偶看新闻ff14皇帝的新裤子:晨星投资课程2
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201-Stocks and Taxes
Course 201:
Stocks and Taxes
Unlike death, taxation can at least be minimized. In this lesson, we will
examine the basic framework of individual taxation in the United States as it
relates to stock investing and review some simple steps you can take to be a
more tax-efficient investor.
The information in this lesson is not necessarily exclusive to stock
investing; much of it is also relevant to mutual fund investing. Nevertheless,
if you are going to invest in any asset class, including stocks, it is
imperative to understand exactly how taxes work so you may keep as many
dollars as possible in your pocket and away from Uncle Sam.
Ordinary Income Versus Capital Gains
Capital gains--the difference between what you sell a stock for versus what
you paid for it--are "tax preferred," or taxed at lower rates than ordinary
income. Ordinary income includes items such as wages and interest income.
Capital gains arise when you sell a capital asset, such as a stock, for more
than its purchase price, or basis. Capital gains are further subdivided into
short term and long term. If a stock is sold within one year of purchase, the
gain is short term and is taxed at the higher ordinary income rate. On the
other hand, if you hold the stock for more than a year before selling, the
gain is long term and is taxed at the lower capital gains rate.
Conversely, you realize a capital loss when you sell the asset for less than
its basis. While it's never fun to lose money, you can reduce your tax bill by
using capital losses to offset capital gains. Also, to the extent that capital
losses exceed capital gains, you can deduct the losses against your other
income up to an annual limit of $3,000. Any additional loss above the $3,000
threshold is carried over to the be used in subsequent years. (Note that due
to the IRS' wash-sale rule, you cannot claim a loss if you purchase
substantially identical securities 30 days before or after the sale.)
Jobs & Growth Tax Relief Reconciliation Act of 2003
Among other things, the 2003 tax cut (known affectionately as JGTRRA) lowered
the tax rate for both long-term capital gains and qualified dividends to 15%
for most taxpayers, and to 5% for taxpayers whose income places them in the
10% or 15% income tax brackets.
Since the basic idea behind the dividend tax cut was to reduce the burden of
"double taxation," or taxation of the same profits at both the corporate and
shareholder level, any dividends paid out of profits not subject to corporate
taxation will not be considered "qualified dividends" eligible for the reduced
tax rate. Therefore, one notable exception is dividends from real estate
investment trusts, or REITs, which are typically still taxed at ordinary
income rates. In addition, to qualify for the reduced dividend tax rate, you
must have held a stock for at least 60 days out of the 120-day period
beginning 60 days before the ex-dividend date (the date on which you must be
holding a stock to receive the dividend).
Unless the provisions of the 2003 tax cut are extended, the lower rates for
long-term capital gains and qualified dividends will expire in 2009. In that
year, the old 20% and 10% rates for capital gains will return, and all
dividends will again be taxed at ordinary income rates. However, in 2008, the
special 5% tax rate for lower-income taxpayers will drop to 0%.
Tax-Advantaged Accounts
One easy way to become a more tax-efficient stock investor is to utilize
tax-advantaged accounts such as 401(k)s and individual retirement accounts
(IRAs). These special accounts allow you to enjoy either tax-deferred or
tax-free growth of your investments.
Tax deferral can lead to significant savings over time. Let's assume two
investors each start with $10,000 and earn a 10% annual return for 30 years.
One has 100% of her gains tax-deferred, while the other realizes the full
amount of his capital gains each year and pays a 20% tax on those gains. Under
this scenario, the tax-deferred investor ends up with almost $75,000 more at
the end than the investor with the taxable gains.
Clearly, it is worthwhile to learn about the types of tax-advantaged accounts
available. Below are some of the most popular:
401(k)s
401(k) plans, so named after a section of the Internal Revenue Code, are set
up by employers as a retirement-savings vehicle. The primary advantage of a
401(k) is tax deferral. First, employees can contribute a percentage of their
income from each paycheck to their own 401(k) accounts on a pretax basis. This
means the amount you contribute to your 401(k) is exempt from current federal
income tax. For example, if you are in the 25% income tax bracket, a $100
contribution will reduce your current tax burden by $25. Second, dividends and
capital gains earned inside a 401(k) are not subject to current taxation. In
short, 401(k) plans allow you to defer taxation on dividends, capital gains,
and a portion of your wages until you begin withdrawing from the plan,
presumably during retirement, when you may be in a lower tax bracket. (All
withdrawals are taxed at ordinary income rates.)
The amount you can contribute to your 401(k) plan is limited to $14,000 in
2005 and $15,000 in 2006. Thereafter, the annual contribution limit can be
adjusted in $500 increments to account for inflation. You also must begin
mandatory withdrawals from your 401(k) when you reach age 70 1/2. Withdrawals
made before you turn 59 1/2 are taxed as ordinary income, and you may be
subject to an additional 10% penalty.
