Off the Beaten Path Book Reviews:
The Funny Money Game by Andrew Tobias
I have found a growing interest in researching past periods in our financial and economic history and what has laid the groundwork for what we know (and don’t know) today. Such interest has led me on some fascinating journeys that I would consider fruitful in developing a latticework model of thinking about the world. Who knew that starting with an interest in investing could uncover tales that weave between the history of statistics and probability, evolutionary biology, game theory, let alone the birth of financial economics.
Peter L. Bernstein wrote Capital Ideas in 1992 describing much of this birth of financial economics, which starts with the first chapter titled “Are Stock Prices Predictable?” However, before we can even tackle that thorny question, what caught my eye was something in the introduction of Capital Ideas. Bernstein quotes Stephen Jay Gould, an evolutionary biologist and popular science writer, to highlight the travails one faces exploring less travelled paths. It is the willingness to endure such travails that open up new fields of study such as the development of behavioral finance in response to efficient market theories.
In my own exploring, I’ve come to realize how much we utilize the idea of games to think about things. The study of games has led to the development of probability and statistics. Game theory as a study of strategy was formalized itself in the 1940s. The thorny question of stock price predictability uses mathematics that originally stemmed from studying betting strategies of the 1800s and ultimately based on Louis Bachelier’s work published in 1900 on the random motion of particles (i.e. brownian motion). Game theory even made it into evolutionary biology in 1973 when John Maynard Smith.
Sometimes, the game takes on a personal flavor. In a truly off the beaten path book, take the The Funny Money Game published in 1971 by Andrew Tobias. I originally found Andrew Tobias because he wrote a book titled The Only Investment Guild You’ll Ever Need. A book written right when the Efficient Market Hypothesis was taking shape and a new breed of financial economists were attempting to combine rational expectations and equilibrium economic models. The Funny Money Game was a rewarding read as Tobias spins a story sandwiched between graduating college in 1968 and entering business school in 1970. The Funny Money Game was a reminder of the shenanigans that occurred in public companies at the time versus the highly idealized world being developed by financial academics. Tobias by his own admission questioned many times why he didn’t blow the whistle on the company he was working for and ultimately questioning his own rational behavior. Rather it’s a story about the power of incentives, his stock options for example, and bounded rationality.
The Funny Money Game marked a time when corporations were using questionable accounting (i.e. pooling accounting for acquisitions) to promote the conglomerate synergy story. But it was also about the lack of corporate financial controls which allowed the backdating stock options, aggressive reserve accounting, and general management malfeasance. While the power of incentives seemed to be the driving force of the story, Tobias does provide some insight into what a rational investor should consider when he asked what an investor would pay for $1 of earnings? He asked if $3 was a good deal, the answer was yes … of course! At that time the market was paying around $20 of $1 of earnings. But what if the earnings are increasing at 300% a year, he asks. After two years $1 or earnings are worth $9. For his company, National Student Marketing Corporation (NSMC), investors were paying $100 or 100 times the earnings and expecting that kind of growth. The challenge as he explains is that NSMC wasn’t growing earnings organically at 300% but needed to acquire companies to reach those growth targets. Enter accounting shenanigans.
Tobias highlights the acquisition accounting trick in the acquisition of a target company by NSMC. Consider the target company with $2.5 million in sales and $100k in earnings (the same as NSMC) might have an estimated worth of 10 times earnings or $1.0 million. However, NSMC offers $3.0 million in stock at $100 per share. This will require 30,000 new shares to be issued, diluting NSMC shares from 100,000 to 130,000. However, combined earnings are now $200,000 with the acquisition or $1.54 per share versus $1.00. If the market continues to value NSMC at 100 times earnings, then there’s a possibility that the stock could trade up to $154. The power of incentives.
There is much more fun and shenanigans in The Funny Money Game including bad stock picks, questionable college major decisions, and noisy refrigerators. However, it is clear that this autobiographical sketch shows why there has been a shift over the past several decades towards the development of behavioral economics and frameworks for decision making. Despite being written almost 50 years ago, Tobias’ book was rather prescient in the challenges investors have in making decisions and why despite the fact the markets might be hard to beat, they don’t necessarily reflect that the price is right.
Where the path leads next from Tobias’ expose who knows. Maybe a look back at The Essays of Warren Buffett: Lessons for Corporate America as an offbeat book on the library shelf. Wherever it goes, it will be off the beaten path in search of new insights, new ideas to synthesize, and new mental models to incorporate.