Not only was their optimism premature, the wine itself was of merely average quality for several years. This delivered a double blow to importers and wholesalers, who, trusting the marketing forecasts, had recklessly overstocked their warehouses with superpremium grape juice.

The result was a 50% price collapse in 1974-75, when some great wines were sold in the liquor stores for less than half what the trade had paid for them.

Wine sellers evidently learned an enduring lesson about illiquid markets -- no pun intended -- and that is one reason they are reluctant to stock up on $100 bottles of Chianti these days.

Today's stock market investors clearly do not share such concerns; otherwise they would not be bidding hundreds of times earnings for a stake in companies that have yet to earn a profit.

If share buyers do not yet see themselves as prospective bag-holders, they probably are not as attuned to the nuances of supply and demand as wine vendors and they are evidently harboring the illusion that it will be easy to unload shares before a bear market can get rolling.

That is too dangerous a game for my friend, who sees an analogy in the joke about the wine importer who bought a hundred crates of sardines for 50 cents a can, thinking he could make a killing. First time around he did just that , selling the entire shipment to a supermarket chain for $1.00 a can.

The next time, he bought twice as many sardines for 75 cents a can, again selling them for a hefty profit. But when the buyer opened a can, tasted the goods and found them inferior, he called the next day to ask for his money back. The erstwhile wine importer replied, "Those sardines aren't for eating -- they're for trading!"

Investors should pay heed, since the day may soon arrive when their exorbitantly priced trading stocks will have to be eaten.

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