Friday, August 15, 2008

The Investment Zoo Chapter 13: Looking for Warning Signs

Jarislowsky gives advice on several things to watch out for when deciding on the quality of a company and its management. First, he elaborates on the problems with mergers and acquisitions.

With mergers and acquisitions, if a company vertically integrates, they often lack the necessary manufacturing skills to get the expected benefits out of the integration. As well, foreign acquisitions are problematic because the acquiring foreign entity may not have the necessary skills to effectively manage in the remote country.

Jarislowsky also believes there are lots of problems when larger corporations buy up entrepreneurial cultured firms. Often, the entrepreneur will leave the larger corporation as soon as its possible and many of the entrepreneur's top personnel leave shortly afterwards. In an entrepreneurial culture, the entrepreneur is often very hands on, and after leaving the corporation, the acquired work force may not be as productive as prior to the acquisition.

Jarislowsky also warns that an "industry consolidator" has to be both a good financier and an excellent leader. Just being a financial engineer and working towards consolidation of an industry due to desirable financial ratios will end in disaster.

He also gives some warnings for investing in specific types of industries. With mining and metal companies, only buy deep in the down cycle, but even then, the heavy cost operators can easily go bankrupt. Jarislowsky feels that mining and metal companies over the long term have lower growth rates than the overall economy. Airline companies should also be avoided entirely in his opinion, since these companies at best just stay alive.

Jarislowsky opines that insurance companies and banks often follow the herd mentality and so they regularly "go over the cliff in droves". If you are going to buy an insurance company or a bank, try to get one with excellent financial management and disciplined management.

He counsels to be wary of buying into fashionable stocks and industries as perceptions can change rapidly. Rather, buy companies that will be around for a long time. Jarislowsky gives the examples of beverage companies , drug and food retailers and even tobacco companies (although subject to heavy litigation) that have been around for a long time and proven themselves.

He is looking for companies with predictable annual growth rates of 12% or better, in non-recessive industries that will survive for a long time and are best of breed companies with top current and future management. Jarislowsky prefers large companies to small ones because in times of trouble, a large company often gets a second chance to fix mistakes whereas a smaller one often does not.

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