Wednesday, December 30, 2009

Kodak, Bill Gates and efficient markets

I am just back from my summer holidays on the New South Wales South Coast.  To my (mostly) Northern Hemisphere readers I should boast about warm water, perfect waves, beaches in national parks with only one or two pairs of footprints on them and no people, fish that seem to suicide on your lines, etc – but that would just be boring.

In the middle of every day – when the heat became too much and the surf had waterlogged me I read.  On my kindle of course.  And some books which I had never read I read happily made easy mostly by the kindle’s large font options.  One of those books was Alice Schroder’s too long but otherwise excellent biography of Warren Buffett.  There was plenty there – I just want to share a single throw-away observation.

Warren Buffett has a group of his best investing friends get together once a year.  He originally called it the Graham group in honour of his mentor Ben Graham who presented at the first annual meeting in 1968.  By 1991 the group had expanded somewhat to include not only the original fabulous stock pickers but some business luminaries who could help enlighten the group on the nitty-gritty of their industries.  One regular attendee was Bill Gates of Microsoft fame.  From here I will quote Alice Schroder:

After a while Buffett asked everyone to pick their favourite stock.

What about Kodak? asked Bill Ruane.  He looked back at Gates to see what he would say.

“Kodak is toast,” said Gates.

Nobody else in the Buffett Group knew that the internet and digital technology would make film cameras toast.  In 1991, even Kodak didn’t know it was toast.

Gates was right of course – and since 1991 Kodak has been a terrible stock – and I would have counted Bill Gate’s comments as “knowledge” in as much as a statement about markets and technology could be knowledge.  But it would be an awful long time before that “knowledge” would be reflected in stock prices.  Here is a graph of the stock price since 1 Jan 1990. 



If you had taken Gates to heart in 1991 and shorted the stock then for almost ten years you looked like toast.  If you sold the stock because of something Bill Gates said then you looked silly for six or more years unless you purchased something better.

Indeed if you had the “knowledge” probably the best thing to do with it was to use it just to avoid the photography sector altogether.  That would mean you might outperform the market – but that outperformance was slight.  [If avoiding that sort of catastrophe was your mechanism of making money you probably needed an enormous amount of “knowledge”.]

Anyway there is little question that if you understood the implications of digital photography in 1991 you were – at least on that item – the smartest guy in almost any room.  And it did not help you make (much) money.

The market could stay wrong for a very long time.  Maybe as long as some blinkered academics could continue to believe in strong versions of the efficient market hypothesis.




  1. of course Gates understood Moore's Law in his water...but the rise and rise of digital photography has as much to do with the charge coupled device:
    whose developers won the 2009 Nobel Prize for Physics:

    funny how technology turns out, eg the battle for brand (and pricing) supremacy in computer processor chips (Intel, AMD), while 1 cm away in a laptop a hard disk of (equally) fabulous precision spins away at thousands of revs per minute, which is a mere commodity (see 'The Innovator's Dilemma', Clayton Christianson)

    anyway, the point to this post I think was market timing-there's a 'Gladwellian' book to be scribed on the 'meta' of prediction and hunches of people like
    Soros et al (and you, John?)

  2. As someone in snowy Switzerland, thanks for sparing me the tales of warm seas and sunshine!

    There was a quote attributed to Keynes that puts things well:
    "The market can stay irrational longer than you can stay solvent."

    Being right is good but timing is essential for stock picking too. Best wishes for 2010...

  3. I myself don't believe this invalidates the strong EMH.

    If I took your argument, replaced Kodak with IBM, and mechanical computer with electronic, then supposedly I would have an ironclad argument that would demonstrate that IBM should've become toast by the 60s.

    Why didn't that happen? Well, my guess is that they had more experience and knowledge of the business sector than any other company, and they were able to use that to adapt successfuly. This is not uncommon. The Fortune 500 is full of corporations that have survived several technological paradigm shifts.

    I'd be very surprised if the analysts who work at the large institutional investors that determine the market price weren't well aware of the impending technological shift in photography and its implications. Perhaps they quite understandably believed that Kodak would be well placed to adapt to digital photography. That didn't happen, and I'm not sure there was enough of a reason to believe that was the case until the late 90s when the stock price started to fall.

  4. Stephen - I think the analysts became aware of digital photography by 1998. At least that is about the earliest someone sophisticated - but generalist - might have thought about the topic.

    Gates was 7 years early. In order for the information to have a real effect on the stock price it needed to be better disseminated.

    I first heard Kodak mooted as a short in 2002 based on digital photography.

