“The real fortunes in this country have been made by the people who put their capital into a business that had a future, worked hard, invested more capital, and stayed with their investment throughout the years — depression and boom alike. Such names as Ford, DuPont, Rockefeller, Duke, Carnegie, Woolworth and many others that are well known to all. These names are legend. Fortunes are still being made this way and you and I can participate in their continued growth as their shares are available in the market.”
— Thomas Rowe Price, Jr, “What is a Share in a Business Worth?”, October 25, 1947
Many things in life are completely out of our control. Most fundamentally, the year of our birth is something that none of us had any control over, yet this biographical detail has an enormous impact on our lives. Those who enter the labor force in a robust economy do so with more ease. Even individuals with marginal skills and work ethic can find employment. Coming of age in a period of stagnation creates headwinds that only the determined will overcome. Just as importantly, the baseline psychology of an individual is drastically affected by the environment in which he or she is raised and gets started in life.
Warren Buffett often says that he won the “genetic lottery” of life in terms of being born in 1930 and brought up in a relatively affluent environment. Coming of age right as the post-World War II boom was getting underway clearly shaped his outlook and opportunity set. What if Mr. Buffett had been born thirty years earlier instead, right at the turn of the twentieth century? If he had been born around 1900, he would have come of age in the aftermath of World War I, experienced the roaring 20s as a young man, and then suffered through the subsequent crash and depression. One can argue that the generation of investors that came before Mr. Buffett had more headwinds to deal with and certainly lived through more challenging macroeconomic environments as they were getting started.
Most modern-day investors are familiar with Benjamin Graham and Phil Fisher, both of whom were born within a few years of the turn of the century. However, relatively few investors are familiar with the life of Thomas Rowe Price, Jr, who in his later years was recognized as one of the best investors of the century and known as the “Sage of Baltimore”. T. Rowe Price: The Man, The Company, and The Investment Philosophy by Cornelius Bond is the first-ever biography of Price and provides readers with a comprehensive understanding of the man and his investment approach. Bond worked directly under Price for nearly a decade during the 1960s, relatively late in Price’s career. From this vantage point, Bond provides his recollections and insights regarding Price coupled with the findings of research into Price’s earlier years. Although Bond shows a deep level of respect and admiration for Price, he manages to avoid veering into hagiography and presents a balanced and worthwhile view of Price’s life and his times.
Early Years Shape The Man
Benjamin Graham and T. Rowe Price were born within a few years of each other in the final years of the nineteenth century and both came of age around the same time, with the main difference being that Graham started on Wall Street in the midst of World War I while Price was still a student. Neither Graham nor Price chose to study business in college. Graham was such a gifted student at Columbia University that he was offered teaching positions in English, Philosophy, and Mathematics upon graduation. Price entered college intending to pursue a pre-med program but ended up earning a Chemistry degree from Swarthmore where he did not take a single class in business or economics.
While Graham turned down his academic job offers and opted to start a career on Wall Street, Price initially had no intention of pursuing a career in business. He initially obtained jobs in his field of study but soon became fascinated with finance while working for DuPont. Price found that he could pursue a career in a field that offered solid remuneration while also enjoying what he was doing. He entered the field of investing in 1921 at the age of 23 and witnessed the roaring 20s firsthand, albeit from the vantage point of Baltimore rather than Wall Street.
In 1925, Price joined Mackubin, Goodrich & Co, a small financial firm in Baltimore where he would spend the next twelve years of his career as market euphoria peaked in the late 1920s and then crashed in the 1930s. Unlike Graham, who lost most of his investments in the early Depression years, Price was at an earlier stage of his career and, fortunately, was not a partner in his firm.
In 1930, Mackubin, Goodrich & Co had significant cash flow issues that forced partners to liquidate securities to raise cash in order to keep the firm afloat. Price obviously observed this turmoil but was not forced to liquidate his investments. Price appears to have taken this as a lesson to avoid leverage based on a journal entry at the time:
“When once again we are in good times with rising prices and the public is clamoring for profits, BE SURE to point out the horror of a depression and BE SURE to state that the worst depressions come when least expected. If you are buying something which you cannot pay for in cash, you must be prepared to take losses.”T. Rowe Price, p. 54
Although Price took losses on his holdings during the early 1930s, he does not appear to have fallen into financial distress to the same degree that many of his contemporaries suffered. He also was able to hone his own investment approach and came to the conclusion that starting his own firm was the only way to pursue his passion for research and providing investment council.
