WARNING: EXREMELY LONG (2-PART) POSTFirst of all: Steven, you are definitely not off the hook.I had the feeling we were losing people in this 15 part thread, so I tried to put together a rough summary to bring myself (& any intimidated lurkers) up to speed.Please don't be offended if I missed something important that you said; I pretty much read over the recommended posts (which are dwindling - why I think we're losing people).If you are feeling intimidated or lost, please come back into the book club. We need you in order to learn together.1. Does the company have products or services with sufficient market potential to make possible a sizable increase in sales for at least several years?Fisher says Those companies which decade by decade have consistently shown spectacular growth might be divided into two groups. For lack of better terms I will call one group those that happen to be goth 'fortunate and able' and the other group those that are 'fortunate because they are able' And then goes on to discuss management ability. What's interesting is that Fisher's bias is clearly toward product companies - those that produce tangibles. Of course, companies that "produce" intangibles were very few at that time. What, I wonder, would be his view of the combinations of software companies and services companies that we're seeing today? (itkin)Companies that are fortunate and able are those companies that I would describe as in the right place at the right time. They have been able to take advantage of the good fortune of being well positioned in a market place where sales are growing not because of their innovations but because of others innovations. I am trying to think of a modern day example, but am having trouble coming up with a good example. I'm sure there are many, does anyone else have any examples? Companies that are fortunate because they are able are those companies who make things happen and are able to look into the future and see things that the rest of the world is unable to see. A company that immediately comes to mind is Microsoft. Bill Gates was able to see the value of acquiring the DOS operating system when IBM didn't. Bill Gates' ability to do this over and over again is well documented. As far as relating point one to the RM criteria, I think Fisher touches on all the first 5 criteria in this point. The first 5 RM criteria essentially elaborate on Fisher's 1st point. The 5 RM criteria are 1.Dominant brand, 2.Repeat purchase business, 3. Convenience, 4. Expanding possibilities, and 5. Your familiarity and interest,. In order for a company's products or services to to have sufficient market potential to have a sizable growth in sales for years and years to come the product must meet most or all the these 5 RM criteria. I like relating Fisher's 15 points back to the RM criteria, and I think it really will help if we can find a more recent example of what each point really means for companies going into the 21st century. (mayacourt)"increase in sales" - well, we've looked at "Sales Growth of at least 10%" - sounds pretty good to me! Of course, thus far we've looked at past history with this criterion, but used it as an indicator of future performance. "market potential" - this sounds a lot to me like a variation on things like "Dominant Brand" and "Expanding Possibilities". On the other hand, Fisher proposes looking at several years at a time, not just a single year-to-year comparison.(itkin)Point 2 = Does the management have a determination to continue to develop products or processes that will still further increase total sales potentials when currently attractive product lines have largely been exploited? Point 1 is a matter of fact…Point 2 is a matter of management attitude.. While short and simple on the surface, FP2 brings up a critical topic that I'd like to open up for discussion: How should we distinguish healthy diversification from unhealthy diworseification(cf. Peter Lynch). F sums it up: a company with research centered around each of these divisions, like a cluster of tress each growing additional branches from its own trunk, will usually do much better than a company working on a number of unrelated new products which, if successful, will land it in several new industries unrelated to its existing business.(mlc) Before leaving FP2, IMHO, the processes developed by the CFO are very important today. Marketing and sales frequently reside in the CFO position. The position may have different labels (not always) and is often listed second to the CEO. To me, Fisher guides us to look at management processes, not just the manager. Fisher cites the importance of joining the marketing organization to the success of the business. Some of this info lies in the SEC management discussions, long and verbose in many instances.(BC). Point 3 = How effective are the company's research and development efforts in relation to its size? The key word here is effective. You can crunch a few numbers, but then you must go back and examine management. F. starts with several warnings concerning what companies consider research spending, but I don't think we need to worry about this as much if we focus on research productivity. In no other major subdivision of business activity are to be found such great variations..between what goes in as expense and what comes out in benefits as occurs in research. By my count, F. discusses 3 types of managerial expertise required for optimal efficiency: 1. leaders who can coordinate the work of people of such diverse backgrounds & keep them driving towards a common goal 2. Close & detailed coordination between researchers working on each developmental project & those thoroughly familiar with both production and sales problems…It is no simple task for management to bring about this close relationship between research, production, and sales F later returns to this idea, stressing the importance of a market research organization. The closest I'll come to doing my RM parallel is to point out that this is what set PFE apart from other research pharmaceuticals, and may be in large part responsible for its success. 