Ayn Rand wrote an influential book, Atlas Shrugged, in the '50s that seems to resurface in popularity with each new wave of government intrusion on the lives of our overregulated, overtaxed citizens. The book describes a world that was on a slow but steady path toward ever more central planning by meddling bureaucrats interfering with the entrepreneurial class who relied on one another for their production of output. As the pages of the book are turned, this "road to serfdom" (a phrase I borrow from Friedrich Hayek) reaches a peak with the last of a small subset of productive entrepreneurs dropping out of their respective professions and sealing themselves off in a secret location created by John Galt. Their isolation from government interference in Galt's secret hideaway was designed to allow this subset of creative, hard-working individuals to pursue their dreams and live in a rational way, trading value for value with one another. The vision of Galt in his hidden refuge is consistent with the Ayn Rand objectivist philosophy that she advocated her entire life as an immigrant to America from the Soviet Union.
Rand never wrote a sequel to Atlas Shrugged, but I wonder where she would pick up after the first novel ends. We're left with John Galt and his band of entrepreneurial cohorts waiting to eventually reenter the failed utopia created by central planners. Taking a peek out of his libertarian lair, I wonder what Galt would think of America today. Some of the current dismal economic statistics seem consistent with the world Ayn Rand created in her fictional novel. The latest Census Bureau figures show a larger percentage of people receive some form of means-tested public assistance than work full-time. Would this be a rock-bottom entry point where Galt and his band of entrepreneurial cohorts can once again return to the world and begin rebuilding America based on principles of limited government and free markets? Not quite yet. One last worn-out shoe has yet to drop: the U.S. stock market.
Unlike the beaten-down real economy, activity on Wall Street continues to flourish. Large banks and their institutional clients have benefited from the artificial stimulation promulgated by the Federal Reserve. By keeping interest rates near zero percent for the last five years, middle-income families receive next to nothing off their life savings, while institutional clients can borrow money at bargain rates from large banks. In a classic example of crony capitalism, banks have rewarded their institutional clients with cheap loans, enabling them to use borrowed money and speculate on stocks, driving valuations to levels not seen since before the bank bailout in 2008. The governor of the Bank of England recently commented that "banks operated in a privileged heads-I-win-tails-you-lose bubble."[i] I believe Galt would be disgusted at this unintended consequence of government intervention that is driving a wedge between the elite on Wall Street and the average American struggling to make ends meet on a beleaguered Main Street. If Galt were a stock investor, would he trade in some of his gold for fiat currency, cozying up to this collection of institutions buying large-cap stocks on margin? At these nosebleed valuation levels, Galt would probably "flip the bird" at Mr. Market before sliding back into his hidden sanctuary until greener pastures emerged in the equity investment arena. Galt strikes me as the kind of independent investor that would keep his libertarian powder dry until the current statist experiment ran its complete course, waiting patiently to scoop up the right kind of stocks at a great price. Assuming the skeleton infrastructure of an organized stock exchange still remained on the day of Galt's return to the investment arena, what stocks would he select from the rubble left on the corner of Broad and Wall? A review of the character's profile might give us a few clues. Let's go through a few stock categories I believe John Galt would avoid. Buying large company stocks would probably be out of the question for Galt. In the recent past, these stocks were the economic football the large institutions speculated on with borrowed money. As already mentioned, savers deposited hard-earned money in their bank accounts and received close to a zero percent interest rate, while money was loaned out in a speculative frenzy to the bank's institutional buddies. Adding insult to injury, not only do retirees earn about the same interest rate as preppers get off of canned goods stored in their bomb shelters, their principal is being debased from continuous quantitative easing by the Federal Reserve. The stench coming off this large-cap football used by highly leveraged institutions in stock speculation would be too much for Galt to muster a bid order.
