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SKARBECK: How Grace stayed patient under pressure to sell

April 3, 2010

Ken Skarbeck InvestingIn my last column, I shared the beginning of the amazing story of Grace Groner, who invested $180 in Abbott Labs in 1935 and never sold the stock.

When we left, we were trying to imagine a few of the many obstacles Grace might have encountered as her initial investment grew into $7 million over 74 years.

We were speculating how Grace may have felt in late 1987, 52 years after her original investment, with her stock now valued at about $200,000 after suffering a $100,000 drop during the Black Monday market crash.

Perhaps a friend had encouraged her to seek the advice of a financial consultant to help her with her concerns. The consultant may have presented Grace a portfolio of diversified mutual funds that would exchange her large investment in one company for smaller investments into hundreds of companies.

Slightly disturbed by the steep drop in value of her holding, she may have conducted a simple analysis of the pros and cons of diversifying out of Abbott. Grace knew that if she sold, she would pay over one-quarter of her investment’s value in taxes. She also knew there would be costs to manage the funds.

If Grace could have reviewed mutual funds like investors can today, she would have been aided by rules that require funds to present projected fees in a table near the front of their prospectus. For example, one locally managed mutual fund shows that—based on their annual fees and assuming a 5-percent annual rate of return in the fund—a $10,000 investment could expect to incur $1,838 in fees over a 10-year period.

Grace would have likely weighed the tax costs and fees against the performance of both her Abbott stock and the mutual funds. And, in her case, she would have concluded that these “frictional” costs were a significant hurdle to overcome for the sake of diversifying her investments.

Grace surmised that the prospects for Abbott were still good as long as the U.S. economy progressed over the long term. Also, few mutual funds had track records that approached the long-term performance of her Abbott stock. But she also knew there were no guarantees going forward; the market crash had made that clear.

She did derive great comfort in that, over the years, she had come to understand Abbott’s business. She had learned about the business by taking a couple of hours every four months reading through Abbott’s financial filings. Grace even used a few simple methods of valuation that gave her a ballpark value for the entire company, using conservative multiples of earnings, cash flow and calculated growth rates to track her estimates of Abbott’s business value.

She knew that, often, the stock price would not agree with her calculated value—that in the short-term, stock prices can be influenced by the manic-depressive behavior of the stock market. Her calculation of intrinsic value for the business was similar to what an informed private owner might pay to acquire the entire company. Sometimes, when she checked, Abbott’s price was well below her calculation of value; other times, the stock price was ahead of itself. But, as long as the business was progressing, she figured her net worth would rise.

We’ll continue this tale in two weeks, as Abbott and the stock market were just getting warmed up for Grace. After all, the roaring 1990s were just around the corner.•

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Skarbeck is managing partner of Indianapolis-based Aldebaran Capital LLC, a money management firm. His column appears every other week. Views expressed are his own. He can be reached at 818-7827 or ken@aldebarancapital.com.

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