3. Top management must understand the fundamental nature of commercial research..In essence they must practice appropriate DD, followed by LTBH. ..once a project is started, to allow budget considerations and other extraneous factors to curtail or accelerate it invariably expands the total cost in relation to the benefits obtained. So what's an investor to do? Wanna guess? Time's up. Scuttlebut However, F concedes that A simpler and often worthwhile method is to make a close study of how much in dollar sales or net profits has been contributed to a company by the results of its research organization during a particular span, such as the prior 10 years.(mlc) Another way to look at this is to follow the $1 premise looking at how much in net income was created by each $1 invested in R&D. This has been posted on this board in the past for Intel and a couple of others. (Phil Weiss). Point 4. Does the company have an above-average sales organization? In this competitive age, the products or services of few companies are so outstanding that they will sell to their maximum potentialities if they are not expertly merchandised. It is the making of a sale that is the most basic single activity of any business. Without sales, survival is impossible. Because sales effort does not readily lend itself to ... formulae, many investors fail to appraise it at all in spite of its basic importance in determining real investment worth. Pretty straightforward, this one. I am definitely left with questions, namely "above average sales force compared to whose?" and also just how we are to appraise it, given that it doesn't lend itself to quantitative analysis. As for that last one, of course, we can always ask ourselves how many ads we, the consumer, have seen for that company lately. As for the first one, I have no answers but I would assume it's fair to compare a company to other companies within the industry. Some industries naturally seem to involve more advertising/sales than others. Examples of heavily advertised industries would be soft drinks and clothing retail... more lightly advertised industries might include plumbing supplies and non-cellular telephones. Having pulled those examples out of thin air, I might see a rule of thumb here: the more optional it is for a consumer to contribute to an industry, the more important a good sales force becomes to a company in that industry. If a consumer really needs a product, he/she will seek it out, sales force or no. What do you guys think? I think the nearest approach to this in the RM philosophy is the "dominant brand" requirement, as it requires a good sales force (good if the product is great, great if the product is merely okay) to achieve widespread "mindshare" and consumer recognition. However, it is possible to have an excellent sales force that still does not make a company a dominant brand, at least in the minds of consumers, if the sales force aims only at customers and the company only sells to other companies. (Not sure if this is off topic, but...) I believe, for example, that Cisco has only recently begun its campaign to win over the public, but this alone would not be enough for me to discredit the work of their sales force in years past.(lemming)First, a couple of comments. Tom Peters and Peter Drucker are two of my favorite authors on management. Peters writes about beating the competition through skill enhancement and putting sales and service first. This sounds like Fisher knew what he was talking about. How to find someone is mentioned in badlemmings post, in his statement when he says to ask the salesperson. Agreed! How to find this person? I guess I would offer what has worked for me and that is networking through friends and acquaintances I see at church, alumni meetings, business organizations, cocktail party or wherever. If I am seeking a person affiliated with business, I usually find someone who knows someone right in my own community (IBM salesman). I bought him lunch and took it off my taxes. I never had anyone turn down a question about their business, of course, this is not always possible. And what about the MF Boards, I have seen this kind of question posed. Lastly, I would like to revisit the question of time spent training salespersons based on personal experience. New technology and the salesperson are invaluable. For example, in my operating room experience the salesperson was there to answer questions when new technology was employed. The technical expertise is only gained through experience, and they have it (often animal practice, hope no one from PETA is out there). Yes, the surgeon has taken training with the technology and has videos, but those salesperson's technical input with their product is amazing (new joint prosthesis require unbelievable instrumentation-sometimes just mixing the glue is a real deal, harmonic scapel, lasers, laproscopic tools, complex catheters, implants, and now robotics.) With technological advances in medicine, that meant something new just about every week. Some things are attached to complicated machines with settings you can't imagine. Yes, sometimes a procedure with new tech couldn't be scheduled because the salesperson was not available, he/she was updating his knowledge, we waited until they were available to implement new technology. New technology, more training for implementation, regardless of the field. (BC) Point 5. Does the company have a worthwhile profit margin? Profit