    But back in 1991 Kodak was still building (many) new film and paper plants predicated on sustained growth in the silver-halide medium.

    In 1991 the knowledge was VERY specialised. Certainly Shcroder makes clear that the Gates observation was new to Warren Buffett. Also Gates apparently gave a sophisticated analysis of the problems of photography versus say TV companies and other industries that were changed by digital distribution.

  5. Even if what Gates said was true, why would the market immediately write down Kodak? Film was still a profitable business. In fact, film is still a profitable, though shrinking, business. Kodak's film division turned a profit, and they've produced a new emulsion--Ektar 100--within the last year. I've tried it--it's an excellent film. The real irony is that Kodak's film products remain as top-tier products, and if Kodak dies, it will largely be because their consumer digital products suck.

    Though I do remember that the first thought I had the first time I saw a consumer-grade digital camera was that Polaroid was toast. I mean, here was a device that clearly targeted the same instant-gratification market as Polaroid. And they couldn't adapt.

  6. Of course, what really distinguishes Gates' own company from Kodak is that the former collects economic rents; the latter, not so much.

  7. Nice post. In my somewhat limited experience, I have found that insiders (at the sales or engineering or research mid-levels that I deal with) are almost invariably wrong about the short term direction of their companies' stock prices. Why? I'm not entirely sure, but I think it's because they assume that if the quarter is going to be bad or good, that that information is not reflected in the stock price.

    As for Kodak, I worked there briefly in the 80's and could have made the same prediction--the place was loaded with apparatchiks and stifled anyone who actually tried to accomplish anything. It was my first introduction to a big company and I couldn't imagine how a business could be run so poorly--and yet, it took them 15 years to collapse (and that collapse was not inevitable).

    That long term chart is fascinating--where the run in the late nineties came from is something to investigate. Was it driven by revenue increases, or profit margin increases, or PE ratio increases? I would be happy to work on this if anyone can point me to Kodak's numbers from the time. Is any of that data still around?

  8. That is a great quote and your point on Gates knowledge of the implications for TV and media in general was even more impressive.

    Bill Miller even in 2004 did not expect how game changing was all this.

  9. As other posters above have pointed out, you are ignoring all of the other possibilities that Kodak had. They could have owned digital photography and provided consumers with the transition in to it. Or, you could bet that Kodak had a long future as a cash cow serving the large numbers of slow adapters to that technology. Look at XRX as another company that turned out (a little bit) differently.

  10. Fine Post John,
    Enjoy your summer. You didn't mention the flies!

    Back on topic. Alan Greenspan was also 4 or 5 years early with his "irrational exuberance" call. You could argue however, that Alan could have well done his best Susan Powter impression and "STOPPED THE INSANITY".

    Have a great 2010.

  11. Actually, someone who believes that Kodak is toast who probably short Kodak and go long the SP500.

  12. I don't get it.

    Sure - Bill was right and in 1991. The stock price continued rising - very nicely too - for a couple of years.

    But during that time, Kodak was doing well, no? the business was making money. The fact of its inevitable future demise made no difference to the here and now, because people here and now were buying Kodak product because the digital revolution hadn't yet occurred enough for them to be able not to do so.

  13. Kodak's main problem is that senior management thought of themselves as an imagining company. I would argue they were a chemical company.

    As the change to digital photography started they should have been figuring out ways to apply their chemical knowledge to new markets. These markets could have been medical, solar, and specialized sensor applications.

    Pursuing digital photography feels like a decision that was made by one of those precious Harvard MBA types. They looked at where they sold their current products. They assumed all engineering R&D was interchangeable and generic. They made their vision statement. They made a dreadful decision, but I'm sure they collected a healthy bonus for it!


  14. It is common among commentators to conflate two very different assertions:

    1. It is extremely difficult to “beat the market”
    2. Markets are efficient.

    The common error is to assume that 1 proves 2 which is most definitely not the case. Shleifer and Vishny discussed this in their paper on the “Limits to Arbitrage”.

    Timing is extremely important especially when taking a short position for many reasons:

    1. Short equity is a short volatility position i.e. limited upside, unlimited downside. At the very least, margining requirements in the interim “inefficient” period may kill you before the market corrects. Long equity positions can atleast be left alone if liquidity permits and if the position is not leveraged.
    2. Principal-agent problem: Fund managers need to get the timing spot on when they are taking on contrarian positions. Else, they will be fired by their investors long before the market corrects.
    3. Even if one is not an agent, simple uncertainty means that we’re never certain about our judgement. The longer the market refuses to come around to our viewpoint, the less certain we become and the more tempted we are to liquidate.

