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Page 1 of 265 90% off but is it a bargain? A few days ago I was in a store and I discovered to my delight, a 90% off rack. I have never in my lifetime seen such a thing and I was very excited at the prospect of finding a bargain. I kept stopping people to point it out but they, unlike me, were no longer surprised by the high level of discounting – the store was filled with 70% and 80% off racks and 90% to them was just another number. I finally found someone to comment on it, a salesperson. I told her “I have never seen a 90% off rack”. She replied “ yes, it’s just this one and we’re losing a fortune on these items.”. All the better for me, I thought like the big bad wolf. I looked them over and noted the decline in prices – one jacket had started its life at $1695, then was marked down to $1019, again at $999, then $699 and finally rested at $499. With 90% off, it was now selling for $49.90 a total markdown of 97%! As I stood in line to try on these bargains, a lady in the line made a comment that I would like to explore: “ but what was the markup originally?” she asked when I commented on my surprise at 90% off. This got me thinking about mark-ups and mark downs and pricing in general and how it applies to the markets (and jackets). In this case, the markup really didn’t matter because there was no way this jacket cost $50 to make, ship and store in the retail outlet. The fabric, sewing and design would have gobbled up at least the $50 current price. Shipping, sorting and inventory costs would have added to that number even in an optimistic environment. I figure the minmum this jacket could have cost all in was $100-$150. So, at its peak of $1695, the markup was huge, if my calculations are anywhere on the ball. But that is the problem. I don’t actually know what the jacket cost to make and I don’t know how far off the mark the original price was. So we get back to where we always get to – price is a function of what someone is willing to pay at the time for the item in question. The stock market over the past few years is very similar to this jacket. It had a huge markup. Everything was booming and when it came down , in many cases, stocks dropped 50-75%. Earlier this year, people were, on average, not willing to pay anything for assets even though they were on the sale racks. They just didn’t want them. In March, when all the pessimists were calling for the final meltdown, I figure the S&P was trading at around 8x the reduced earnings outlook for the next year. But, like the jacket’s cost, I can’t know for sure. In the past, the low on the market valuation has been at 6.6x with hindsight. Of course, at the time of the exact low we don’t know the price of the earnings, and can only guess what the earnings may be under a variety of scenarios. It is only with hindsight that we can see that the market usually bottoms around 6.6x historically. The two things we don’t know at the time are the earnings and the price we should pay for them. And, that’s basically everything we need to know! Since that is everything we need to know to buy the market, we don’t buy it. At the time, like the shoppers in my store, we figure 90% off isn’t such a great deal. But stocks are not wasting assets like a jacket in a store. They are growth assets and become more valuable over time especially with inflation and we must remember this. So, I am going to go out on a limb: I would like to state that I know for sure that the earnings for 2009 will be very bad . And, I believe the price we will eventually pay for them will be around the 6.6x level or in the vicinity. The big question is when. But let me finish this blog with the piece de resistance. I was so happy with my 90% off purchase that I actually returned to the same store get more unbelievable bargains (greedy consumer that I am). When I got back into the store, not only had the 90% off rack disappeared as well as the 80% rack but the exact same jacket that I had purchased for $49 was now priced at $350 just 3 days later! I would like to make one comment about this story: it is infinitely easier to price something like a jacket than intangibles such as stocks, bonds or other financial assets. But even with a tangible item that can more easily valued, I noticed a certain psychological argument going on in my head: - If this jacket is worth so much, why hasn’t anyone else grabbed it?
- What if I am paying too much? (crazy but I did think it)
- What if it goes down further in price? I might get a discount of 99%, for example.
- Is it really worth $49?
Although all these thoughts sound completely crazy in hindsight and in view of the immediate increase in price of the jacket, I really did think these things as I was waiting in line. The comment by the lady in line, shook my confidence in my judgment severely as I considered the possibility that the real value of the jacket was something I could not really pin down and it could actually be worthless and only a fool would buy it. There are many lessons in this life experience. One is that we never really know for sure everything about the things we are buying and we may not even know the really important things enough to make a proper judgment but when something is down 90% and you can use it, it’s probably a bargain. Second, is that psychology plays the biggest part in buying bargains and this makes it doubly hard to go against the crowd at these times. But, truly great investors, do just that.
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