Traditional IRAs
Individual retirement accounts are another vehicle for tax deferral. When you
contribute to a traditional IRA, the IRS allows you to take an income tax
deduction up to the amount of the contribution, subject to income limitations.
In addition, dividends and capital gains earned inside a traditional IRA are
not subject to tax until withdrawal.
However, there are some important limitations to remember. First, you must be
age 70 1/2 or under with earned income to contribute to a traditional IRA.
Second, the annual contribution limit is $4,000 from 2005 to 2007. The limit
rises to $5,000 in 2008, and thereafter can be adjusted in $500 increments to
account for inflation. If you are age 50 or older, you can make additional
"catch-up" contributions of $500 in 2005 and $1,000 from 2006 onward. Finally,
like 401(k) plans, you must begin mandatory withdrawals when you reach age 70
1/2. Withdrawals made before you turn 59 1/2 are taxed and may be subject to
an additional 10% penalty.
Roth IRAs
These are typically the best retirement account option for many taxpayers. As
with traditional IRAs, interest income, dividends, and capital gains
accumulate tax-free. However, the main feature of Roth IRAs is that they are
funded with aftertax dollars (contributions are not tax deductible). The
upside of this is that qualified distributions from a Roth IRA are exempt from
federal taxation.
The Roth IRA has the same annual contribution limits and "catch-up" provisions
as a traditional IRA, but you must meet certain income requirements to
contribute to a Roth IRA. Generally, single filers with income up to $95,000
and joint filers with income up to $150,000 are eligible to make the full
annual contribution to a Roth IRA. Contributions to a Roth IRA can be
withdrawn at any time without paying taxes or penalties, but withdrawal of
earnings may be subject to income taxation and a 10% early withdrawal penalty
if made before you turn 59 1/2.
In addition, the distribution must also be made after a five-tax-year period
from the time a conversion or contribution is first made into any Roth IRA.
So, if you open your first Roth IRA and make your first contribution on April
15, 2005, for the 2004 tax year, your five-year period starts on Jan. 1, 2004.
Assuming you meet the other requirements, distributions made in this case
after Dec. 31, 2008, from any Roth IRA will receive tax-free treatment.
Tax Planning 101
Besides taking advantage of 401(k) and IRA accounts, you can also follow a few
basic planning strategies for investments held in taxable accounts. However,
you should keep in mind that your goal as an investor should be to achieve the
highest aftertax rate of return, not to avoid paying taxes. Taxes are a
consideration, but they should not control your investment decisions.
The Value of Deferral and Stepped-Up Basis
All things being equal, it is better to pay taxes later than sooner.
Therefore, you should endeavor to defer taxation as long as possible. An
investor who purchases the shares of sound businesses and patiently holds them
will not only enjoy the benefits of tax-free compounding, but will also save
on brokerage commissions. At the least, toward the end of the year, you should
consider delaying the realization of capital gains until January to defer your
tax liability until the following year.
If you are extremely patient and die still owning a stock, your beneficiaries
will receive the stock with a "stepped-up" basis, or a basis equal to the
market value on the date of your death. Your beneficiaries can then sell the
stock and owe no tax on the capital gains accumulated during your lifetime.
There are special limitations on basis step-up if you happen to die in 2010,
but after that year, the rule returns in its current form.
Wait for Long-Term Capital Gain Treatment
If you purchased a stock on Jan. 1, 2005, selling it for a gain on Dec. 31,
2005, is likely not to be a smart tax move. In this case, your capital gain is
short term and taxed at ordinary income rates. Had you sold the same stock a
few days later on Jan. 2, 2006, the gain would have been treated as long term
and taxed at the lower 15% or 5% rate, and in addition would be delayed
another year.
Take Short-Term Losses
If you happen to have both short-term and long-term capital gains, you may
want to consider realizing short-term capital losses on stocks you have held
for less than one year. These short-term losses will offset your short-term
gains, which are taxed at higher ordinary income rates. This will give you the
most tax mileage for your capital loss.
Timing Capital Gains and Losses
When faced with large capital gains and losses, it may be advantageous for you
to realize both in the same year. Suppose you have $30,000 of capital gains
and $30,000 of capital losses. If you realize the gain in 2005, you will have
to pay tax on the entire $30,000. If you decide to realize your loss in 2006,
you'd have no capital gains to offset it, and you could only deduct $3,000
against your other income. The remaining $27,000 loss must be carried over
into future years. Instead of delaying the tax benefits of your loss, you
could choose to realize both the capital gain and loss in the same year. Since
they completely offset each other, you would not owe any taxes. On the other
hand, if you do not have a large capital loss to offset, you should generally
time the realization of long-term capital gains--which will be taxed at
favorable rates--for years when you do not realize any capital losses. Then
you can realize your future capital losses in years when you can immediately
deduct them against other income that may be taxed at higher ordinary income
rates.
