ALEXANDRIA, VA, (August 7, 1997) -- BUYING A COMPANY WITH A TWENTY-YEAR TIME HORIZON
For the past few days, you have seen numerous promises that we would outline our approach to purchasing companies in a Dividend Reinvestment Plan (DRP). Well, fret no more, good Fool -- it's here! Over the next two days, I will outline the criteria we will be examining when deciding whether or not to purchase shares of a specific company using its dividend reinvestment plan. Today I will focus on participation in a growing business and the company's industry position.
o Participation in a business with a clear, long-term future
You want to avoid purchasing shares of a company in an industry that is declining, an industry about to undergo serious competitive realignment, or an industry that is really, in the end, just a fad. Although many times these are exactly the companies that are statistically the cheapest, because you are committing to purchasing a company's shares on a regular basis over a long time period, the ability to grow the business is much more important than the current valuation.
Declining Industries. Using a Dividend Reinvestment Plan (DRP) to regularly purchase shares of a buggy whip manufacturer or an ice delivery service at the turn of the century would not have been a bright move. Both industries underwent a long, painful decline when shares of those companies looked perpetually cheap on a statistical basis. As a way to tell true decline from a few years worth of softness, true decline normally comes from technological innovation or shifts in cultural norms. You want to focus on buying the cream of the crop when you are committing to investing over periods measured in decades. The Drip Portfolio avoid any industries that we view as declining businesses over the next few decades.
Serious Competitive Realignment. When the future is fuzzy even though it is clear that demand in an industry will go up, it is not always a good idea to commit funds over multi-decade periods when you may not end up betting on one of the top horses. Local telephone companies and utilities both qualify for this status here in 1997. Although reform in both arenas has increased the potential growth going forward, at the same time it has brought into question what the most successful business strategy will be over the next five years, let alone the next twenty. The Drip Portfolio will avoid any company where the competitive landscape going forward is completely up in the air. We don't mind competition -- we just want to have an idea of who will be competing and what they bring to the table.
Fad Companies. Although normally a fad company is not around long enough to even have a DRP, this is not always true and is worth mentioning. Sometimes a company will benefit in the short term from a fad when it is clear that there is no long-term business model in place to continue the growth. It is always worth questioning if a company's short-term performance is the result of fad activity.
o Currently holds one of the top three spots in any industry in which it competes
When you are investing outside of a DRP, sometimes it makes sense to purchase shares in companies that are not absolutely dominant in their industry, but once you start making twenty-year commitments, your margin of error diminishes substantially. In order to assure that you are purchasing shares in a company that can grow consistently at approximately the same rate as the overall industry and that can consistently attract and retain skilled management, buying a company that is tops in its industry is a great way to minimize risk.
Tomorrow we'll take a look at part two, and of course I need to share thoughts regarding Coca-Cola, and then Owens Corning and Kansas City Southern.
--Randy Befumo, Fool
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