Another category of stocks that Galt would pass on is ones that don't pay a dividend. In the novel Atlas Shrugged, transactions in Galt's hideaway took place in gold. The investment world Galt would be reentering operates on a chassis of fiat currency. Holding paper financial assets that provide no dividend income strikes me as far too risky for someone used to trading value for value in gold. It seems natural that somebody returning to a world he once abandoned would be cautious about investing in it. Who knows how long it would take before the stocks Galt purchased would recover from the wreckage of a centrally planned economy? In the meantime, receiving a steady stream of dividend income on any new stock purchases would be a must for a guy used to living in a hidden location that used gold as the currency of the realm.
One last group of stocks would be screened out by Galt. In Atlas Shrugged, Galt dropped out of a world contaminated with bureaucrats interfering in the affairs of men. He was left with no choice but to abandon everything and encourage others to choose the same path. In his mind, everything Galt left behind was worthless. This perception of a valueless asset not only included land and buildings, but stocks and bonds as well. If Galt returned, he would be extremely conservative on the price of any stock purchased that only yesterday was perceived as worthless in his mind. Any stocks trading at a share price above liquidation value would be off limits to Galt.
If liquidation value is the cutoff on a stock purchase price for Galt, how do we calculate that figure? In term of analysis, we'll use Benjamin Graham's current-asset value as our proxy for liquidation value. The calculation is made by subtracting all liabilities - including preferred stock - from the most liquid assets on a company's balance sheet, and converting the figure to a per share basis. This measure of liquidation value is a good estimate of what shareholders would receive if the company were dissolved and sold off into pieces. A good rule of thumb for Galt would be to only purchase stocks if they traded at a price point below Benjamin Graham's measure of liquidation value or current-asset value.
So that's the laundry list of buying criteria that I believe Galt would use if he rejoined the general population and bought stocks. The John Galt from Atlas Shrugged strikes me as an independent investor, taking equity positions in only smaller companies unhindered by the previous shenanigans pulled by the masterminds on Wall Street. His stocks must all pay a dividend, offsetting some of the damage of losing purchasing power during the holding period as his fiat currency continued being debased all around him. The price paid for a stock must also trade below liquidation value, using Benjamin Graham's definition of current-asset value. Buying stocks valued at a sticker price worth not much more than a discarded cartridge from an e-cigarette vaporizer, the modern-day version of the cigarette butt, seems about right for Galt.
The performance of stocks purchased using the Galt buying criterion is summarized in the chart below. It shows the percentage of stocks in each return category following his filtering criteria.
Galt Stock Portfolio Criteria:
- Small-cap stocks trading with a market cap in the range of $25 million to $250 million in 2002 dollars.
- Paid an annual dividend over the previous 12-month period.
- Purchased at a price point below 75% of Benjamin Graham's liquidation-value criterion.
*All stocks that met John Galt selection criteria were from 1951-2009 and held for one year.
As indicated on the graph, over the last 60 years, the Galt criteria produced mainly winning stocks, assuming a one-year holding period. Close to 80% of all stocks in the Galt portfolio turned out to be winners. Not a bad score sheet for someone who, in the recent past, lived a quiet life hidden from the world of high finance. According to one academic study, most rank-and-file investors can't boast of those kinds of performance stats.[ii] Based on sound logic and not some form of wishful thinking, I like to think Ayn Rand would be pleased to see how many winning stocks were in the Galt portfolio.
In my next blog posting, I'll take the analysis a step further and compare the Galt portfolio performance to both a large- and small-cap index fund. We'll see whether a portfolio based on the Galt stock selection criteria translates into superior performance over the long haul relative to an index fund.
"Money is only a tool. It will take you wherever you wish, but it will not replace you as a driver." - Ayn Rand
[i] Speech given by Mark Carney, Governor of the Bank of England. Conference on Inclusive Capitalism, London, England. May 27, 2014. Page 3.
[ii] Brad M. Barber and Terrance Odean. "Trading is Hazardous to Your Wealth: The Common Stock Investment Performance of Individual Investors." Journal of Finance 55, No. 2 (April, 2000): 773-775.