This chapter includes discussion of the present and the author's investment advice.

T. Rowe Price, as a firm, has produced good long‐term stock market results over many years and is continuing to do so. The only lengthy period of time when this was not true was during the decade of the 1970s. During that time, based on the Growth Stock Fund's annual results in its annual reports, which generally reflected the Councilor Division, the Growth Stock Fund only outperformed the Standard and Poor's 500 Index annually on four occasions, and ranked near the bottom of mutual funds with a goal of equity growth with income secondary. This was quite a comedown from being the number one fund in the country in its category for its first ten years.

Largely because of the outstanding results of the T. Rowe Price funds and the firm's pension clients in the 1960s, however, T. Rowe Price Associates began to take on a disproportionate share of new business in the early 1970s, as discussed in the April 1972 issue of Fortune. Competitors' clients began to demand exposure to growth stocks. Many investment firms responded by investing in the same growth companies that were publicly displayed in the Growth Stock Fund and New Horizons shareholder reports. The larger growth companies in the Growth Stock Fund were even given a special name in the financial press: the “nifty fifty.” Soon, the pension funds and fund portfolios of competitors began nearly to mirror the holdings of the Price funds. This copycat behavior caused a large inflow of capital into a relatively small part of the stock market over a short period of time, in what Charlie had called a “laser beam” in his forecast that this would happen a decade before, as discussed earlier. This phenomenon pushed growth stocks to high relative valuations.

This overvaluation was recognized by the firm and discussed in the shareholder reports of the New Horizons Fund and the Growth Stock Fund in the late 1960s and early 1970s. The stock market did break sharply in 1973, initiating a bear market that continued throughout 1974, with growth stocks leading the way in the decline. The readjustment of the high valuations of growth stocks caused them to decline in value, despite their continued superior earnings growth. The New Horizons Fund dropped a heart‐stopping 42 percent in 1973, and followed with another 39‐percent decline in 1974. The Growth Stock Fund dropped 26 percent in 1973 and 34 percent in 1974, far worse than the Dow Jones Average. The counsel accounts generally followed the performance of the Growth Stock Fund.

As mentioned earlier, this was not the first time that large growth stocks had a period of poor relative performance. In the years immediately following the Growth Stock Fund's launch in 1950, the fund only beat the Dow Jones Industrial Average once in its first three years. The investment committee, in an attempt to achieve better short‐term market performance, reduced their holdings of large growth stocks modestly, and added high‐dividend‐paying, low‐priced “value” companies, such as those in the fire and casualty business and paper industry. Fortunately, after a pause of several years, growth stocks resumed their good relative performance. The committee quickly switched back to better growth stocks.

In the early 1960s, growth companies again became extremely overvalued, with a number of the firm's favored growth companies selling for more than fifty times earnings. Again, the committee bought some lower‐priced, slower‐growing companies, such as airlines, but the market break in growth stocks lasted only a few years. Growth stocks again recovered and the nongrowth stocks were sold, impacting the fund's recovery only to a modest extent.

In looking back on these two episodes, it could be argued that switching from higher‐priced growth companies to cheaper, slower‐growing growth stocks had not been a good move. Simply holding higher‐growth stocks through these temporary periods of overvaluation would have been the better strategy.

Growth stocks did recover in 1975, and the Growth Stock Fund and New Horizons Fund temporarily did better than the market averages, based on the GSF and NHF annual reports. The adjustment in the value of large growth stocks, however, turned out to be far from over. Following this short rebound, growth stocks entered a long period of relative underperformance. New Horizons did better, particularly in the later years of the decade. Its decline had been sharper at the outset, and the rapid growth in earnings of the small, resilient companies that made up its portfolio caused New Horizons to recover much faster than the Growth Stock Fund.

With the initial expectation that the poor performance of growth stocks would once again be brief, it was decided to stay with them in the 1970s. Closing the fund was impractical, as the Growth Stock Fund and counsel accounts shared basically the same investments. Switching to nongrowth stocks seemed to make no more sense than it had proven to be in the past. Most clients had chosen T. Rowe Price because of its success with growth stocks, and this was what they wanted. The Growth Stock Fund had been specifically bought by its shareholders because of its portfolio of growth stocks. Its emphasis on the Growth Stock Philosophy was clearly spelled out in the prospectus. The research department, except for a few analysts connected to the New Era fund, was well versed in growth companies, but had little experience with nongrowth companies. In the counselor division, individual clients had huge gains, which would be very expensive to liquidate.

In the end, the firm did modestly raise some cash reserves, but continued to very selectively purchase growth stocks, as they became better values. After all, these were still the best‐managed companies in the world, operating in very fertile fields longer term.

