Common Stocks and Uncommon Profits

When to buy:

On capex that drives earnings growth:

All buying points do not arise out of corporate troubles. In industries such as chemical production, where large amounts of capital are required for each dollar of sales, another type of opportunity somtimes occurs. The mathematics of such situations are usually about like this: A new plant or plants will be erected for, say, $10 million. A year or two after these plants are in full-scale operation, the company’s engineers will go over them in detail. They will come up with proposals for spending an additional, say, $1.5 million. For this 15% gretear total capital investment the engineers will show how the output of the plants can be increased by perhaps 40% of previous capactiy.

…and since no additional general overhead is involved, the profit margin on this extra 40% of output will be unusually good. If the project is large enough to affect the company’s earnings as a whole, buying the company’s shares just before this improvement in earning power has been reflected in the market price for these shares can similarly mean a chance to get into the right sort of company at the right time. pp 101

So complex and diverse are these influences that the safest course to follow will be the one that at first glance appears to be the most risky. This is to take investment action when matters you know about a specific compnay appear to warrant such action. Be undeterred by fears or hopes bases on conjectures, or conclusions based on surmises. pp 104

On Ego

None of us likes to admit to himself that he has been wrong. If we have made a mistake in buying a stock but can sell the stock at a small profit, we have somehow lost any sense of having been foolish. On the other hand, if we sell at a small loss we are quite unhappy about the whole matter. This reaction, while completely natural and normal, is probably one of the most dangerous in which we can indulge ourselves in the entire investment process. More money has probably been lost by investors holding a stock they really did not want until they could “at least come out even” than from any other single reason. If to these actual losses are added the profits that might have been made through the proper reinvestment of these funds if such reinvestment had been made when the mistake was first realized, the cost of self-indulgence becomes truly tremendous.

the dislike of taking a loss, even a small loss, is just as illogical as it is natural. If the real object of common stock investment is the making of a gain of great many hundreds percent over a period of years, the difference between say a 20 percent loss or a 5 percent profit becomes a comparatively insignificant matter. What matters is not whether a loss occasionally occurs. What does matter is whether worthwhile profits so often fail to materialize that the skill of the investor or his advisor in handling investments must be questioned. pp 106

On losses

They should always be reviewed with care so that a lesson is learned from each of them. If the particular elements which caused a misjudgement on a common stock purchase are thoroughly understood, it is unlikely that another poor purchase will be made through misjudging the same investment factors. pp. 107

When companies no longer qualify in regards to the fifteen points

Usually happens for one of two reasons:

1. there has been a deterioration of managment
2. the company no longer has the prospect of increasing the markets for its product in the way it formerly did.

If growth prospects have been exhausted:

• we can only assume it will do about as well as the industry as a whole.

in this instance, selling might take place at a more leisurely pace than if management deterioration had set in. Possibly part of the holding might be kept until a more suitable investment could be found. pp 108

The amount of capital gains tax, no matter how large, should seldom prevent the switching of such funds in some other situation which, in the years ahead, may grow in a manner similar to a way in which this investment formerly grew. pp. 108

A good test for further growth:

This is for the investor to ask himself whether at the next peak of the business cycle, regardless of what may happen in the meantime, the comparative share earnings will probably show at least as great an increase from present levels as the present levels show from the last known peak of general business activity. If the answer is in the affirmative, the stock probably should be held. If in the negative, it should probably be sold.

On timing market declines

Most frequently given of such reasons is the conviction that a general stock market decline of some proportion is somewhere in the offing. …postponing an attractive purchase because of fear of what the general market might do will, over the years, prove very costly. This is because the investor is ignoring a powerful influence about which he has a positive knowledge through fear of a less powerful force about which, in the present state of human knowledge, he and everyone else is largely guessing. pp. 109

Ask yourself, “Am I selling out of this opportunity due to fear of something I can’t quantify and is largely a guess made by other people ? Or is it something I have positive reasoning for believing is true?”

The idea of when to sell can be summed up with the following:

If the job has been correctly done when a common stock is purchased, the time to sell it is – almost never pp. 113

Quotes

William Shakespeare:

there is a tide in the affairs of men which, taken at the flood, leads on to fortune

Never promote someone who hasn’t made some bad mistakes, because if you do, you are promoting someone who has never done anything – Dr Herbert Dow pp 254

If you can’t do a thing better than others, don’t do it at all – Dr Herbert Dow pp 255