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My recommendation: 9/10

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Summary of notes and ideas

“To summarize:The company that qualifies well in this first dimen-sion of a conservative investment is a very low-cost producer or opera-tor in its field, has outstanding marketing and financial ability”

“The company that qualifies well in this first dimen-sion of a conservative investment is a very low-cost producer or opera-tor in its field, has outstanding marketing and financial ability and a demonstrated above-average skill on the complex managerial problem of attaining worthwhile results from its research or technological organization. In a world where change is occurring at an ever-increasing pace, it”

“is (1) a company capable of developing a flow of new and profitable products or product lines that will more than balance older lines that may become obsolete by the technological innovations of others; (2) a company able now and in the future to make these lines at costs suffi-ciently low so as to generate a profit stream that will grow at least as fast as sales and that even in the worst years of general business will not diminish to a point that threatens the safety of an investment in the business; and (3) a company able to sell its newer products and those which it may develop in the future at least as profitably as those with which it is involved today.”

“The annual salaries of top management of all publicly owned companies are made public in the proxy statements. If the salary of the number-one man is very much larger than that of the next two or three, a warning flag is flying. If the compensation scale goes down rather gradually, it isn’t.”

“A large company’s need to bring in a new chief executive from the outside is a damning sign of something basically wrong with the existing management—no matter how good the surface signs may have been as indicated by the most recent earnings statement”

“The first dimension of a conservative stock investment is the degree of excellence in the company’s activities that are most important to present and future profitability. The second dimension is the quality of the people controlling these activities and the policies they create. The third dimension deals with something quite different: the degree to which there does or does not exist within the nature of the business itself certain inherent characteristics that make possible an above-average profitability for as long as can be foreseen into the future.”

“In the business world there are but two ways a company can protect the con-tents of its honey jar from being consumed by the insects of competition. One is by monopoly, which is usually illegal, although, if the monopoly is due to patent protection, it may not be. In any event, monopolies are likely to end quite suddenly and do not commend them-selves as vehicles for the safest type of investing. The other way for the honey-jar company to keep the insects out is to operate so much more efficiently than others that there is no incentive for present or potential competition”

“There is a saying in the pharmaceutical industry that, when a truly worthwhile new drug is created, the company that gets in first takes and holds 60 percent of the market, thereby making by far the bulk of the profits. The next company to introduce a competitive version of the same product gets perhaps 25 percent of the market and makes moderate profits. The next three companies to arrive divide perhaps 10 per-cent to 15 percent of the market and earn meager profits. Any further entrants usually find themselves in a quite unhappy position. A trend toward the substitution of generic for trade names may or may not upset these ratios, and in any case there cannot be said to be an exact formula applicable to other industries; nevertheless, the concept behind them should be kept in mind when an investor attempts to appraise which companies have a natural advantage in regard to profitability and which do not.”

“In certain circumstances these can also occur in the area of marketing or sales. An example is a company that has created in its customers the habit of almost automatically specifying its products for reorder in a way that makes it rather uneconom-ical for a competitor to attempt to displace them. Two sets of conditions are necessary for this to happen. First, the company must build up a reputation for quality and reliability in a product (a) that the customer recognizes is very important for the proper conduct of his activities, (b) where an inferior or malfunctioning product would cause serious problems, (c) where no competitor is serving more than a minor seg-ment of the market so. In view of the importance of all this, it is truly remarkable that so few have looked beneath the surface to understand exactly what causes these sharp price changes. Yet the law that governs them can be stated reasonably simply: Every significant price move of any individual common stock in relation to stocks as a whole occurs because of a changed appraisal of that stock by the financial community.”

