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- 1. G6 EZ EE KLMNO SUNDAY, MAY 18, 2014 Inflation-adjusted returns in the 1970s hit a loss of almost 75 percent. It was also different in the 1980s and ’90s: A universe of new technologies emerged — cellular, semiconductors, software, storage, micro-processors, Internet — that really were different. They created a massive new wealth when new industries were created. The investor who refused to buy anything over traditional P/E ratios — despite enormous growth rates and increasing revenue and profit — missed out on an era of generational wealth creation. Rates are now at unprecedentedly low levels. That’s a fundamental difference from the prior 30 years of inflation and yield on fixed income. There is a lack of competition from fixed-income products for your investment dollar, thereby making equity dividend stocks that much more appealing. This is a significant fundamental difference in the markets and valuation and prices. Distinguishing between the two is crucial. Identifying when things really are different and when the collective madness of the crowd is in full force is the difference between sitting out a 180 percent rally or participating in it. You are never different. But sometimes, the data is. The sooner people understand this, the better off their portfolios will be. Ritholtz is chief investment officer of Ritholtz Wealth Management. He is the author of “Bailout Nation” and runs a finance blog, the Big Picture. Twitter: @Ritholtz. pulled money out of the markets and sat on the sidelines. This time was different. Human nature is unchanging. During the boom, greed dominates. After the crash, the residual emotion is fear. Investors need to recognize when the economic environment really is different. In 1974, the P/E ratio of the S&P 500 was a low 7.33, but inflation was running at 11 percent and the 10-year bond yield was 7.4 percent. Were investors to ignore that different data? By 1981, P/E ratios were about the same, but risk-free yield of the 10-year was more than 15 percent. Some investors dismiss fundamental differences with a wave of their hand, often quoting Templeton in a misinterpretation at the same time. When fundamental factors are very different, it is worth noting. Those investors in the early 1970s who bought stocks because they were cheap were surprised when they got much cheaper. Looking at the booms, we see that phrase has a specific meaning, involving investors caught up in the frenzy of the moment. They allow greed to get the best of them. The collective psychology of the crowd leads to all manner of excuse-making and rationalization as people fall into the throes of a speculative bubble. I said the formula was two parts psychology; the first part takes place during the booms, the second after the inevitable bust. Greed is replaced by fear. Risk aversion occurs, as the recent past dominates investors’ collective mind-set. Indeed, since the March 2009 lows, I have been calling this “the most hated rally in Wall Street history.” Markets that are cut in half — as the major indices were — typically bounce back about 70 percent, and as much as several hundred percent. Earnings recoveries of 150 percent are hugely bullish for stocks. Low rates support higher equity prices. These things did not matter. Investors Initial public offerings were up 500 percent on their first day of trading. Many of these companies were merely a wisp of an idea, and not fully developed firms with real revenue and earnings. It was a new paradigm, and all about “eyeballs” and “clicks” and “registered users” and “first mover advantage.” Profit no longer mattered, despite a century of data that it in fact was the most important valuation measure. This time was different. Only, it wasn’t. Within three years, the tech-laden Nasdaq, where most of the high-flying dot-com, tech and telecom companies listed their stock, fell nearly 80 percent from the March 2000 peak. Fourteen years later, the Nasdaq remains 20 percent below its 2000 high of 5,100. The same can be said of the more recent subprime credit bubble and housing boom. Despite millennia of lending based on the credit worthiness of the borrower, the new metric became the ability of the lender to sell the debt to a third-party securitizer. Traditional measures of median home prices to median income moved almost three standard deviations above normal. Traditional metrics said housing valuations were historically high and unsustainable. They subsequently fell 35 percent nationally. The investor psychology of the credit bubble was simply to ignore the traditional metrics. Underwrite that mortgage to an unqualified buyer, buy that home despite the huge run-up in prices. History did not matter. This time was different. are many other factors that also impact valuation: economic growth, inflation, interest rates, cost of capital, investment options, etc. And there are countless variations of how to measure it. Last year, Merrill Lynch’s quant team looked at 15 metrics that measured equity valuation — but the basic formula is typically a version of price relative to a profit-related metric. As we have seen during various manias, basic valuation measures become disconnected from historical averages. During bull markets, P/E ratios often rise with the stock market. Multiple expansion was responsible for nearly 75 percent of market gains during the 1982- 2000 bull market. The Standard & Poor’s 500-stock index began that secular bull