by Andrew Beattie
Great investors tend to find one thing they are exceptionally good at and stick to it. Donald Trump has real estate, Warren Buffett has value stocks, and Jesse Livermore knew momentum. Thomas Rowe Price, Jr., mastered a new type of investing with every new market he faced - and he did it to make money for his clients rather than himself. In this article we will look at the visionary career of Thomas Rowe Price.
A Mad Scientist
Price was a chemist by training, but he found the lure of finance too much to resist. After a very brief stint as a chemist and two false starts at brokerages that went under, Price found steady work at Mackubin, Goodrich & Company (now Legg Mason (NYSE:LM)). He worked his way up to become the firm's chief investment officer even though he was in constant conflict with the company's management.
Famously abrasive, Price disliked having to produce research for stocks the firm was issuing, seeing it for the conflict of interest it was. Price felt investment advice should be offered for a fee and not bundled together with commissions. He was also trying to convince his superiors to try his growth investing strategy, and their resistance eventually led to him leaving to start his own firm in 1937.
The Father of Growth Stock Investing
The heart of Price's growth stock investing strategy was the belief that stocks were like humans: they went through phases of life. For stocks, the phases were growth, maturity and decline. Price saw that stocks in the growth stage would offer the best returns of the three stages. This was a big idea at a time when old rail, steel, oil and other blue chip stocks were the bedrock of almost every investing strategy.
Working with two partners, Price began searching for young companies with big earning potential. In the doldrums of the 1930s, he picked companies like Coca Cola (NASDAQ: COKE), Proctor & Gamble (NYSE:PG) and IBM (NYSE:IBM) over big stocks in rail and shipping because he saw these sunset industry companies hitting an earnings peak and entering their old age. He was, however, willing to take growth from mature industries spinning off divisions with new products like plastics and air conditioning. Unfortunately, many of these companies were prematurely aged by outside factors such as heavy government regulation and legislative risk - this was the era of the New Deal.
Tweaking the Formula
It took years of tinkering before Price had the right formula for his investing alchemy. He added new criteria for growth stocks: They had to be in industries with minimal government regulation, lack cutthroat competition and produce a superior product. But above all, Price was absolutely firm on the earnings. He would not buy without earnings increases of at least 100% over the previous 10 years. Price and his partners were focused on finding good companies early on and sticking with them as long as earnings continued to grow. If these companies showed signs of maturing, Price would sell.
Creating the No-Load Fund
Price was producing outsized returns by the 1950s, but he wanted to expand to handle smaller accounts for smaller investors. Remembering his early mistrust of commissions, Price created the T. Rowe Price Growth Stock Fund. It was a no-load fund with no sales commissions and a 1% redemption fee to encourage long-term holding. In return, Price's firm avoided the costs of hiring a sales force to flog the fund's shares. Price would, however, often test issues before putting them in the fund. He would buy for himself, then his wife, and then put them into the fund. This is illegal nowadays and probably would have gotten him charged by the Securities and Exchange Commission (SEC) for front running, but it was Price's version of eating your own dog food.
Price's strategy kept outpacing the general market and gained the attention of pension fund money. Pension funds were a relatively new force on the market and they moved to the managers with the best records. With the top-performing no-load fund in the industry, more and more money was being funneled into the firm. Price converted his three-man partnership into a proper corporation and grew to match the inflows.
Inflation Clouds the Horizons
Unfortunately, Price's own popularization of his strategy in articles and pamphlets, combined with his stellar results, brought others into the growth-investing circle. This forced Price to look at smaller companies earlier in the growth cycle in the hope of keeping ahead of the competition. The economy had also started to change; with the gold standard abandoned, Price lost his faith in growth stocks' ability to outpace inflation. Worrying more about inflation and needing more growth to outpace it, Price started the New Horizon Fund, aimed at picking the best small companies long before they could be identified as traditional growth stocks.
It was derisively nicknamed the "Horizontal Fund" because it languished behind the market for two years, but hit its stride in 1965, jumping 44% while the S&P 500 only managed 12%. In fact, the New Horizon Fund put together the best 10-year return of the fund industry. The new interest in even the most risky growth stocks sent the earnings multiples higher and higher on potential buys, worrying the chronically worried Price. The performance cult had pushed fundamentals into the corner and started jumping on momentum, driving the market dangerously high.
A New Era
Eventually, Price saw that even early-stage growth stocks would not be enough to head off inflation. He changed his strategy and pushed for an inflation-hedge fund that would load up on commodities. But Price was no longer the principal partner in a small partnership - he was now a fund manager within a large corporation. Price's abrasiveness and lack of tact didn't help matters, so his fund got started late. It was named the New Era Fund. Again, it was a slow starter until the stagflation Price had been waiting for hit. Then Price was once again at the forefront of the market, beating out many of the funds he had helped found at the firm.
A Slow Starter, But a Great Finisher
New Era was Price's final innovation. He passed away in 1983, just as a bull market was forming; his former funds and firm would be at the forefront of this charge. Price had a gift for seeing around the next curve and the intelligence to tailor his investment strategy for what came next, whereas most of his fellow fund managers were reacting afterward. He went after growth when Wall Street coveted safety, switched to small growth companies when Wall Street started in on the big ones, and jumped into commodities and inflation hedges when Wall Street was piling into securities of all types. He will remain an inspiration to contrarians as well as a high mark for all other fund managers to measure themselves against. Much like the game show, Price was often right.
