While the stock market fluctuates from year to year, it’s reassuring that some core principles of investment theory have remained steadfast for generations. “Common Stocks and Uncommon Profits,” published in 1956, offers advice on investing that is just as relevant today as it was during Eisenhower’s presidency.
This summary highlights the essential traits to look for when investing in a company and helps you assess whether you’re a high-risk or conservative investor. Like a detective, a successful investor meticulously researches and gathers all pertinent information before committing their money.
After reading this summary, you’ll understand how to determine if a company’s stock is overvalued, why the stock price doesn’t necessarily reflect the company’s true quality, and how to overcome doubt and act decisively when it’s time to buy.
Common Stocks and Uncommon Profits
Smart Investment Strategies Target Companies with Long-Term Growth Potential
The common perception of investing is that it is fast-paced and brutal, with investors buying and selling seemingly on a whim, seeking quick profits above all. Yet, smart investing involves much more thought and planning, ideally focused on the long term. Smart investors don’t chase quick profits; instead, they seek companies with growth potential that can multiply an initial investment over time.
Identifying companies with this kind of growth potential is not easy. Many stocks are either over- or undervalued, complicating the investment process. Smart investors look for undervalued companies with strong potential, as these can grow rapidly, potentially doubling or even tripling the initial investment.
Fortunately, companies with growth potential often share common characteristics. They offer products and services capable of sustaining high sales volumes for several years. Additionally, they invest in research and development to ensure continuous growth even when their current product lines no longer provide opportunities.
For instance, in the 1950s, television manufacturers thrived, but by the middle of the decade, nearly everyone who wanted a black-and-white TV already had one, leading to flat growth until the color television was developed. Motorola, now known for mobile phones, initially produced televisions and radios. However, their management wisely leveraged the company’s technical expertise to enter the two-way communication business, sustaining growth while other TV manufacturers faced stagnant sales.
Moreover, companies with high growth potential boast a solid management team and good employee relations. It’s crucial to avoid investing in companies where internal conflicts hinder productivity and executives fail to inspire a shared vision among the workforce.
Common Stocks and Uncommon Profits
Thoroughly Research a Potential Company from Every Angle Before Investing
Successful investing is a lot like detective work; it requires thorough research and detailed analysis of all available data. When evaluating a company’s investment potential, gather comprehensive information from every angle.
While you might be tempted to ask a trader for recommendations, remember that traders often protect their own interests, and their advice may not always be reliable. Instead, employ the scuttlebutt method: dig for information from diverse sources. Reach out to vendors, customers, former employees, and research scientists or executives in trade associations. You’ll uncover valuable insights, provided you assure confidentiality to your informants.
Contacting the company’s competitors can also yield surprisingly accurate and detailed information. Once you’ve compiled a comprehensive profile of the company, engage with its management directly to ask informed questions.
Although the scuttlebutt method is accurate, it is time-consuming. To maximize efficiency, carefully select the companies you wish to research. Pre-select those that offer the growth potential you seek for your investment.
Begin by talking to friends or other investors, reviewing printed materials, and identifying companies that appear promising. For instance, if you read that a company’s manager is resigning due to questionable dealings, it’s best to avoid investing in that company.
Common Stocks and Uncommon Profits
Capitalize on Stock Price Dips to Invest Cheaply and Benefit from Future Growth
Once you’ve identified a company with strong long-term growth potential, is it time to buy? Since stocks are often over- or undervalued, how can you ensure you get the most value for your investment?
Stock prices reflect the financial community’s current perception of a stock’s value, creating a cycle. If the community values a stock too highly, people rush to buy, pushing the price up further, resulting in a price “bubble.”
Investors typically don’t consider future potential. For example, if a successful company encounters an unexpected expense, such as a research project, the investment community may downgrade future projections, causing the stock price to fall—even if the research project would drive future profitability.
Understanding this market irrationality can lead to extraordinary profits. Companies with growth potential are often innovators, encountering obstacles that cause the financial community to undervalue their stocks.
Consider a widget manufacturing company with huge growth potential. Initially, hype causes the stock price to rise. However, a problem arises: the casting mold for the company’s widgets is improperly sized. Perceiving the product as a flop, investors cause the stock price to fall.
This is the perfect time to buy in cheaply, positioning yourself to profit when the company fixes its issues. If you miss this opportunity, there may be another chance during the next dip. For instance, the company’s stock rises after fixing the mold problems but falls again when the sales staff incurs unexpected costs during the product rollout. Frustrated, the financial community bails out, doubting the company’s success. Yet for you, this presents another opportunity to buy the stock at a lower price.
Common Stocks and Uncommon Profits
Trust Your Decisions: Avoid Doubt and Resist Following the Herd
Doubt is natural. Inevitably, once you’ve identified a stock you want to buy, you’ll feel the pangs of hesitation. However, a successful investor has no room for doubt. Don’t hesitate once you’ve identified a company with profit potential.
Often, this hesitation stems from following the crowd. If no one else is jumping on a stock, it’s easy to question its value. Yet, as we’ve seen, the financial community is often wrong about a stock’s worth. While it can be scary to buy when everyone else is selling, if you truly believe in a company’s potential, take a deep breath and invest.
Buying what everyone else is buying usually means the stock is too expensive to be a great investment. If you hesitate, you might never get the same opportunity again. Avoid the urge to wait for a stock’s price to fall further. Doing so might cause you to miss a golden opportunity.