The Bottom Line
As you can see, taxes can have a meaningful impact on your long-term
investment performance. Investing in stocks without regard to the tax impact
can greatly reduce your return. But by understanding the basic framework of
investment taxation and using a few simple tax-planning strategies, you can
work to maximize the only number that matters in the end: the amount of money
that goes into your pocket.
Course 203: Understanding the News
"The Dow fell 71 points today…"
"The S&P 500 continued its recent climb…"
"ABC Company missed its quarterly earnings target…"
"XYZ Company's shares jumped $2 as a result of analyst upgrades…"
These are common statements you may hear on any given day as you flip past a
financial news channel on your TV or scan the headlines in your newspaper. But
what are the Dow and the S&P 500? What is the Nasdaq? What happens when a
company misses earnings targets or gets upgraded or downgraded by analysts?
What does any of this stuff mean to you, as an investor?
In this lesson, we are going to focus on building an understanding of some of
the things you may typically hear in the financial news. Then we are going to
learn how to separate what actually matters from what is nothing more than
"noise."
Stock Indexes
A stock index is simply a grouping or a composite of a number of different
stocks, often with similar characteristics. Stock indexes are typically used
to discuss the overall performance of the stock market, in terms of changes in
the market price of the stocks as well as how much trading activity there is
in any particular period. Three of the most widely followed indexes are the
Dow Jones Industrial Average, the S&P 500, and the Nasdaq Composite.
The Dow Jones Industrial Average
Known as just the "Dow" for short, this index is not really an average, nor
does it exclusively track heavy industry anymore. The index is composed of 30
large stocks from a wide spectrum of industries. General Motors GM and General
Electric GE are the only two companies that have been part of the Dow Jones
Industrial Average since it was created in 1928. The latest change to the Dow
was the addition of insurance company American International Group AIG,
pharmaceutical firm Pfizer PFE, and telecommunications company Verizon VZ in
April 2004, while AT&T T, Eastman Kodak EK, and International Paper IP were
dropped to make room.
At the close of business on Jan. 1, 2005, the Dow stood at 10,783. How is this
figure calculated?
The index is calculated by taking the 30 stocks in the average, adding up
their prices, and dividing by a divisor. This divisor was originally equal to
the number of stocks in the average (to give the average price of a stock),
but this divisor has shrunk steadily over the years. It dropped below one in
1986 and was equal to 0.135 in January 2005. This shrinkage is needed to
offset arbitrary events such as stock splits and changes in the roster of
companies. With the divisor at 0.135, the effect is to multiply the sum of the
prices by about 7.4. (The numeral one divided by 0.135 is approximately 7.4.)
To look at it another way, each dollar of price change in any of the 30 Dow
stocks represents a roughly 7.4-point change in the Dow.
Because the Dow includes only 30 companies, one company can have much more
influence on it than on more broad-based indexes. Also, since the prices of
the 30 stocks are added and divided by the common denominator, stocks with
larger prices have more weight in the index than stocks with lower prices.
Thus, the Dow is a price-weighted index. It's also useful to remember that the
30 stocks that make up the Dow are picked by the editors of The Wall Street
Journal, rather than by any quantitative criteria. The editors try to pick
stocks that represent the market, but there's an inevitable element of
subjectivity (and luck) in such a method.
Despite its narrower focus, the Dow tracks quite well with broader indexes
such as the S&P 500 over the long run.
The S&P 500
The Dow Jones Industrial Average usually gets most of the attention, but the
S&P 500 Index is much more important to the investment world. Index funds that
track the S&P 500 hold hundreds of billions of dollars, and thousands of fund
managers and other financial professionals track their performance against
this ubiquitous index. But what exactly is the S&P 500, anyway?
The Standard & Poor's 500 as we know it today came into being on March 4,
1957. The makers of that first index retroactively figured its value going
back to 1926, and they decided to use an arbitrary base value of 10 for the
average value of the index during the years 1941 through 1943. This meant that
in 1957 the index stood at about 45, which was also the average price of a
share of stock. The companies in the original S&P 500 accounted for about 90%
of the value of the U.S. stock market, but this percentage has shrunk to just
more than 80% today as the number of stocks being traded has expanded.
Although it's usually referred to as a large-cap index, the S&P 500 does not
just consist of the 500 largest companies in the U.S. The companies in the
index are chosen by a committee at investment company Standard & Poor's. The
committee meets monthly to discuss possible changes to the list and chooses
companies on the basis of "market size, liquidity, and group representation."
New members are added to the 500 only when others drop out because of mergers
or (less commonly) a faltering business.
