Wall Street: One Hectic Week

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The classic way to gauge a stock's worth compared to its price is the price-earnings ratio, i.e., its market price in relation to profits per share of the company. In the late 1920s, Al Smith's good friend John J. Raskob, who then functioned simultaneously as an officer of Du Pont and General Motors, shocked the investment world by allowing that under favorable circumstances a stock might be worth as much as 15 times earnings. (Despite this bullish tenet, Raskob, like the President's father, Joseph Kennedy, saw the 1929 crash coming; unlike Kennedy, he did not sell short soon enough to make a killing.) Raskob's 15-times-earnings ratio became an accepted rule of thumb almost immediately, but the unfavorable circumstances of the Depression pressed the ratio down. As late as 1950 there was little to worry about: stocks in the Dow-Jones industrial index were underpriced, selling at a rock-bottom six times earnings.

Then, with the Korean war, a new boom-and-inflation cycle set off the roaring bull markets of the '50s. The war itself sent the Government on a buying spree, and the cease-fire released a burst of dammed-up consumer demand for cars, houses, appliances. Its confidence bolstered by Dwight Eisenhower's election, business began to expand. As the economy reached new highs, big wage hikes were followed by still bigger price rises. The real value of the dollar went down by 3∧ every year.

Rising in the Red. In this ebullient atmosphere, a new generation of younger and less sophisticated investors (and investment counselors) flocked into the market. Few of these investors had ever sweated out a serious market tumble.

Most of them bought stocks not to collect dividends but to multiply their capital and thus protect their savings against inflation's ravages (those who hung on to war savings bonds lost more by the decline of the dollar than they made on interest). The new gamblers thought they were in on a sure thing if they picked and chose correctly. The cold war and Sputnik would force the U.S. Government to spend lavishly on anything even vaguely related to defense; the population was going up, and to serve it the U.S. economy would boom as never before in the new decade that was being alliteratively billed as the "Soaring Sixties.'' Operating on these premises, the U.S.

investor bid stock prices up to giddy highs, concentrating particularly on producers of the new scientific wonders—transistors, computers and space-age gear.

At their peaks, such stocks as IBM. Texas Instruments. Xerox and Hewlett-Packard climbed to anywhere from 80 to 120 times earnings. Raskob was a piker. Some companies such as Itek and Farrington became glamour stocks even while they were still operating in the red. And as investors became more and more intoxicated by growth, the inflation in price-earnings ratios spread across the board, from speculative risks to the conservative blue chips. Such companies as General Electric. Johns-Manville and International Paper saw their stock prices rise even though their per share earnings failed to increase—or even declined.