Common Stocks and Uncommon Profits and Other Writings

1 8 0
1
The First Dimension
of a Conservative
Investment
Superiority in Production, Marketing,
Research, and Financial Skills
A
corporation of the size and type to provide a conservative invest-
ment is necessarily a complex organization. To understand what 
must be present in such an investment we might start by portray- 
ing one dimension of the characteristics we must be sure exist. This 
dimension breaks down into four major subdivisions: 
LOW-COST PRODUCTION 
To be a truly conservative investment a company—for a majority if not 
for all of its product lines—must be the lowest-cost producer or about 
as low a cost producer as any competitor. It must also give promise of 
continuing to be so in the future. Only in this way will it give its own-
ers a broad enough margin between costs and selling price to create two 

---

 
The First Dimension of a Conservative Investment
1 8 1 
vital conditions. One is sufficient leeway below the break-even point of
most competition. When a bad year hits the industry, prices are unlike- 
ly to stay for long under this break-even point. As long as they do, loss- 
es for much of the higher-cost competition will be so great that some 
of these competitors will be forced to cease production. This almost 
automatically increases the profits of the surviving low-cost companies 
because they benefit from the increased production that comes to them 
as they take over demand formerly supplied by the closed plants. The 
low-cost company will benefit even more when the decreased supply 
from competitors enables it not only to do more business but also to 
increase prices as excess supplies stop pressing on the market. 
The second condition is that the greater than average profit margin
should enable a company to earn enough to generate internally a sig- 
nificant part or perhaps all of the funds required for financing growth. 
This avoids much or even all of the need for raising additional long-
term capital that can (a) result in new shares being issued and diluting 
the value of already outstanding shares and/or (b) create an additional 
burden of debt, with fixed interest payments and fixed maturities (which 
must largely be met from future earnings) which greatly increase the 
risks of the common-stock owners. 
However, it should be realized that, just as the degree to which a 
company is a low-cost producer increases the safety and conservatism of 
the investment, so in a boom period in a bullish market does it decrease 
its speculative appeal. The percentage that profits rise in such times will 
always be far greater for the high-cost, risky, marginal company. Simple 
arithmetic will explain why. Let us take an imaginary example of two 
companies of the same size that, when times were normal, were selling 
widgets at ten cents apiece. Company A has a profit of four cents per 
widget and Company B of one cent. Now let us suppose that costs 
remain the same but a temporary extra demand for widgets pushes up 
the price to twelve cents, with both companies remaining the same size. 
The strong company has increased profits from four cents per widget to 
six cents, a gain of 50 percent, but the high-cost company has made a 
300 percent profit gain, or tripled its profits. This is why, short-range, the 
high-cost company sometimes goes up more in a boom and also why, a
few years later, when hard times come and widgets fall back to eight 
cents, the strong company is still making a reduced but comfortable 
profit. If the high-cost company doesn’t go bankrupt, it is likely to pro-
duce another crop of badly hurt investors (or perhaps speculators who 

---