Post of the Day: Consistent Cash Creators

This topic will cover some math that is well beyond many novice investors ability to apply; however, the discussion about projecting future growth rates is very helpful. George, does a great job explaining the difficulties businesses face when trying to compound their capital for long periods of time. This is the primary reason why Warren Buffett looks for a business with a "Moat." We will discuss moats and competitive advantages in future posts. Check out Fat Pitch Financials:

Exponential growth is seen in nature when reproduction is not limited by food, space, or disease. When bacteria colonies first form, they often grow exponentially. In the business world, when a radically new product catches on with the masses, or goes “viral”, its sales can grow exponentially for a time.

Young innovative companies with low capital reinvestment requirements can sometimes grow their free cash flows exponentially. However, as time passes on, these exponential growers face resource scarcity, market saturation, and labor scarcity. The law of diminishing marginal returns kicks in and it becomes increasingly more expensive to produce additional units of goods or services because each additional input added is less and less productive. Often while this is going on, competitors seeing these excess profits enter the market and start to drive down prices. It is exceptionally difficult to maintain exponential growth for long in competitive markets. This is the reasoning that has always made me hesitant in using exponential growth rates in my valuations..."

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High Hopes for VISA, Another MasterCard? Google?

I was first exposed to the very bright, very concentrated (small number of positions in his portfolio) Mark Sellers at last year's Value Investing Congress West. He is an investor worth listening to. In this article he talks about great companies and their IPOs (Initial Public Offering). His article discusses some relatively recent, successful IPOs and more importantly he is excited about the upcoming VISA IPO. Enjoy!

When Google completed its initial public offering in August 2004, the stock seemed overpriced. Even after reducing its IPO price from $108 to $85, the company’s trailing price/earnings ratio was well over 200. Journalists, analysts and market pundits exclaimed that Google was the most overpriced IPO in years, and warned investors to avoid it.

Shortly after the IPO, analysts were confused about how to model the company’s earnings. The average analyst estimate for Google’s first quarter as a public company was 56 cents a share, but the range of estimates was all over the map. Clearly, there was no “consensus” earnings number. Most analysts were cautious.

When Google then reported earnings in October 2004, its earnings per share were 70 cents a share, and the stock jumped 15 per cent in one day. Analysts then rushed to increase their estimates for the following quarter, but were again too cautious. The next quarter, Google beat the average analyst estimate by 15 cents, earning 92 cents a share compared with estimates of 77. The quarter after that, Google earned $1.29 compared with the average estimate of 92 cents.

As it turned out, Google’s stock was incredibly cheap at its IPO price of $85..."

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Post of the Day: On the History of Gillette

One of Warren Buffett's more famous investments is his purchase of Gillette stock (now owned by Procter & Gamble (PG). This story detail the history of Gillette and his marketing campaign. Investors can learn alot about building a moat from this article.

At the age of 40, King Gillette was a frustrated inventor, a bitter anticapitalist, and a salesman of cork-lined bottle caps. It was 1895, and despite ideas, energy, and wealthy parents, he had little to show for his work. He blamed the evils of market competition. Indeed, the previous year he had published a book, The Human Drift, which argued that all industry should be taken over by a single corporation owned by the public and that millions of Americans should live in a giant city called Metropolis powered by Niagara Falls. His boss at the bottle cap company, meanwhile, had just one piece of advice: Invent something people use and throw away.

One day, while he was shaving with a straight razor that was so worn it could no longer be sharpened, the idea came to him. What if the blade could be made of a thin metal strip? Rather than spending time maintaining the blades, men could simply discard them when they became dull. A few years of metallurgy experimentation later, the disposable-blade safety razor was born. But it didn't take off immediately. In its first year, 1903, Gillette sold a total of 51 razors and 168 blades. Over the next two decades, he tried every marketing gimmick he could think of. He put his own face on the package, making him both legendary and, some people believed, fictional. He sold millions of razors to the Army at a steep discount, hoping the habits soldiers developed at war would carry over to peacetime. He sold razors in bulk to banks so they could give them away with new deposits ("shave and save" campaigns). Razors were bundled with everything from Wrigley's gum to packets of coffee, tea, spices, and marshmallows. The freebies helped to sell those products, but the tactic helped Gillette even more..."

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Post of the Day: Index of Companies Trading Below Net Current Asset Value

Clyde of CHEAP STOCKs has created a great Index worth tracking. His site is dedicated to Benjamin Graham's method of buying a basket of stocks for a price below their Net Current Asset Value. Please visit his site.

We’ve designed what we believe to be the first index of companies trading below their net current asset value. The main purpose of this index will be to track a passive portfolio of net/nets. This index is chock full of small companies many of which have been beaten down, and some of which may not survive. We’ve developed this index primarily as an attempt to gauge net/net performance using a basket approach.

The Cheap Stocks 21 Net/Net Index is a market cap weighted index comprised of companies that met the following criteria at index inception on Tuesday, February 12th, 2008"

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