Price came out of the depression without a gloomy outlook. He remained an optimist and this was a key factor that allowed him to pursue his approach to growth stock investing. Benjamin Graham emerged from the Depression to establish the school of value investing with its focus on the balance sheet and downside protection. Both men ended up posting excellent investment track records in the post-World War II years, albeit with diametrically opposed approaches.
The Growth Stock Philosophy
Price developed his growth stock philosophy over a period of nearly a half century starting in 1934 when he created a model portfolio while still working for Mackubin, Goodrich & Co. The idea of investing for growth in the midst of the Great Depression was a novel one, to say the least. At the time, investors were more interested in the return of their principal rather than the return on their principal. Price refined his philosophy over the years and published the following summary in 1973:
“A growth stock is defined as a share in a business enterprise which has demonstrated long-term growth of earnings, reaching a new high level per share at the peak of each succeeding business cycle, and which gives indications of reaching new high earnings at the peaks of future business cycles. Earnings growth per share should be at a faster rate than the rise in the cost of living, to offset the expected erosion in the purchasing power of the dollar. The goal is a portfolio of companies that will double earnings over a 10-year period. It is believed that dividends and market value would do the same.”T. Rowe Price, p. 97
The goal of holding a portfolio of companies that will double earnings every decade might seem rather modest to the modern reader but being able to compound at a rate of 7 percent is not a shabby result whatsoever. When combined with dividends, it is likely that such a portfolio would approach 10 percent annualized returns which is more than adequate for the success of any long-term investment program.
When one reads Bond’s chapter describing Price’s Growth Stock Philosophy, it is clear that elements of it closely parallel Phil Fisher’s approach. Price emphasized careful research including the type of “scuttlebutt” techniques that Fisher advocated. Price was a big believer in talking to management and making frequent visits to gain an appreciation for what makes a company and its leaders tick. He looked for managers who prioritized intelligent research that would foster a differentiated product strategy commanding higher than average margins. And although Price always kept his focus on growth, he did not ignore downside protection either. He insisted on strong finances that would allow a growth business to survive business downturns.
Once growth companies are found, Price believed in holding them for a very long period of time, often measured in multiple decades. Like all intelligent investors, Price did not view market fluctuations as “risk” but instead knew that the only risk that counts is permanent loss of capital which is usually driven by weak finances.
Price’s growth stock philosophy worked very well, allowing him to generate an enviable track record over a long period of time. From inception of the strategy in 1934 to the end of 1972, the growth stock strategy returned 2,600 percent, assuming reinvestment of dividends, compared to a 600 percent gain for the Dow Jones Industrial Average. The CPI rose 205 percent over this timeframe.
When to sell is a dilemma facing all investors, but particularly those who focus on growth stocks. Many of the greatest growth stocks always appear to be “expensive” based on traditional metrics used by value investors such as the price-to-earnings ratio or price-to-book value. Price believed in holding his companies for decades but also had an interesting policy that recovered his cost basis in a company while letting his profits ride:
“Once a position is established, if a stock then moved to a significant premium over what it is deemed to be worth, he suggested that the stock be sold until the total cost of the stock position, plus capital gains taxes, is realized. The profit, he believed should be reinvested in long-term government bonds, or good-quality corporate bonds for safety and income. The profit represented by the shares left in the portfolio should be allowed to continue to grow in value until the company matures and is no longer considered to be a growth company. These shares effectively have no cost.”T. Rowe Price, p. 106
On its face, this approach is not a rational one. If one deems a security to be overvalued, which implies that future returns will be sub-par and fail to approach returns achievable in other investments (or an index fund), one should logically sell the entire position. However, human beings have to grapple with our psychology and the fallibility of our analysis. We could be wrong about a company being overvalued. Many great growth companies are “overvalued” for their entire history by conventional metrics. A growth stock investor who adopts Price’s approach of getting their cost basis back might be able to psychologically handle leaving the remaining “house money” invested because it has “no cost”.
