Chapter VI

Putting it all together 

What we’re going to cover

We’re now at the final and shortest chapter!  This section focuses in on the thorny issue of selling.  Completed SSG’s will be presented for discussion.  Finally, a discussion on the advantages of getting involved in an investment club will be covered.

Selling

Selling is probably one of the toughest issues.  The matter has been touched on previously, but let’s revisit the issue here.  There are many reasons for selling, most of them bad J.  The worst reason is probably one that’s based on stock price.

There are two costs to selling—both of which have become less serious.  The issues are commission and taxes.  Today with discount brokerage houses, commissions are becoming much less of an issue.  Changes to the tax code have reduced long term capital gains—further decreasing one of the other stumbling blocks to selling.

Broadly speaking, selling falls into one of two categories: having to selling and wanting to sell.  A person with a sudden bill, an interest in purchasing a house, needs to pay a bill, all of these suggest a person who has to sell.  The goal of saving is to delay consumption—save now, buy later.  Once retirement is reached, an investor might want to reap the rewards of many years of diligent effort.  That person might want to sell.  After all, you can’t take it with you.

Reasons for selling center around a few issues; they are

1.    Management can make or break a company.  When a change in management occurs, pay attention to your holding.  If the new ‘team’ has ideas—get worried!  This new team could unravel many years of careful work.  The new team might try new markets, make purchases of what appear to be related business and so on.  Keep your ears and eyes open and read the business press.  Watch pretax profit and ROE quarterly.  Be leery if the new management decides to take on more debt to fund asset purchases.  New management might try to fix what ain’t broke!

2.    Declining profits are a warning of reduced earnings.  If you monitor section 2 of the SSG carefully, you can get an indicator of a problem—you’ve spotted it, you’re looking at management again.  Declining profit margins are usually a warning of either poor control of expenses, intensifying competition or both.  The former can be corrected, the latter must be tolerated.  Do an SSG on the competition—you may find the new leader in the industry.

3.    Keep an idea on the capitalization of the company—the debt level.  When a company increases the debt level, there should be a concomitant increase in sales—otherwise, what’s the point of taking on debt and buying assets?  You can track the debt level from year to year in Value Line.  Debt also gives a short-term boost to ROE.

4.    If you own a small cap company, chances are you own a company with a single idea.  Ideas, like businesses, have a life cycle.  Unless it’s one great idea (and a tiny percentage of companies have it), then the company needs to do something else to survive and thrive.  In a nascent industry, the leader often goes around buying weaker competitors—thus expanding the customer base and adding related products or services.   If a company has a single product or service and you see erosion in the top line of the income statement (revenues), saddle your horse!  If this product is nearing the end of it’s life, the company is in potential jeopardy.

The one basic reason to sell is because future earnings are in peril.  If the company cannot sustain growth in the future, it’s time to find one that can.

Before I leave this subject, I want to quote Gordon Hakes one more time.  Take these words to heart.

“I have made all my mistakes selling.”

Investment Clubs

The great advantage of a club is that you learn with people you like.  Chances are you’re with a group of people with expertise in a broad range of industries.

The ‘template’ for starting a club is described in the official manual: chapters 16 to 23.  It is a superb guide.

Keep in mind one thing about your club.  The membership ‘zones.’  There are three zones, most often they split 20%:60%:20%.  Many organizations ‘zone’ this way!

The first 20% are the “movers and shakers.”  They run the club.  You find them organizing everything—and they’re fun to be with.

The next 60% are the infantry.  They do things that the movers and shakers ask.  They are often the lifeblood of the club.  Sometimes members who are infantry become movers and shakers and vice versa.

Finally, there’s the other 20%, the padding.  The padding usually does nothing; they think they do everything and they complain a lot.  I suggest you realize that organizations have a certain amount of padding; it’s best to grin and bear it.  They can make life intolerable on some rare occasions—but that’s the price we pay for having a society!

I suggest too that you take particular care with the partnership agreement.  It is important to run a club as a business.  Voting should be in proportion to the ownership interest in the club; however, for practical purposes, working on a ‘one member—one vote’ basis works fine—unless something important has to be resolved.

To me the partnership agreement is like an airbag.  You take great care installing it, you hope you never have to see it, but if there’s an emergency, it comes to its own and saves the day!

Other Issues

Receivables, payables and inventories

Accounts receivable, accounts payable and inventories are often the three largest components of ‘working capital.’  Receivables are moneys owed to the company that will soon become cash; payables are moneys owed by the company and inventories are items waiting to be converted or sold.  Actually, inventories come in three flavors: finished goods, these are things ready to be sold.  Work in progress (WIP) inventories are items that are being completed by are not yet finished.  Finally raw materials are items the company bought to convert into finished goods.

Generally, receivables and payables will grow with revenues.  If receivables grow at a slower rate, it means that the company is collecting cash payments more quickly.  If payables grow at a faster rate, it means that the company has obtained better credit terms form suppliers.  Both of these situations are promising.  Inventories should grow with revenues too.  If they start growing faster than sales, it could turn out to affect the company performance.

I have blocked this section out.  It’s still being worked on.  However, I want to cover a few important topics, including what to watch for in the annual report, accounts receivable & sales figures, ‘one time’ charges that companies use.

The next few pages are inserts containing completed SSG’s.  They start in the next section of this document.