Q1 2021 Market Recap

April 21, 2021

Piggly Wiggly: The Curious Case of Clarence Saunders and a Short Squeeze Gone Wrong

Before the recent “meme stock mania,” which resulted in significant drama for companies like GameStop and AMC Entertainment, the annals of financial market history are littered with other so-called “short squeezes” that did not end well for those who bid up shares in the open market to inflict pain on short position holders. One of the most famous of these episodes took place in 1923 and involved a company called Piggly Wiggly, a grocery chain that is still in operation today.

Back then, Piggly Wiggly was headquartered in Memphis, Tenn. and its founder, Clarence Saunders, was an innovator. In 1916, he developed what is thought to be the first self-serve model of grocery store operation. You know this model well (as it is employed by every major operator in the sector today): customers file through aisles of food offerings, selecting what they want and bringing it to the front of the store to pay. Prior to Saunders’ ingenious idea, shopping lists were given to clerks to fill, the common practice of the day. The year after the first store opened, Saunders secured his ideas with several patents belonging to his Piggly Wiggly Corporation. By then, there were nine locations in and around Memphis. His business model quickly took off as he franchised the Piggly Wiggly idea and issued public stock in the company.

It was clear that, by 1921, Saunders’ elegant, yet simple, transformation was here to stay. With a mixture of company-owned stores and franchises, there were 600 Piggly Wiggly locations in total. To fund future expansion, new capital was required. Toward the end of 1922, Saunders announced plans to sell 100,000 shares. However, this secondary offering – in combination with news of a Piggly Wiggly franchisee filing for bankruptcy – created heavy selling pressure in the stock. To further compound the price declines, firms like Merrill Lynch piled on, attempting a “Bear Raid” by selling short Piggly Wiggly stock, which quickly sank from $45 to $30.

In response to the Bear Raid, Saunders created a context for the issue in the press as “good vs. evil,” using phrases like “Shall good business flee? Shall it tremble in fear? Shall it be the loot of the speculator?” according to Mike Freeman’s book “Clarence Saunders and the Founding of Piggly Wiggly: The Rise and Fall of a Memphis Maverick.” To counter the short sellers, Saunders borrowed $10 million (keep this borrowing in mind – we will address this later) from some banks and set out to buy up all the outstanding shares of Piggly Wiggly. This buying spree had the stock price pushed up to $120 on March 20, 1923, when the NYSE suspended trading in the shares as Wall Street firms shook in their boots.

Saunders and his associates did such a good job in their pursuit of squeezing the short positions that they owned nearly all outstanding shares at extremely high prices. However, owning nearly all shares was not enough. The New York Stock Exchange, as it later admitted, was fearful of this accumulation of one issue could roil the entire stock market and postpone indefinitely the date at which Saunders could call in the shares he accumulated control of – the shares that were still on loan to Wall Street. You see, by now, Saunders was “The Bank of Piggly Wiggly Stock” and he wanted to call his stock home, at any price. He chose $250 per share. The delay engineered by the NYSE proved to be fatal to Saunders’ squeeze. Wall Street firms combed far flung places like New Mexico and Iowa for owners of stock, who gladly parted with them for about twice what they paid – $100 – in over-the-counter transactions, since the stock could not be traded on the exchange. Wall Street, as it usually does, had found a way to survive by delivering stock, instead of paying Saunders his non-negotiable $250 per share.

According to Barron’s, Saunders had simply suffered “the customary fate of the Main Streeter who attempts to beat Wall Street.” But today, instead of one large shareholder holding all the stock at a loss, there may be thousands of smaller investors facing the same fate Saunders suffered, as the “meme stock” trade situation continues to unfold.

What Do the Three Words ‘Saunders,’ ‘Stonks’ and ‘Archegos’ Have in Common?

Answer: Leverage, debt or borrowing on margin.

We promised earlier to address the leverage or borrowing on margin that Clarence Saunders took on to buy shares of Piggly Wiggly. In our opinion, this is a crucial aspect as to why the short squeeze in Piggly Wiggly stock did not work. The financial press has now been touting stories of another instance – although not short squeeze related – regarding the recent downfall of hedge fund Archegos Capital. Archegos used derivatives, not borrowed money, to leverage its portfolio; however, the outcome was the same.

The point is this: leverage – no matter how you attain it – can magnify both positive and negative outcomes. Said another way: leverage is like turbo jets; it will get you “there” faster but the direction is unknown. Here is some math to deconstruct what happens when leverage is used. These same calculations apply to buying stocks on margin or buying real estate with a loan.

In the table above, we have outlined a scenario where an investor has $10,000 and borrows an additional $40,000 to put toward an investment. The cost of borrowing is 4%. When the investment returns +9%, the return – including the leverage – is +29%, while the loan is responsible for more than two-thirds of the entire leveraged gain. In the opposing scenario, with the investment being down 9%, the total leveraged return is -61%. It is interesting to note that, in the negative return column, the borrowing is responsible for approximately 85% of the loss. Behold the turbo jets of return!

“When you combine ignorance and leverage, you get some pretty interesting results.” -Warren Buffet

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