Of course, this type of mental accounting is not strictly rational. The remaining shares in the portfolio most certainly have an opportunity cost. They could be sold and reinvested. The market doesn’t “know” that you have retrieved your cost basis and are playing with house money. Yet, if this type of approach helps a growth stock investor to stay the course in promising companies through periods of transient overvaluation, perhaps that is a psychological trick that has some merit. Those of us who fall into the value investing camp are not likely to be comfortable with the house money concept but we should not easily dismiss its utility from a psychological perspective, especially for those with a focus on growth stocks.
A Different Era
It is impossible to read this biography without noting that Price and others during his lifetime operated by very different ethical standards compared to modern day Wall Street. The reason Price started his own firm in 1937 was primarily because he did not believe that the firm he was working for was focused entirely on providing investment council to clients but was instead always likely to view the world from a transactional perspective of a broker. Price wanted to forge long-term relationships with clients and had a higher sense of fiduciary duty.
The modest salaries taken by Price and others in his firm illustrate an ethos from an earlier time. In 1947, as his firm was regaining its footing after the war, Price paid himself an annual salary of just $12,000. According to the Bureau of Labor Statistics, this is equivalent to $134,000 in 2019 dollars. The other founding members of the firm earned just half of Price’s salary. By 1950, Price was earning nearly $23,000 in taxable income, or the equivalent of $241,000 in current dollars, a year that he referred to as “the most successful year in my business career from every angle.” At this point, Price was in his early 50s and at the start of an incredible run building his mutual fund business.
Until the early 1950s, T. Rowe Price & Associates was primarily focused on managing separate accounts for wealthy individuals and institutions. Several tailwinds in the 1950s, principally the fact that institutions started investing their pension funds in stocks, led to massive growth in the mutual fund industry. T. Rowe Price initially created its Growth Stock Fund as an ancillary service for existing clients and made it a no-load fund. Most funds at the time charged sales loads of five percent or more. Assets under management catapulted from $152 million in 1954 to over $1 billion by 1965 when Price began the process of selling his interest in the firm.
By modern standards, the $720,000 Price received for his interest in T. Rowe Price & Associates in 1966 seems microscopically tiny for a controlling interest in a successful asset management company. This amounts to only $5.6 million in 2019 dollars. Two years later, he sold his interest in Rowe Price Management, a firm that he established to manage portfolios of small growth stocks, for just $1.5 million, or $10.9 million in current dollars. Price earned significant wealth in his lifetime, but nothing like what modern executives in finance, many with no real skin in the game, earn in just a single year!
The life of Thomas Rowe Price, Jr. is well worth serious study and it is somewhat surprising that his first biography was written in 2019, 36 years after his death in 1983 at the age of 85. During his later years, he received the professional recognition that he always craved and was well known in the investment community as the Sage of Baltimore but in recent years his name is more likely to bring to mind the firm he founded rather than his growth stock philosophy and investment track record. That’s a shame because investors have much to learn from his life and approach to investing.
While none of us had any control over the outcome of the “genetic lottery” and, to a large degree, are products of our times, it is fascinating to read about how different people react to the same circumstances. Much of this, no doubt, has to do with temperament and personality. One gets the sense that Price was an eternal optimist. There is no doubt that this shaped his willingness to seek out investments with multi-decade time horizons even as the world was in the midst of depression and world war. Ben Graham lived through the same period and adopted a radically different, and much more skeptical approach. Yet both men did very well with their different approaches because they adopted styles congruent with their outlooks and personalities.
There are many ways to win in business and in life. Chances are that if you are reading this article, you are already a major winner in the lottery of life. There are truly unfortunate people in the world who have little opportunity based on the luck of the draw. Those of us fortunate enough to have built up capital to invest based on enterprise and hard work should bear in mind that we can pursue our activities through all sorts of economic vicissitudes knowing that following logically consistent and rational approaches will stand the test of time.
Disclosure: The Rational Walk LLC received a review copy of this book from the publisher.