“The matter of “appraisal” is the heart of understanding the seeming vagaries of price-earnings ratios. It should never be forgotten that an appraisal is a subjective matter. It has nothing necessarily to do with what is going on in the real world about us. Rather, it results from what the person doing the appraising believes is going on, no matter how far from the actual facts such a judgment may be. In other words, any individual stock does not rise or fall at any particular moment in time because of what is actually happening or will happen to that company. It rises or falls according to the current consensus of the financial community as to what is happening and will happen”

“The risk of making a mistake and switching into one that seems to meet all of the first three dimensions but Actually does not is probably considerably greater for the average investor than the temporary risk of staying with a thoroughly sound but currently overvalued situation until genuine value catches up with current prices. Investors who agree with me on this particular point must be prepared for occasional sharp contractions in the market value of these temporarily overvalued stocks. On the other hand, it is my observation that those who sell such stocks to wait for a more suitable time to buy back these same shares seldom attain their objective. They usually wait for a decline to be bigger than it actually turns out to be. The result is that some years later when this fundamentally strong stock has reached peaks of value considerably higher than the point at which they sold, they have missed all of this later move and may have gone into a situation of considerably inferior intrinsic quality.”

“In other words, all the favorable factors, so much in the financial community’s mind when chemical stocks were darlings of the market,continued to be there after they had lost considerable status. But the unfavorable factors so much in the forefront in the 1960s were also there in the earlier period when they were largely ignored. What had shifted was the emphasis, not the facts”

“Today there is a new awareness of the financial strain on small companies with products that are usually leased rather than sold and of the determination of the major com-puter mainframe manufacturers to fight for the market of the products “hung on” their equipment. Have the fundamentals changed or is it the appraisal of the fundamentals that has changed?”

“All this can be summarized in a basic investment rule:The further into the future profits will continue to grow, the higher the price-earnings ratio an investor can afford to pay.”

“All this can be summarized in a basic investment rule:The further into the future profits will continue to grow, the higher the price-earnings ratio an investor can afford to pay. This rule, however, should be applied with great caution. It should never be forgotten that the actual variations in price-earnings ratio will result not from what will actually happen but from what the financial community currently believes will happen”

“In down-ward markets, a change for the worse in the financial community’s image of a company gets accepted far more quickly than a change for the better. Just the opposite is true in rising markets.”

“The only true test of whether a stock is “cheap” or “high” is not its current price in relation to some former price, no matter how accustomed we may have become to that former price, but whether the company’s fundamentals are significantly more or less favorable than the current financial-community appraisal of that stock.”

“When interest rates are high in either the long- or short-term money markets, and even more so when they are high in both, there is a tendency for a larger part of the pool of investment capital to flow toward those markets, so the demand for stocks is less. Stocks may be sold to transfer funds to these markets. Conversely, when rates are low, funds flow out of those markets and into stocks. Therefore, higher interest rates tend to lower the level of all stocks and lower interest rates to raise that level. This fourth dimension to stock investing might be summarized in this way: The price of any particular stock at any particular moment is determined by the current financial-community appraisal of the particular company, of the industry it is in, "

“One of the major steps in pru-dent investment must be to find out about a company’s affairs from those who have some direct familiarity with them.”

“From then on, I was to realize that all the correct reasoning about an investment policy or about the desirability or purchase or sale of any particular stock did not have the least bit of value until it was translated into action through the completion ofspecific transactions.”

“However, in the business world, top-notch managerial ability also calls for another skill that is quite different. This is the ability to look ahead and make long-range plans that will produce significant future growth for the business without at the same time running financial risks that may invite disaster. Many companies contain managements that are very good at one or the other of these skills. However, for real success, both are necessary”

“This matter of training oneself not to go with the crowd but to be able to zig when the crowd zags, in my opinion, is one of the most important fundamentals of investment success.”

“Contrary opinion, however, is not enough. I have seen investment people so imbued with the need to go contrary to the general trend of thought that they completely overlook the corol-lary of all this which is: when you do go contrary to the general trend of investment thinking, you must be very, very sure that you are right.”