market with a P/E of about 8 and ended with a P/E of over 30. As the bull turned into a bubble toward the end of that 18-year cycle, P/E ratios soared. It was as if valuations no longer mattered. This leads to the second part of the math: Mean reversion occurs. Equity prices eventually revert to their long-term valuation measures. As prices fall, P/E ratios often careen far below that average when panic selling and margin calls force liquidations. Now let’s look at the psychology, which is especially fascinating. When it comes to risking capital in exchange for potential returns, human emotions are two-sided: greed and fear. Recall the dot-com bubble, when profitless companies soared in price. ritholtz from G1 Our last-ditch effort was to pack it into pints and sell it to the mom-and-pop grocerystoreswepassedonthewaytothe restaurants. That’s how we got into that business. Can you take me through your legend- ary marketing battle with Pillsbury? Greenfield: Sure. We had just started to package ice cream and sell it to grocery stores, and Häagen-Dazs had just been acquired by Pillsbury, so they were now owned by this large conglomerate. Our companyhadpartneredwithdistributors upnorthtostartsellingBen&Jerry’s,and most of them were carrying Häagen- Dazs. At some point, Pillsbury came to the distributors and told them to drop Ben & Jerry’s or they would stop selling them Häagen-Dazs, which was a profitable item for these distributors. So they were going to stop selling our products. We knew that trying to sue Pillsbury, a $4 bil- lion company, wouldn’t work, so, we de- cided to take our case to the people with a campaign called “What’s the Doughboy Afraid of?” We took out signs on buses and put an 800 number on our ice cream packaging. If customers called, they would get an answering machine message with Ben and me explaining the situation. And if they left their address on the machine, we would send them a mailing kit with a bumper sticker, and they could order a “What’stheDoughboyAfraidof?”T-shirt. It was this classic David-and-Goliath story, and it got picked up in the press, and eventually Pillsbury backed down because they were getting so much public pressure. That’s really what permitted Ben & Jerry’s to be distributed across the country. Eventually Ben & Jerry’s was sold to a large conglomerate, Unilever. How did that sale happen? Greenfield: It’s still not clear to us whether the company was approached or not. Our CEO at the time said he was approached, though he had quite an in- terest in selling the company because he was very incentivized with stock options. So he’s probably the only guy who really knows. Once that happened, though, sev- eral companies showed interest, and we got into a bidding war. Once the company was put in play, there was really no puttingthelidbackonthejar.Honestly,at points, it was excruciating. If you could go back to those small- business years and give yourself some advice, what would it be? Greenfield: I think we could have been more selective in chasing opportunities. We just felt so much pressure to go after so many different things when we started growing: new markets, new products. It’s hard to do things well when you’re trying to do so much so quickly. I would also put even more time into making sure we put the right people in place, ones who believed in our social mission but also had the necessary busi- ness skills. Those don’t always go togeth- er. And we knew that’s what would sepa- rate Ben & Jerry’s: Even more than the great flavors, it was important for us to make our social mission a central part of the company. jd.harrison@washpost.com seasonal business problem and the por- tion-control problem. I started by going around selling tubs to restaurants. I was transportingtheminthisinsulatedboxin the back of my station wagon — the idea being to drive fast, delivering as much ice cream as I could before it melted. I could only hold 16 tubs in that box, though, and we started selling more than that, so we bought a really old ice cream truck with mechanical refrigeration. I drove that for a while, but our delivery costs went up because the truck kept breaking down and would have to be towed back to the garage. enough of it. Cohen: Yeah, come winter, more mon- ey was going out than was coming in, and we didn’t really have any cash reserves. We weren’t making as much money as we had hoped in the summer, either, because wewereover-scooping.Wecouldn’tbring ourselves to scoop smaller portions, be- cause customers wanted the big scoops. Harrison: Is that what pushed you into the wholesale business? Cohen: Right. We thought we could drum up extra business by selling tubs of ice cream, which would solve both the ing in through the ceiling. Ben spent hours up there repairing it. So you’re the ice cream makers and the repairmen? Cohen: I had to. It was in bad shape, andwewereshortonmoney.Iwentbythe local newspaper, and they had stacks of thesethintinsheetstheyusedtoprintthe papers, and they would sell the stacks for 10 or 15 cents apiece. I would tack them onto the roof, with some tar to cover the holes. Thatworkedprettywellforawhile,but eventually it started to leak. So we put up this giant sheet of plastic across the top of the ceiling to catch the water. But then that started to sag. So we cut a hole where it was sagging and ran a hose to a sink in the back. Greenfield: It wasn’t exactly elegant. Cohen: Yeah, but it worked — until the thermostat broke one day and the plastic melted. The fire