margin being, of course, net income divided by revenue: how much of every sales dollar is retained as net earnings? The value of this metric to a company is obvious--a tightly run company will keep every penny it can for every dollar a consumer sends its way. Note that you should compare a company to its competitors, in Fisher's view (deviating slightly from the RM criteria in which all companies may be compared to each other), and that "such a study should be made, not for a single year, but for a series of years." Fisher is careful to point out that "young companies" sometimes spend their money on growth, R&D, and sales when they otherwise could have used it to report a high profit margin. He simply cautions us to be sure the activities bringing down the margin are productive. (A comparison of net margin to gross margin seems to scream to be included here, but he does not mention gross margin... hmmm.) "Older and larger" companies, on the other hand, have no excuse for anything but a broad profit margin. Boy is this ever an easy one to relate to the RM criteria. The Fool agrees, and nominates 7% as the definition of "worthwhile", although there is a strong faction arguing for 10%. End of comparison. :) Fisher's argument for letting "young companies" get away with less is straying into Rule Breaker territory, which I'm not an expert on.(lemming) I found the discussion regarding marginal and lower cost companies particularly interesting. For Fisher, the companies with the highest profit margins over the short-term may be the weakest companies, depending on the market conditions. Fisher really likes to look at things over 10 year time horizons whether its past calculations or looking into the future (cruncher)Point 6. What is the company doing to maintain or improve profit margins? The success of a stock purchase does not depend on what is generally known about a company at the time the purchase is made. Rather it depends upon what gets to be known about it after the stock has been bought. Therefore it is not the profit margins of the past but those of the future that are basically important to the investor. Net profits of the future? We are definitely moving ahead of the standard RM criteria!! To increase profit margins, a company can increase price (bad in the long run) or decrease cost of production (good). Some companies acheive great success by maintaining capital-improvement or product-engineering departments..Many companies are constantly reviewing..to see where economies can be brought about. To see how this is done in practice, search the RM & DRIP archives for columns on INTC. These guys are masters of FP6. I'd love to hear about other companies, and how we can make an educated prediction about their future profit margins. The prospective investor should give attention to the amount of ingenuity of the work being done on new ideas for cutting costs and improving profit margins. Here the scuttlebut method may prove of some value, but much less so than direct inquiry from company personnel. Fortunately, this is a field about which most executives will talk in some detail. Any net based ways to investigate companies in this regard? (mlc)PF point 7: "Does the company have outstanding labor and personal relations?" In essence Fisher acknowledges the direct connection between profitability and the feelings of self worth of the individual worker. As an entrepreneur I have often experienced first hand the destructively negative impact that demoralized workers have on a companies profitability. They often revert to go slows, indifference and sometimes outright sabotage to get their own back against the bosses. That type of management then more often than not revert to harsher methods to attempt to improve the situation. A downward spiral into eventual financial oblivion, although unscrupulous management might continue running such a unhappy company for many years only for their own personal benefit. Fisher expresses a great wisdom when he says; "If workers feel that they are fairly treated by their employer, a background has been laid wherein efficient leadership can accomplish much in increasing productivity per worker." The interesting aspect is his empowerment of the 'leadership' which is required to increase productivity. Theory Z was it? Get their consent then tell them (lead them) what to do. I tried to run a couple of companies by mutual consent with very arbitrary results, workers need to be lead. Unhappy workers lead to higher expenses in loss of production, cost of training new workers and so into a declining Gross Margin and resultant Net Margin - directly connecting us to the Rulemaker metrics. Scuttlebut (Where does this word come from? Scuttling your but around to get information?) is the only answer to get the low down on human relations in the company. Most of the indicators are not at all visible or discernable except by careful and in depth investigation. It probably requires talking to the workers themselves to get a feel for the human relations attitude of management. Invariably a bad management attitude will not be evidenced in public, more likely than not there will be a deviousness designed to fool even the most dedicated questioner. The guilty lie much better than the non guilty. This is one area of DD where it is quite difficult to get real hard evidence of bad relations. I say, if your investigations result in a bad smell, it is not necessary to prove the source of the smell. Just get out of range. Fisher does of course give us all the pointers which enable us to draw up a questionnaire and perhaps even a spreadsheet where we could create weightings out of ten for each of his areas of concern. We can then Scuttle our buts to dig up the evidence and put a totally subjective (on most) percentage