“With this in mind, I established what I called my three-year rule. I have repeated again and again to my clients that when I purchase something for them, not to judge the results in a matter of a month or a year, but to allow me a three-year period. If I have not produced worthwhile results for them in that time, they should fire me. "

“He completely agreed with me and asked where the stock had closed that particular afternoon. I told him $34½. He gave me a signif-icant order and said he would pay $33¾ but no more. Over the next day or two the stock fluctuated in a range just fractionally above his bid. It never got down to it. I phoned him twice, urging him to go up a quarter of a point so that I could buy stock. Unfortunately he replied, “No, that is my price.” Within a few weeks the stock had risen over 50 percent and, after allowing for stock split-ups, never again in the company’s history was it to come down to anywhere near where he could have bought it.”

“For this reason, the shares of companies run by abnormally capable people can be tremendous bargains at the time one particular bad mistake comes to light. In contrast, the company that doesn’t pioneer, doesn’t take chances, and merely goes along with the crowd is liable to prove a rather mediocre investment in this highly competitive age”

“For this reason, the shares of companies run by abnormally capable people can be tremendous bargains at the time one particular bad mistake comes to light. In contrast, the company that doesn’t pioneer, doesn’t take chances, and merely goes along with the crowd is liable to prove a rather mediocre investment in this highly competitive age. The other of Dr. Dow’s comments which I have tried to apply to the process of investment selection is “If you can’t do a thing better than others are doing it, don’t do it at all.”

“On this subject, I fear I hold a minority view given the invest-ment psychology prevalent today. Now more than ever, the actions of those who control the vast bulk of equity investments in this country appear to reflect the belief that when an investor has achieved a good profit in a stock and fears the stock might well go down, he should grab his profit and get out. My view is rather different. Even if the stock of a particular company seems at or near a temporary peak and that a sizable decline may strike in the near future, I will not sell the firm’s shares provided I believe that its longer term future is sufficiently attractive”

“So, putting it in the simplest mathematical terms, both the odds and the risk/reward considerations favor holding. There is a much greater chance of being wrong in estimating adverse short-term changes for a good stock than in projecting its strong, long-term price appreciation potential. If you stay with the right stocks through even a major temporary market drop, you are at most going to be temporarily behind 40 percent of the former peak at the very worst point and will ulti-mately be ahead; whereas if you sell and don’t buy back you will have missed long-term profits many times the short-term gains from having sold the stock in anticipation at a short-term reversal. It has been my observation that it is so difficult to time correctly the near-term price movements of an attractive stock that the profits made in the few instances when this stock is sold and subsequently replaced at signifi-cantly lower prices are dwarfed by the profits lost when timing is wrong”

“Buy into companies that have disciplined plans for achieving dramatic long-range growth in profits and that have inherent qualities making it difficult for newcomers to share in that growth”

“Focus on buying these companies when they are out of favor; that is, when, either because of general market conditions or because the financial community at the moment has misconceptions of its true worth, the stock is selling at prices well under what it will be when its true merit is better understood”

“Hold the stock until either (a) there has been a fundamental change in its nature (such as a weakening of management through changed personnel), or (b) it has grown to a point where it no longer will be growing faster than the economy as a whole. Only in the most exceptional circumstances, if ever, sell because of forecasts as to what the economy or the stock market is going to do, because these changes are too difficult to predict. "

“For those primarily seeking major appreciation of their capital, de-emphasize the importance of dividends. The most attractive opportunities are most likely to occur in the profitable, but low or no dividend payout groups”

“Making some mistakes is as much an inherent cost of investing for major gains as making some bad loans is inevitable in even the best run and most profitable lending institution. The important thing is to recognize them as soon as possible, to understand their causes, and to learn how to keep from repeating the mistakes”

“There are a relatively small number of truly outstanding companies. Their shares frequently can’t be bought at attractive prices. Therefore, when favorable prices exist, full advantage should be taken of the situation”

“A basic ingredient of outstanding common stock management is the ability neither to accept blindly whatever may be the domi-nant opinion in the financial community at the moment nor to reject the prevailing view just to be contrary for the sake of being contrary. Rather, it is to have more knowledge and to apply better judgment, …”

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