The Devil's Financial Dictionary

This glossary of financial terms is inspired by Ambrose Bierce’s masterpiece The Devil’s Dictionary, which the great American satirist published sporadically between 1881 and 1906. (View free versions of Bierce’s text here or here.) Like Bierce’s brilliantly cynical definitions, the explanations presented here should not — quite — be taken as literally true. Some of these entries are adapted from articles published previously in Financial History, Money, and The Wall Street Journal.


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NEW ERA, n.  A period of investing in which, according to its proponents, the old rules no longer apply. Buying stocks on the basis of their past earnings and current assets is retro, square, obsolete, passé, so yesterday; instead, you should buy stocks whose future profits are unlimited. In this new era, there is no uncertainty about the future.

As Benjamin Graham and David Dodd wrote in their masterpiece, Security Analysis, in 1934:

The notion that the desirability of a common stock was entirely independent of its price seems incredibly absurd. Yet the new-era theory led directly to this thesis. If a public-utility stock was selling at 35 times its maximum recorded earnings, instead of 10 times its average earnings, which was the preboom standard, the conclusion to be drawn was not that the stock was now too high but merely that the standard of value had been raised. Instead of judging the market price by established standards of value, the new era based its standards of value upon the market price. Hence all upper limits disappeared, not only upon the price at which a stock could sell, but even upon the price at which it would deserve to sell. This fantastic reasoning actually led to the purchase for investment at $100 a share of common stocks earning $2.50 a share. The identical reasoning would support the purchase of these same shares at $200, at $1,000, or at any conceivable price.

An alluring corollary of this principle was that making money in the stock market was now the easiest thing in the world. It was only necessary to buy “good” stocks, regardless of price, and then to let nature take her upward course. The results of such a doctrine could not fail to be tragic. Countless people asked themselves, “Why work for a living when a fortune can be made in Wall Street without working?” The ensuing migration from business into the financial district resembled the famous gold rush to the Klondike, with the not unimportant difference that there really was gold in the Klondike.

 

A New Era The Klondike Gold Rush, ca. 1898. From the collection of the Library of Congress, http://www.loc.gov/pictures/item/2006690364/

A New Era
The Klondike Gold Rush, ca. 1898.
From the collection of the Library of Congress, http://www.loc.gov/pictures/item/2006690364/

 

The new era described by Graham and Dodd had peaked in 1928 and 1929, but it repeated itself seven decades later.

On Feb. 29, 2000, hedge-fund manager James J. Cramer gave a speech in which he urged investors not “to be constrained by that methodology” of trying to buy companies that have actual profits or physical assets. Money-losing but ultra-fast-growing Internet companies like Digital Island, Exodus Communications, and Mercury Interactive, he said, “are the only ones that are going higher consistently in good days and bad.” Saying that investors who seek to buy stocks valued at low multiples of their earnings or book value “have already gone astray,” he added: “You have to throw out all of the matrices and formulas and texts that existed before the Web. You have to throw them away because they can’t make money for you anymore…. If we use[d] any of what Graham and Dodd teach us, we wouldn’t have a dime under management.”

Eight trading days later, the NASDAQ index of technology stocks peaked. Digital Island, which had traded at $148 per share, fell to $3.40 by the time it was taken over in May 2001; Exodus Communications went bankrupt in September 2001; Mercury Interactive’s shares stopped trading on NASDAQ amid allegations of improper accounting.

By the end of 2002, $10,000 invested in these new-era stocks that were “the only ones that are going higher consistently in good days and bad” would have been worth a grand total of $597.44, a 94% loss in 22 months.

New eras were also declared in 1720 and 1844, among many other times. And there will almost certainly be at least one more declaration of a new era during your investing lifetime. So when you hear anyone tell you that the old rules no longer apply, remember the wise words of the great investor Sir John Templeton: “The four most expensive words in the English language are ‘This time it’s different.’”

 

NEWS, n. Noise; the sound of chaos; the reason the prices of investments move; the lifeblood of traders; often, the bane of investors.

It is almost certainly no accident that newspapers were first widely read in the coffee shops of Amsterdam and London, where crowds of overcaffeinated brokers waited to pounce on the news about (and brought by) the latest ship to arrive in the harbor.

As Joseph de la Vega wrote in his Confusion de Confusiones, the earliest known book on the stock market, published in Amsterdam in 1688: “the business in stocks and the bustle of the sales which are made when unforeseen news arrives is wonderful to behold.”

As one early analyst wrote in 1726: “Upon the Arrival of some Intelligence about the Situation of our Affairs, which we call bad News, these Views have been given over, and the Declension of our Stocks on that Occasion attributed to and accounted for only from that Intelligence.”

In a series of brilliant experiments conducted in the 1980s, the psychologist Paul Andreassen found that investors who received frequent news updates on the companies in their portfolios traded roughly 20% more often and earned less than half as much, on average, than investors who didn’t follow the news.

Keeping current on what is happening in the financial markets is not the same as knowing what will happen, as this classic front page reminds us:

The New York Daily Investment News, Oct. 25, 1929. The stock market fell 24% more over the ensuing three days and 86% before the crisis was finally over. From the collection of the Museum of American Finance, www.moaf.org

The New York Daily Investment News, Oct. 25, 1929. The stock market fell 24% more over the ensuing three days and 86% before the crisis was finally over. From the collection of the Museum of American Finance, www.moaf.org

No intelligent investor would stop following the news completely; you have no hope of succeeding unless you are well-informed and cultivate your curiosity about the world. But no intelligent investor succumbs to the temptation to track the news moment to moment, every day. The financial news is like sunlight: A moderate amount is essential, but excessive exposure is dangerous and potentially fatal.

 

NEXT, adj.  In the real world, likely to appear or occur in the near future; on Wall Street, unlikely to happen at all.

Every young Internet stock with a rising price will almost instantly be described as “the next Google,” every two-bit conglomerate on a hot streak will be declared “the next Berkshire Hathaway,” any stock with high expectations will be christened “the next Apple,” and every fast-growing retailer will be called “the next Wal-Mart.”

A Google search in mid-2004 for the phrase “the next Warren Buffett” turned up 135,000 results — highly impressive, especially when you consider that there are only about 700,000 investment advisers in the United States.

Because of REGRESSION TO THE MEAN, stocks and investment managers tend to look hottest just before they go cold. Thus, at the very moment when they are anointed “the next” something-or-other, it’s highly likely that they will turn out to be the next losers. The proportion of money managers predicted to be “the next Warren Buffett” who turned out to be even a shadow of him in the long run is approximately 0.001%.

As Peter Lynch, the great manager of the Fidelity Magellan Fund, wrote in his classic book One up on Wall Street:

Another stock I’d avoid is a stock in a company that’s been touted as the next IBM, the next McDonald’s, the next Intel, or the next Disney, etc. In my experience the next of something almost never is – on Broadway, the best-seller list, the National Basketball Association, or Wall Street. How many times have you heard that some player is supposed to be the next Willie Mays, or that some novel is supposed to be the next Moby-Dick, only to find that the first is cut from the team, and the second is quietly remaindered? In stocks there’s a similar curse.

The irony is that, after Mr. Lynch retired from active fund management, hundreds of fund managers were proclaimed to be “the next Peter Lynch.” None of them ended up amounting to a hill of beans.

If Mr. Lynch himself had a dollar for every article in the financial press that declared some whippersnapper to be “the next Peter Lynch,” he would be quite a bit wealthier.

Whenever you see or hear of a stock or a money manager that purports to be “the next” anything, the next thing you should do is forget about it.

 

 


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