against each factor. I absolutely adore trying to do that type of quantification, but inevitably it only confirms what our noses told us long ago and so often it turns out to be a waste of time. Human nature will prevail though, we get so greedy because everything else looks so good that eventually we convince our noses to get used to the smell. That is why I find TMF and the boards so very valuable. They serve as sounding boards (really?) and bring us back to our senses. (Of smell as well I hope.) Then again when the greed runs we will ignore the sounding boards and know that only we are right - not so fellow Fools? (Been there done that got the burnt T shirt.) (aikona) http://www.cepnyc.org/profiles.htm (helpful link)Point 8. Does the company have outstanding executive relations? Fisher speaks of creating a good working atmosphere for executive personnel. In particular, he cites promotions based on ability, competitive salaries with adjustments when merited, and promoting from within the organization as much as possible. He also points out that there will always be a certain amount of factionalism and human friction in such situations. In a well-managed company, these will be kept to a minimum. Point 9. Does the company have depth to its management? Fisher observes that humans are "finite", as he puts it. They're finite in two ways--in lifespan, and in the amount of work they can handle. Depth in management means more than having someone who can replace a key leader, if necessary. Fisher believes that once a company reaches a certain size, it can no longer be effectively run by one person alone--there comes a point when delegation is necessary. Thus, depth of management also means having competent executives who can effectively run various parts of the business. In Point 9, Fisher adds an item to his Point 8 critera: giving executives responsibilties and letting them carry out those responsibilities without interference. Such a policy allows executives to develop their abilities to perform duties and solve problems, and thus become more competent and experienced. Fisher also believes that good management will welcome and evaluate suggestions from personnel, even if they're critical of current company practices. In my mind, Points 8 and 9 are very closely connected. It reminds me of what Fisher did with Points 1 and 2 (re sales growth)--one is an extension of the other. Point 8 looks for companies where execs are allowed to work effectively; Point 9 looks for the product of that climate, a very competent upper-level management. Relation to RM criteria: RM doesn't deal directly with caliber of management. Rather, RM seems to focus on the results of management -- the commercial success of the company's products and the excellence of the various metrics we calculate. In my own mind, I tend to connect Points 8 and 9 with Expanding Possibilities. When I think of expanding possiblities, I think of how well a company is prepared to handle the future and whatever problems and challenges that may hold. My favorite companies are the ones whose management inspires confidence in me--they have the ability to grow and change with the times, and to compete successfully in the long run. I think that kind of success comes, in part, from management's collective self-confidence and good working relations. (Lynne) Point 10. How good are the company's cost analysis and accounting controls? Today financial statements that are provided to the SEC by large companies are basically prepared in accordance with GAAP which is Generally accepted accounting principles. GAAP applies to the broad concepts or guidelines for detailed practices of accountants, whether a CPA or an internal company CFO. These guidelines provide the principles that make up the framework of the accounting practicies that the investor can expect have been used to provide the figures for the financial statements filed with the SEC. One of the key points of the principles of GAAP is reliability or quality of information. Just as over the years the SEC has improved and standardized requirements for securities, GAAP has improved and standardized the requirements for accounting and financial statements. It seems to me that today the reliability of information provided in financial statements is much more certain than in the days that Mr. Fisher wrote CSUP. Questions about the reliability of a companies financial records could be addressed by looking at the qualifications of the CFO of the company in question as well as the qualifications of the companies accountants. Also investigating issues such as frequency and types of audits performed. Information regarding the name of the accounting firm that has prepared the financial statements is provided within the accountant's opening letter or statement of opinion. This letter or opinion will state the level of examination performed by the accountants. In addition the accountant will offer an opinion regarding the financial position of the company examined as well as the quality of the records provided. Accountants who are members of the American Institute of Certified Public Accountants must abide by a code of professional contact which further enhances the likelihood that the statements and records are adequate. I do not think the issue of quality of financial statements, in this context, is addressed in the RM criteria. IMO verifying that the financial statements are properly prepared in accordance with GAAP by an accounting firm or accountant who is a member of the American Institute of Certified Public Accountants is very easy to do and offers adequate protection for investors. (Deb Brown) If you still have the stomach, proceed to the next post for FPs 11-15....
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