    As John mentions, timing the market requires not only holding the contrarian view but knowing when this view will dissipate through the market. “Wisdom of the Crowds” explanations of the market require that the uninformed majority hold sufficiently diverse opinions. Given that betting on Kodak’s demise is tantamount to betting on a technological paradigm shift, the “crowd” by definition is not diverse and is wedded to the old paradigm.

    This is essentially the reason most contrarian investors are long-only long-term investors. This is the style of investing that Jack Treynor called betting on “slow travelling ideas”. The always excellent Michael Mauboussin has a discussion on wisdom of crowds and slow travelling ideas here ( and here (

  15. This is a question, not a comment. Suppose that you know with certainty that a stock is overvalued, but you don't know when this information will become sufficiently public to drive the stock down. Is there some strategy to avoid the Keynesian trap noted by JB?

  16. “Microsoft is toast,” says Me. 10 years from now...

  17. I think what's "lost" in this thread of conversation that underscore why the circle would find Gates' comments to be prescient is that Buffett and Graham are value investors, and presumably, so are this circle of stock pickers. As Buffett himself have stated, his investment horizon is infinite; so for someone in that position, he should _not_ buy Kodak in '91 as time (and the chart of Kodak) has shown.

    The discussion most likely did not centre around shorting Kodak which Buffett and his circle presumably would not be interested in doing.

  18. Talk is cheap. It's actions that count. And Bill's actual actions in share buy and holds are not all that.

    Holding such stocks as OTTR for a decade.

    Oh yes, and by the way, Bill owns a grip of EK right now.


    -Bob Dobb

  19. Nice post and comments.
    The concept of cultural lag seems to fit, and in retrospect, Kodak looks like it had a case of stock lag.
    The many parts of modern culture as they relate to an industry (consumer photography) do not change at the same rate. A fast change inone area requires an adjustment in the related parts. For Kodak, it was unequal change, i.e., slowing/altered film and camera sales form alternate sources. The interdependent parts within the company created maladjustments from which it could not recover.
    There is seldom perfect adjustment or complete lack of adjustment.

    Right now we all concerned that the fed not have implementation lag. LOL.

  20. If one considers the company in which Bill Gates' outlook was given and the sort of businesses the likes of Mr. Buffett invests in, then Mr. Gates' conclusion re: EK was PURE GOLD. The matter of timing is irrelevant to a "value investor," is it not?

    Now, per this matter of timing it does not matter one wit what the fundamentals behind a company are. Nor does it matter what anyone thinks about these fundamentals.

    What matters most if you are long a stock (or thinking of doing so) is whether a stock is increasingly being sold (out of fear of loss occurring in the near future) as its price rises. Very simple.

    This simple reality characterizes "the wall of worry" stocks are said to climb, and is easily discovered observing the volume of shares exchanged. Thus, once you begin to see volume tailing off as prices continue their rise, then you can assume the spirit of complacency is setting in, which rarely is a wise posture to take when holding "risky" financial assets like stocks.

  21. John,

    From McLuhan onward it was de rigeur to treat the past as toast, guys like Toffler later reducing his argument to cheerleading. Nothing particularly exciting about Gates' commentary beyond the more general comment on the future of photo film. And I can think of a number of possible outcomes for Kodak that would have proved him wrong.

    The fundamental problem is that Kodak tried to convert itself into a camera company for a very demanding techy market. Other than in the case of the Retina series, they had always been a low end camera manufacturer and certainly carried that baggage with them when they went marketing the digitals. They couldn't compete with the high end names or the tech companies allied with lens grinders.

  22. John,

    Is this post about Kodak and efficient markets or are you saying you're early on your Freddie prediction?


  23. Nice post in general, but I take issue with the parting shot regarding the Efficient Market Hypothesis.

    According to Yahoo Finance, the cumulative dividends paid by EK since 1990 come to $38.78 and by my reckoning if you had bought EK at $30 in 1990, the IRR based on the dividends until they were suspended last year plus the current share price comes to about 5%.

    While a 5% (pre-tax) ex post return undoubtedly lags the ex ante expected return of a 1990 investor, it's hardly a refutation of the EMH. Moreover, a 1990 buy-and-hold investor has had the option to sell the stock at any time during this holding period, and as your stock history manifestly shows, would've realized returns consistent with (or better than) the long-term performance of US stocks if he'd sold at any time prior to the past year.

