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Common Stocks and Uncommon Profits

Conservative Investors Sleep Well

1.The First Dimension of a Conservative Investment

A conservative investor should look for 4 things in an organisation:

 

A.Low - Cost of Production:

A company should have the lowest cost of production in its industry. There are 2 aspects to this: - A company’s cost should be below the average break-even point of its industry.  In a downturn, a company which has low costs will be able to survive easily, whereas a company with high costs of production will most likely exit from the market.

 

A company with a low cost of production will have high returns and will be able to generate finance internally. This will remove the need for raising additional equity, debt, etc.

 

The author says that in a boom, the percentage rise in profits will be higher for a high-cost company than for a low-cost company. For example, in a market, there are 2 companies. Company A and B, both sell a watch for ₹10. Company A has a profit of ₹4, whereas company B has a profit of ₹1 per watch. Demand for watches has increased and so the price is now ₹12 per watch. The higher profit-making company “A” increased its profits by 50%, whereas, the high cost company “B” increased its profits by 300%. That's why it's important to look at the profits and not just the profit margins.  

 

B.  Strong Market Organisation:

 

A strong organization should constantly be alert to the changing desires of its customers so that the company can supply what is desired today, and not what was used to be desired. 

The author says that just recognising these changes is not enough. A company needs to make its customers aware of the changes which have been made. Efficient production and marketing are the two key areas in which a company should have significant expertise if it wants to be successful. 

 

C.Outstanding Research and Technical Effort:

This point was discussed earlier, A company’s R&D team should come up with products which can be readily sold in the market, or whose customer demand is high. To achieve this, strong market research is required. A product which cannot be sold right now is useless. 

 

D.Financial Skill:

A company should have adequate knowledge about each element of its costs, not just in manufacturing, but in selling and research as well. This will spotlight even the minor phases where a company can reduce its costs. Through skillful budgeting and accounting, a company can create a system through which it can detect anything that can hamper the profitability of a company.

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Units 13/18