Unfortunately, unexpected international events and high inflation continued to create a poor environment for growth stocks. Oil stocks, which represented a large percentage of the value of the stock market, were doing very well, with political events and accelerating inflation rapidly increasing the price of oil. By 1977, this poor relative performance of growth stocks had become a major issue with clients and the shareholders of the Growth Stock Fund. Many of the firm's competitors were beginning to publicly question its Growth Stock Philosophy and to promote “value stocks.”

John Boland, in the November 8, 1982, issue of Barron's, probably said it best: “That year [1973] marked the last gasp of the growth stock frenzy. It also ended the long trend of rising fortunes for the Growth Stock Fund's Investors, who saw the value of their shares plunge more then 50% over the next two years. By the end of the decade ‘Nifty Fifty’ was a byword of ridicule, a reminder of Wall Street's follies. A bear market and a decade of inflation had crushed the premium price‐earnings multiples.”

The article “Identity Crisis at T. Rowe Price,” in the November 1982 issue of Institutional Investor magazine, begins with a T. Rowe Price associate “rather testily” saying, “If pension funds were on the ball, they would know we're not just growth stocks.” The author continued, “Plagued by poor equity performance, T. Rowe Price has…moved away from growth stocks.” Others accused the firm of falling in love with its investments and not seeing the infirmities and other blemishes that had infected their beloved large‐growth companies.

With his legacy in question, Mr. Price began to accept interviews with newspapers and other publications. He would point out the excellent performance of his own model growth fund portfolio, buoyed by better‐performing small growth companies, as well as by very large positions in gold and other natural resource companies, which were responding very well to the inflationary environment.

The stock market stayed in a funk, without any clear direction, throughout the late 1970s. The relative decline in the valuation of large growth stocks continued to negatively impact the performance of Growth Stock Fund and counsel accounts.

However, the world turned again, and the stock market soared on the back of the “Volcker Market.” In what would prove to be his last memo, “The Overlook for 1983 and Beyond,” on August 1, 1983, Mr. Price's first sentence read, “The outlook for 1983 is favorable for business and the stock market.” Later in this memo, he said that as of June 30, he had “71% of his portfolio in common stocks and convertible bonds,” up from 51 percent in his prior memo. The bear market for Mr. Price was over. All of the recommendations in the article were traditional growth stocks.

During the decade of poor performance there had been much criticism that T. Rowe Price, the firm, had lost its way. It was claimed that it was investing in mature companies that were no longer growth companies. To respond to these concerns, we have analyzed three of the Growth Stock Fund's portfolios: 1960, when the fund had a superb first ten‐year performance, beating all other U.S. equity funds with similar objectives; 1972, which marked the twenty‐year period where it enjoyed a very good performance compared to other large growth equity mutual funds, as indicated in the April 1972 issue of Fortune; and 1980, when it was ranked by Wisenberger fifth‐sixth out of fifty‐nine large long‐term growth funds with the worst decade of relative performance in its history.

We looked at three key statistics of these portfolios: five‐year sales growth, which is the best indicator of underlying growth, assuming no acquisitions; five‐year per share growth, which defines the performance of a growth stock; and return on equity, which is the key financial parameter used by Mr. Price in identifying a true growth company. A company's long‐term growth is ultimately tied to its return on equity.

Comparable Annual Portfolio Statistics

This table was created by Karen Malloy, retired TRP fund statistician.

A review of this table indicates that the 1980 portfolio had a very good mix of growth companies, which, if anything, were performing financially better than the two earlier portfolios. There is no indication that the firm had suddenly stopped identifying and investing in vigorously growing companies. As can also be noted, the price to earnings ratio was 54.4 in 1970 but had dropped to 14.6 in 1980. This cut its appreciation by nearly 75 percent and was the real reason for the fund's poor performance.

Could this happen again? In the sixty‐eight years of the Growth Stock Fund's existence, this long under‐performance has only happened once. There are so many different ways that money is managed and invested today that it seems doubtful that a majority of the country's investors would once again suddenly descend on growth stocks and push their relative prices to such heights.

If a period of substantial overvaluation should reoccur, however, we would hope that the readers of this book would recognize it, based on Mr. Price's advice for calculating fair value and, perhaps, do some selective trimming of the most overpriced stocks, but continue to hold the great majority through the episode. One thing remains certain, that the government will demand its percentage of any realized gains.

For those who prefer more diversified portfolios, T. Rowe Price now offers more than one hundred mutual funds, with many different investment strategies and the ability to easily switch among them. Well‐known, excellent mutual fund companies offer many others.