Sunday, January 31, 2010

Conservative Investors Sleep Well: Chapter 1

Warren Buffett has called himself "85% Graham and 15% Fisher". While the works of Graham are often cited, Fisher's book "Common Stocks and Uncommon Profits" is not. Here follows a summary of the expanded version of this book, which includes 2 other works by Fisher including "Conservative Investors Sleep Well" and "Developing an Investment Philosophy".

A conservative investment conserves purchasing power with minimum risk. Fisher starts this book by discussing what he calls the first dimension of a conservative investment. Every conservative investment must have the following four characteristics:

1) Low-cost production/operations

A conservative investment must be the lowest-cost producer in a majority of its product lines, and must appear able to continue to do so in the future. Its margins must be such that if business conditions worsen, its competitors will go out of business, allowing it to take share and profit in such a situation. Note, however, that in a bullish period, such conservative companies will not see their stocks rise as much as their competition, a situation best illustrated by example: if two companies competing in the same industry both see their revenues rise (with costs staying flat), the company with the lower margins will see a much higher percentage growth in earnings.

2) Strong Marketing

Companies must be constantly alert to changing customer needs. What is desired today is not the same thing as what was desired yesterday, but many companies fail to utilize this distinction. Being able to explain the advantages of one's products/services in terms the customer understands is a key success factor in maximizing profit and maintaining and growing business. Being the low-cost producer but with a weak marketing team is akin to having a powerful engine with a loose pulley belt that is therefore only producing a fraction of the results it would otherwise attain.

3) Outstanding Research and Technical Effort

This area is not limited to companies engaged in high-tech industries. Today, all companies should be constantly innovating in order to improve existing product lines or open new ones. This requires not only technical competence and ingenuity, but also the teamwork and leadership necessary for people with different expertise to combine their efforts in creating products/services that add value.

4) Financial Skill

Companies with above-average financial skill are at a great advantage. Being able to tell how much a product is costing (which is often difficult to do when overhead is spread across many product lines) can avert disaster, improve returns on capital, and give the company clues as to where it should make investments.

Considering that a conservative investment is meant to conserve capital, why all this talk of growth, increasing profits, and continued development? Companies that fail to go uphill end up going downhill; technological innovation, along with changing habits and customs have resulted in an ever-increasing rate which even the oldest industries are changing. Companies must stay up-to-date or they will not conserve the investor's capital.

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