    In short, the ex post returns to EK are utterly consistent with the notion that, at $30 per share, EK was "rationally" priced in 1990.

    More generally, the fact that a stock was once highly valued and is no longer, is not evidence that the market is irrational. Corporate valuations do change over long periods, often for predictable (and even predicted) reasons, but you can't use that fact to "prove" that the market was irrational at the old price unless by implication, you're suggesting that the market is rational at the current price.

    Consider AAPL's well-known, roller-coaster stock history (plotted on a log scale). At which prices would you claim AAPL was irrationally expensive based on the subsequent performance? There are multiple instances where AAPL lost more than half its value and you might allege that it was therefore irrationally expensive before those declines. But I can point to the current share price to argue that it's been cheap at nearly all points in its history. If ex post performance can be used to "prove" simultaneously that at some point in the past the stock was both irrationally cheap and irrationally expensive, it really doesn't prove anything at all.

    I've written about EK here and about AOL in a related post about the inertia in business models.

  24. One last thought:

    As Bill Gates said in The Road Ahead (c) 1996, "We always overestimate the change that will occur in the next two years and underestimate the change that will occur in the next 10."

    Perhaps he was thinking of his "Kodak is toast" comment when he wrote that.

  25. You need to know when to FOLD, and when to Hold.

    And Bill currently holds 7,950,000 shares of EK.

    As to shorting one of the many highly unprofitable, highly hyped penny stocks. One that our old friend Jason Assad of C&H Capital hyped under one of his many user ID's. He had all sorts of things to say about Xethanol.

    Name and symbol, (Global Energy Holdings - GNH), changed to protect the far from innocent.

    Stockmann/Jason. He had certain things to say about Mark Cuban, when Mark had done a bit of simple due diligence on XNL.

    Poor Mark. And all of the message board abuse.... Guess who was right. 100%..

    December 08, 2009


    Global Energy Holdings Group, Inc. (NYSE Amex: GNH) (the "Company") today announced that it has given notice to NYSE Amex LLC (the "Exchange") of its decision to voluntarily delist its common stock from the Exchange. The Company's board of directors has elected to take this action for the following reasons:

    -- The Company is not in compliance with the Exchange's listing requirements.


    On August 18, 2009, The Company subsequently voluntarily filed to reorganize itself and four of its subsidiaries under Chapter 11 of the United States Bankruptcy Code in the United States Bankruptcy Court for the District of Delaware.

    Smart guys can make big money shorting.

    One just need to know the who, why and where.

  26. I actually bought Kodak as an imaging play in the early 90s. Kodak was already producing digital CDs as a photo delivery system by '92. I know, I started getting prints and CDs when I had my film processed around then. Kodak was also nosing around the professional digital camera market and making some progress. I bought because I saw the company moving forward in digital imaging, which then was becoming the professional standard.

    There was also the rumor of a split, and in 1993 Eastman Kodak split off its chemical operations as Eastman Chemical (EMN). The EK price from 1993 reflects this division, and both companies did well. In fact, EMN is still doing pretty well if you look at it. People still need chemicals.

    Bill Gates was right. Digital cameras were going to eliminate the film and processing market. That money has moved to inkjet paper and cartridges and online image hosting sites. On the other hand, that wasn't going to happen until digital cameras got cheap enough. Only serious photographers were going to spring $5,000 for a digital camera back and an image storage system. Kodak also made a rather good dye transfer image printer which I used at work. It was outrageously expensive, but very high quality by the standards of the era.

    Digital cameras did make the mark, but not until around 2000, and even then they were pretty crufty. I bought a Kodak digital for $250 and wore it out. It was good enough. Kodak still makes fairly good digital cameras, and they made some of the first with WiFi. Their cameras still have a fairly good reputation, especially for ease of use and a convenient feature set.

    So, if you disagreed with Gates and bought Kodak back then, you weren't being irrational. Hell, with the split coming, you would probably have done pretty well, especially if you had a 3-7 year investment horizon. If you were buying the entire company, or a controlling interest, which would limit your liquidity, it would have been a whole different matter.

    Mind you, I think the efficient market hypothesis is unmitigated garbage, but this Kodak example needs a bit more examination.

  27. I'm the smartest guy in the room about American baseball. Nowadays Albert Pujols is widely considered the best player in the game, but I've got a tip for you: Pujols is toast. In ten years he will be retired, too old to play any longer at a high level. The market for baseball players may *stay wrong* for several more years, but in the long run my view of Pujols will prevail. (This just shows that the market can *stay wrong* for quite a long time.)