Filtering companies
The ratio of “companies looked at” to “companies visited” was probably one in every forty or fifty. Its worth mentioning I believe it so impossible to get much benefit from a plant visit until a great deal of pertinent “scuttlebutt” work (primary research) has been done first.
What to buy
Consider that all senior convertible issues have been converted and all warrants/options been exercised when calculating the real number of shares outstanding.
When to sell
If I have a deep conviction about a stock that has not performed by the end of three years, I will sell it. (p245)
Sell a stock if it can no longer grow faster than the economy as a whole or management has failed to grow as companies have grown (p276).
When to hold
After a sharp advance, a stock nearly always looks too high to the financially untrained. It is a mistake to sell a company with unusual growth prospects to realize a good gain when the shares look temporarily overpriced. These investors seldom buy back at higher prices when they are wrong, and lose further gains of dramatic proportions. (p263)
Do not disturb a position that is going to be worth a great deal more later. If the growth rate is so good that in another ten years it’s (free cash flows) may have quadrupled, it shouldn’t be of great concern that its 35% overpriced now. (p111).
There are times when a stock is worthy of retention by conservative investors who own it, but not for fresh purchase with new funds. The great qualities of these companies have become almost legendary in the financial community and thus have been awarded price-to-earnings ratios higher than is warranted by even the strong fundamentals.
The reason to continue holding on to these overpriced companies is because if the fundamentals are genuinely strong, these companies will in time increase earnings not only enough to justify present prices but to justify considerably higher prices.
Secondly, there is always the risk of switching to from this high quality business to one that looks like quality but actually isn’t. It’s actually safer to hold on to the great business which might be temporarily overpriced.
Those that choose to sell seldom get the opportunity to buy back at the lower price they were hoping for. They also wait for a decline to be bigger than it actually turns out to be. (p211)
Conducting primary research
Reading the printed financial records about a company is never enough to justify an investment (p233). One of the major steps in prudent investment must be to find out about a company’s affairs from those who have some direct familiarity with them. It is also necessary to learn as much as possible about the people who are running the company.
I will try to see (or reach on the telephone) every key customer, supplier, competitor, ex-employee, or scientist in a related field. Frankly, if I’m not even close to getting much of the information I need, I will give up the investigation and go on to something else.
Ask to be introduced to the people you need to speak to; be frank about who you want to meet and why. Be clear the information you are seeking is solely for background purposes in determining whether to make an investment. (p167).
Never visit the management of any company he is considering for an investment until he has first gathered at least 50% of the knowledge he would need to make an investment.
Qn: “What is the most important long range problem facing your company?”
When to discard an idea
- Evidence piles up that the company is just run of the mill
- You are unable to gather enough evidence
Why poorer businesses can outperform in a boom period
Take two companies LeanMachine and HighCosts, each selling machines for $10 each. LeanMachine has profits of $4 per machine while HighCosts only has profits of $1 per machine. Suppose now in the boom period the demand for machines goes up and the sales price rises to $12 per machine. LeanMachine will see its profit per machine rise to $6 (a 50% increase), but HighCosts will see its profit per machine rise to $3 per machine (a 300% rise). (p181)
Importance of marketing
In the competitive world of commerce it is vital to make the potential customer aware of the advantages of a product or service.
Management
Of one thing the investor can be certain: A large company’s need to bring in a new CEO from the outside is a damning sign of something basically wrong with the existing management (p189).
How well-managed companies maintain above-average profit margins
Economies of scale. Quite often as companies get larger it becomes harder to run efficiently with too many layers of bureaucracy. On the other hand, when a company becomes the leader in its field, not just in dollar volume but in profitability, it seldom gets displaced from this position as long as its management remains highly competent. The scale enables the cost of operating its fixed assets to be spread over a higher volume of sales, thus reducing production costs per unit. The scale also makes it easier to attract customers because of a well-recognized trade name. But importantly there may also be structural advantages. Campbell Soup, for example, has built up a network of canning sites across the US which reduce the haulage costs from the growers to the canning site and from the canning site to the supermarket.
Switching costs. An example might come in the form of a company that has created in its customers the habit of almost automatically specifying its products for reorder in a way that makes it rather uneconomical for a competitor to attempt to displace them. This can happen when a company has built up a reputation for quality and reliability in a product that:
- The customer recognizes is very important for the proper conduct of his activities
- Where an inferior or malfunctioning product would cause serious problems
- Where the company is synonymous in the public mind with the source of supply
- Where the cost of the product is quite small relative to the cost of operations. Hence moderate price reductions only yield very small savings for the customer.
Second, the company must have a product sold to many small customers rather than a few large ones. These customers must be sufficiently specialized in their nature that it would be unlikely for a potential competitor to feel they could be reached through advertising media such as magazines or television. They constitute a market in which, as long as the dominant company maintains the quality of its product and the adequacy of its service, it can be displaced only by an informed salesperson making individual calls. Yet the size of each customer’s orders make such a selling effort totally uneconomical. (p205)
Evaluating a price move
-Have the fundamentals changed or is it the appraisal of the fundamentals that has changed?
-The conservative investor must be aware of the nature of the financial-community’s appraisal of a stock or industry and whether is it more or less favourable than the fundamentals warrant. (p217)
Valuation
The further into the future profits will grow the higher the price-to-earnings multiple ratio an investor can afford to pay. (p219)
The Equity Analyst 