Investment results are easily measured on an absolute basis. Because they are so easily measured, academics, financial advisors, asset allocators, consultants, individuals and a host of others have devoted a lifetime to scrutinizing the results of others. They look to analysts, portfolio managers, the various public and private enterprises, and the markets in an attempt to find a person, some identifiable trait, or a methodology that can be replicated to produce superior returns. For many, the search continues, while others have ultimately decided that if this skill exists, it is not worth the effort to find it, and they just buy enough differing investments and hope to be in the right place at the right time.

Which brings me to this month’s story of Gulf Oil and Mr. T. Boone Pickens, Jr. In the early ’80s, I can say it was a wonderful time to be a financial adviser, a term used today for the majority of security salesmen, but in those years, not yet invented. Interest rates were at an all-time high. Banks and Savings and Loans were still under the rules of Regulation Q which imposed restrictions on the maximum amount of interest payable on time deposits and prohibited the paying of interest on demand deposits. At the same time, bonds and money market funds were paying double-digit interest rates. Making a living selling these fixed-income investments was easy as the demand was high with minimal competition.

As for common stocks, the demand was beginning to return. The memories of the great crash in the early seventies were weakening, the short recession of 81 to 82 was over, and the prices of common stocks were once again moving higher. Having paid little attention to common stocks, I began in earnest to develop some level of skill needed to include common stocks in the quiver of options available to my clients. The small broker-dealer I was working for had no research department, nor the desire to provide assistance, so I was forced to learn the old fashioned way, through reading the work of others and finding stocks to recommend by pouring over the data included in the S&P Stock Guide. In addition, I relied on the analysis provided by the Value Line Investment Survey. 

While doing this data mining, Gulf Oil stood out to me. I wish I had retained my notes from that period of time, but unfortunately, they are long gone. I don’t remember exactly what made Gulf Oil stand out. It may have been a dividend yield, a price-earnings multiple, a book value, or just the fact that oil prices had declined substantially in the prior year after their huge run-up over the past decade, and the world of mergers and acquisitions of oil companies was in vogue. Whatever it was, it was enough to encourage me to buy shares. 

It wasn’t long before Boone Pickens came along and gave us his gift. Mr. Pickens was well known at this time as a man who started a small company with $2,500 and over the next 30 years turned it into the largest independent oil company. He was known as a corporate raider, a greenmailer, and according to some, a piranha. Well, the piranha decided he would devour Gulf Oil. By the time the job was complete, the shareholders of Gulf Oil received a $6.5 billion dollar boost to their net worth. Never at the time did I hear him called a champion of the shareholder. Yet, for us, he was. If I recall correctly, we made a profit exceeding 50%. It may have been less, but I know that at the time it was the single greatest return I had experienced from a common stock. 

Being quite naive I automatically assumed the results reflected my great skill as a stock picker. Not only could I find a great investment from a list of 5000 individual companies, but I had the ability to time the purchase perfectly!

A few years later, Mr. Pickens’ autobiography Boone was published. This is how he described Gulf Oil at the time of our great analysis:

On Wall Street, Gulf’s reputation was even worse. Between 1978 and 1982, its U.S. reserves had dropped by an astonishing 40%:600 million barrels had been depleted and not replaced. The only thing saving Gulf was OPEC.

          It was deeply involved in the uranium business and had a major price-fixing lawsuit. It also owned a uranium mine in New Mexico which had lost a billion dollars. It also had weak refining and marketing, a money-losing chemical operation, and so on. Although its underlying assets were worth more than $100 a share, the all-time high for the stock was $53 during the pseudo-boom of 1980-1981 and was now anchored in the high $30s.

          With Gulf’s reserves in a steep decline, there was little chance the stock would ever go above $40. And now that oil prices had started to come down, Gulf was a dead duck. By the time prices rose again, the reserves would be depleted. In the middle of the Gulf deal, a financial magazine published a survey that ranked more than a thousand companies in terms of profitability, growth, and stock market performance; Gulf placed in the bottom third in all three categories. But management couldn’t see beyond their cash flow of $3 billion a year.

So much for my superior analysis!

Michael Mauboussin is the Director of Research at BlueMountain Capital Management. In the past, he served as Head of Global Financial Strategies at Credit Suisse and Chief Investment Strategist at Legg Mason Capital Management. He is also currently Chairman of the Board of Trustees of the Santa Fe Institute, a leading center for multi-disciplinary research in complex systems theory that has been a leader in studying the role of luck and skill in investing. 

In an interview with Charles Rotblut, Mauboussin gave this simple test of skill. He said, “There is actually a very interesting test to determine if there is any skill in an activity, and this is to ask if you can lose on purpose. If you can lose on purpose, then there is some sort of skill.”

Personally, I am not willing to “lose on purpose” to test my skills at stock selection or portfolio management. Instead, I will accept the fact that luck plays a part in the results. This requires us to construct and maintain portfolios that can survive a bit of bad luck and still meet the longer-term goals we all strive for. 

T. Boone Pickens left this world on September 11th at the age of 91. I never had the opportunity to thank him for adding a few dollars to the savings for our clients at the time. So Boone, here is a big THANK YOU.