department came out, and we had to really fix the roof. How did you decide on the name Ben & Jerry’s? Cohen: I tried to be cute at first, play- ing around with ideas like Josephine’s Flying Machine, based on the old-timey song. Jerry said it was traditional for home- made ice cream parlors to be named after their owners, and he was right. We played around with Ben & Jerry’s, Jerry & Ben’s, andintheend,Ben&Jerry’sjustrolledoff the tongue a little better. So, we made Jerry the company president to make up for coming last. Greenfield: Not really last. Second. Cohen: All right, that’s true. Second. How did you learn the ins and outs of running a business? Greenfield: Honestly, we learned a lot from these little brochures that the Small Business Administration put out. They were 20 cents apiece, you could get them at the post office, and one would be about how to calculate your break-even point, another would be about how to manage your books. That was pretty much our business education. What about your hiring decisions? Greenfield:Itwascompletelyrandom. We didn’t really know what we were looking for, and we didn’t have any hiring skills. Sometimes it worked out, and sometimes it didn’t. Overall, though, the people we found were amazing, and some of them came up with some our best ideas. Our recipe for hot fudge, for exam- ple, basically the one we still use today, wasarecipeoneofourearlyhiresbrought to us. What was your greatest challenge in the first years? Greenfield: Money. We didn’t have BY J.D. HARRISON In summer 1978, two friends opened a makeshift ice cream parlor in a converted gas station in northern Vermont. Using a single fivegallon ice cream maker, they churned outbatchafterbatchofwackyflavorssuchasChunkyMonkeyandHeathBarCrunch.¶ In the decades that followed, Ben Cohen and Jerry Greenfield built Ben & Jerry’s into a legendary ice cream company, with more than 600 scoop shops in 35 countries around the world and annual sales now topping $500 million. ¶ And to think it all happened because one of them couldn’t get into medical school and the other couldn’t sell his pottery.¶Duringajointinterview,CohenandGreenfieldtookusbacktotheearlyyears at the company. What follows is a transcript, edited for length and clarity. ON THE MONEY BARRY RITHOLTZ Think this time is different? Take your temperature. Then check the data. ON SMALL BUSINESS The scoop on Ben & Jerry’s start How the numbers pile up. Is this time really different? Price/ Earnings 17.35 17.34 24.13 15.28 7.33 Price/ Sales 1.7 1.54 1.9 0.69 n/a 10-year yield 2.60% 4.02% 5.11% 8.07% 7.40% S&P dividend yield 1.85% 1.89% 1.23% 3.74% 5.43% 12 month CPI% change 1.50% 2.80% 3.40% 5.40% 11% TOBY TALBOT/ASSOCIATED PRESS ASSOCIATED PRESS Q. J.D. Harrison: How did you meet? Ben Cohen: Jerry and I met in junior high, when he fainted in gymclass.Itmadequiteanimpressionon me, and we quickly became friends. Some years later, I had dropped out of college and was trying to become a potter, butnobodywantedtobuymypottery,and Jerry had finished college and was trying togotomedicalschool,butnobodywould let him into their medical school. So I was delivering pottery wheels and working as a taxi driver, and he was a lab technician, working on rat brains and cow livers in a research lab, and neither of us really liked what we were doing. So we decided to try to start something together. Why ice cream? Jerry Greenfield: What Ben didn’t mention was that we were both fat, dumpy kids growing up, and we liked to eat. So we knew we wanted to do some- thing with food. We thought about a whole bunch of foods — bagels, fondue, others. In fact, we priced out bagel-making equipment from a used restaurant equip- ment supplier, but we realized it was more money than we had between us. When we found out ice cream would be cheaper, we picked ice cream. How did you learn to make it? Greenfield: We took this $5 correspon- dence course from Penn State. I think we splitit,paying$2.50apiece.Theysentyoua textbook in the mail. We read through the chapters, and all the tests were open book, so we actually did pretty well on those. How did you find your first location, in Burlington, Vt.? Cohen: We were looking for a spot that we could afford, and we came across this old, run-down, dilapidated gas station, across from the City Hall Park, that had parking where the pumps used to be. The roof had failed, though, and there was about four inches of ice on the floor inside. But, you know, we went with it because of the location. How did you finance the start of the business? Cohen: We were both supposed to come up with $4,000. Jerry came up with his $4,000, and I came up with $2,000, andthenImanagedtogetanother$2,000 out of my father. Greenfield: Then we got another $4,000 from the bank, so we started with $12,000. Our initial loan request was for $18,000,butbecausewehadsignedonlya one-year lease, they didn’t think that was very prudent. So they gave us $4,000, and we had to make it work. What was your next move? Greenfield: We had to start with the roof. I mean, you could see daylight com- Today 2007 2000 1990 1974 Sources: BLS, Damodaran DAN KRAUSS/ASSOCIATED PRESS Top, Jerry Greenfield, left, and Ben Cohen pose with their Scoopmobile in Burlington, Vt., in 1986. Middle: The orginal Ben & Jerry’s shop, a converted gas station in Burlington, draws a crowd in 1978, the year it opened. Above: In early 2000, a Ben & Jerry’s in San Francisco is mobbed by people who really don’t want the company sold to a major corporation.