Consider the case of an acquaintance of the author who wanted to buy 100 shares of a stock listed at 35 1/2. To save 50 cents per share, he offered only $35. The share price continued to rise, and had he made that extra 50-cent investment, he would have earned a total of $46,500 twenty years later!
Once you’ve found a good investment, hold on to it. There are only three valid reasons to sell a stock from a business perspective: you misjudged the company’s growth potential, conditions within the company changed despite your sound judgment, or you invested in a middling stock in the short term while searching for an outstanding investment. Any other reasons, such as making quick money or following the crowd, can only harm you. A company with huge growth potential can never be overvalued.
Common Stocks and Uncommon Profits
Conservative Investors: Pursue Stable, Well-Structured Companies with Growth Prospects
We’ve explored how to achieve substantial gains through investments in high-growth companies. However, for some investors, a more conservative approach focused on steady, incremental growth is preferable.
As a conservative investor, you seek out robust companies with potential for expansion. Avoiding start-ups, no matter how promising, is essential when prioritizing safety. Instead, target large, established firms with a proven history of profitability.
Nevertheless, for this strategy to succeed, these companies must still possess growth potential to sustain their market position. While this doesn’t necessarily require astronomical growth, the ability to evolve and progress is vital to avoid being surpassed by more agile competitors.
A strong, growth-oriented company typically exhibits four key characteristics:
Firstly, it employs cost-effective production methods, ensuring profitability even during periods of inflation or market downturns.
Secondly, it maintains efficient organizational structures, enabling the successful delivery of products and services to the market.
Thirdly, it boasts a distinguished track record in research and technical development, facilitating ongoing innovation and enhancement of offerings.
Lastly, the company demonstrates financial acumen, allocating resources judiciously to initiatives with profit potential while heeding warning signs signaling the need for strategic adjustments.
Common Stocks and Uncommon Profits
Key Employees: Essential Assets in Stable, Growth-Focused Companies, and Wise Investments
For conservative investors, scrutinizing a company’s employee base and its treatment of them holds significant importance. This strategy is driven by two primary reasons.
Firstly, a company’s growth potential hinges entirely on its employees who execute its strategies. Every advantage a company possesses is directly attributed to the efforts of its workforce. For instance, to foster innovative technical development, a company relies on dedicated and ambitious research and development teams. Similarly, maintaining cost-effective production methods necessitates astute managers constantly seeking efficiency gains.
Secondly, the treatment of employees reflects the overall productivity and effectiveness of a company. Mistreated employees are unlikely to deliver optimal results, while valued employees contribute to a company’s success. By assessing a company’s human resource and management policies, investors gain insights into its operational efficiency and long-term potential.
For instance, examining how a company handles promotions provides valuable insights. A reluctance to promote internally, instead favoring external hires, signals a lack of investment in employee development and training—a concerning indication of poor human resource management.
Similarly, observing management’s teamwork abilities is crucial. A manager who operates autonomously may struggle to effectively manage as the company expands. Conversely, a company that fosters well-organized teams and managers capable of delegating responsibilities signals a conducive environment for growth and investment.
Common Stocks and Uncommon Profits
Conservative Investors Seek Long-Term Profitability in Companies
When assessing a company, a conservative investor must consider its future prospects. It’s not just about its current strength but also its ability to maintain its position over time.
In this evaluation, profitability is key. Rather than simply focusing on returns, investors should prioritize profit margins—the larger, the better. The goal is to identify a company capable of sustained profitability, even in challenging economic climates.
Profitability is crucial because growth demands continual investment, whether in research and development, inventory expansion, or marketing. Therefore, a company must secure its future profitability to finance future expenses and navigate through tough times.
Moreover, a business can ensure long-term profitability by outperforming its competitors. Market dominance often stems from scale advantages; larger companies can produce more at lower costs than their smaller counterparts. For instance, a company producing a million pencils per month will have lower per-pencil production costs than one producing only 100,000 pencils.
Another strategy is through proprietary technical advancements protected by patents or copyrights, preventing competitors from replicating them.
Ultimately, a company’s strategy should be forward-thinking, prepared for long-term business development and maintaining its competitive edge.
Common Stocks and Uncommon Profits
Determine the Fair Value: Use the Price-Earnings Ratio to Assess a Company’s True Worth
A company’s valuation can often be swayed by the sentiments of the investment community. However, the subjective nature of a stock’s value goes even further, varying from one investor to another.
For instance, what may be deemed valuable to a risky investor could hold less significance for a conservative one. While a risky investor may place a higher value on a stock expected to experience rapid growth, a conservative investor seeks to pay the stock’s real price, devoid of speculative expectations.
In essence, conservative investors seek stable, growing companies either currently undervalued or priced at their intrinsic worth. One method to gauge this is through the price-earnings ratio (P/E ratio), calculated by dividing a company’s stock price by its earnings per share.
For instance, if a company earns $1 per share and its shares are priced at $10, the P/E ratio is 10/1, or ten. If the company’s latest annual report reveals earnings of $1.82 per share, the ratio becomes 10/1.82, or approximately five.
However, higher earnings can lead to positive projections, potentially driving up the stock price. If the company’s shares now sell for $40, the P/E ratio would be 40/1.82, or 22, significantly higher than before.
Ultimately, it falls on the conservative investor to evaluate whether the company’s attributes justify the market’s expectation of continued growth beyond its current share value of $40. While someone seeking short-term gains might overlook a $40 share price, a conservative investor may find it steep given their knowledge of company management and operations.
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