TaketheFifth 81
regarded “stoc koption warrants” as they were then called, as “a near
fraud, an existing menace, and a potential disaster.” He believed they
created value out of thin air, had no excuse for existing except to
mislead people, and should be prohibited by law or at least capped
at a minor part of a company’s total capital.
The major negative effects of options are dilution of existing
shareholders’ ownership interest in the company—including existing
earnings per share, sharing in future growth, enjoying dividend pay-
ments, voting for managers, and other major corporate changes such
as mergers and (a bit ironically) new option plans. Graham could
see no purpose in options generally other than to “fabricate imagi-
nary market values.” In short, Graham condemned stock options as
criminal, a monstrous and “wanton creation of huge paper-money.”^10
Buffett echoes the point less vociferously by saying that “the
business project in which you would wish to have an option fre-
quently is a project in which you would reject ownership. (I’ll be
happy to accept a lottery ticket as a gift—but I’ll never buy one.)”^11
The lesson for investors is clear. Stay away from options and stay as
far away as possible from companies in which options constitute a
significant portion of total capital.
ALCHEMY
Stoc kmar ket bubbles occur when aggregate capital invested in eq-
uity securities exceeds the amount of profitable deployment oppor-
tunities so that prices exceed values by terrific multiples. They result
from the hope that the stocks people pick will turn out to be the
ones that enjoy the profits. But if, say, $100 billion is allocated to
ventures that can only give returns from profitable investments on
$10 billion, then $90 billion in disappointment is going to come—
90% of the dollars will be left standing without chairs to sit in when
the music stops.
The main difference between the musical chairs of market spec-
ulation and the activity at the typical racetrac kis that horse races
take only about two minutes to separate the gambler from her
money. What horse betting and the stoc kmar ket do have in com-
mon, however, is that those who study the horses or businesses and
who bet seldom are more likely to be winners than are those who
bet on every race or stock.^12 In the early stages of a boom that may
bubble, if you can find the cinch stoc kat a low price and load up