Some types of stocks are explicitly excluded from the index, including real
estate stocks and companies that primarily hold stock in other companies. For
example, Berkshire Hathaway BRK.B, the holding company of Warren Buffett,
arguably the world's greatest investor, isn't included, despite having one of
the largest market values of all U.S. companies. Also, the index is composed
exclusively of U.S. companies today.
Size matters with the S&P 500. Because the companies chosen for the index tend
to be leaders in their industries, most are large firms. But the largest of
the large-capitalization stocks have a much greater effect on the S&P 500 than
the smaller companies do. That's because the index is market-cap-weighted, so
that a company's influence on the index is proportional to its size.
(Remember, a company's market cap is determined by multiplying the number of
shares outstanding by the price for each share.) Thus, General Electric and
ExxonMobil XOM, with the two biggest market caps among U.S. companies,
accounted for 3.4% and 2.9%, respectively, of the S&P 500 as of the beginning
of 2005. In contrast, other smaller companies can account for less than 0.1%
of the index.
The Nasdaq Composite
The Nasdaq Composite was formed in 1971 and includes the stocks of more than
3,000 companies today. It includes stocks that are listed on the
technology-company-heavy Nasdaq stock exchange, one of the market's largest
exchanges. (Other major stock exchanges include the New York Stock Exchange,
or the NYSE, and the American Stock Exchange, or AMEX.) Like the S&P 500, the
Nasdaq is a market-cap-weighted index. For a stock to be included in the
Nasdaq Composite, it must trade on the Nasdaq stock exchange and meet other
specific criteria. If a company fails to meet all of the criteria at any time,
it is then removed from the composite.
"Noise" Versus News
Anyone interested in keeping up with current business events has plenty of
opportunity. Walk into any newsstand, and you'll see all kinds of newspapers
and magazine titles dedicated to the business world. Cable television offers
several business news channels. And the Internet provides countless business
and financial Web sites.
Oftentimes, events in the news cause stock prices to move both up and down,
sometimes dramatically. Sometimes the market's reaction to the headlines is
warranted; many other times, it's not. For an investor, the real challenge is
deciphering all of the headlines and stories to determine what is really
relevant for your stocks.
Here at Morningstar, we practice the discipline of scouting out great
companies with long-term competitive advantages that we expect will create
shareholder value for the foreseeable future. Then we wait until their stocks
become cheap before investing in them for the long haul. In keeping a watchful
eye out for solid investment opportunities, we constantly monitor and evaluate
the ever-changing business environment. As we digest the events that affect
any given company, we continually ask ourselves, "Does this information affect
the long-term competitive advantages and resulting cash flow of this company?
Does it change the stock's long-term investing prospects?"
This is key to understanding the investment process. Periodically, news will
break that does not affect a company's long-term competitive advantages, but
its stock price will fall anyway. This may lead to a buying opportunity.
Remember, "Mr. Market" tends to be quite temperamental, and not always
rightfully so.
Negative Earnings Surprises
Wall Street is full of professionals whose job is to analyze companies and
provide opinions about them and estimates about their future financial
results. While most of them are very intelligent individuals who have a wealth
of information and experience, they tend to be much too shortsighted. These
analysts typically will come up with "earnings estimates" for the upcoming
three-month period. If a company's actual results fall short of analysts'
expectations, this is known as a "negative earnings surprise." On such
disappointing news, the company's stock price may fall. (Conversely, if a
company performs better than what analysts expect, it will have a "positive
earnings surprise," which may cause the stock price to increase.)
Let's pretend that Wal-Mart WMT announced earnings that fell short of
analysts' estimates by a measly two cents a share because it didn't sell as
many widgets during the holiday season as people expected. Let's also assume
that the stock fell on the disappointment. Does this disappointing shopping
season mean that Wal-Mart's long-term competitive advantages have been eroded?
Probably not. Wal-Mart remains the largest retailer in the world, with great
economies of scale and a remarkable distribution network, which allows the
company to pass huge cost savings on to customers, which, in turn, keeps
customers coming back. So it fell slightly below analysts' estimates in one
particular quarter…big deal!
Analyst Upgrades/Downgrades
In addition to providing estimates of what they think a company's sales and
earnings will be, Wall Street analysts also provide recommendations for stocks
they cover, such as "Buy," "Hold," or "Sell." When an analyst changes his or
her rating for a company's stock, the stock price often moves in the direction
of the change. Does this upgrade or downgrade affect the business prospects of
the company? No, the opinion of one person does not alter the intrinsic value
of the firm, which is determined by the company's cash flows. But maybe the
analyst made the change because he or she thought the company's business
prospects have deteriorated. Maybe that's right, maybe not. Check it out, and
decide for yourself.
Newsworthy Events
Other times investors will hear about events that have them running for cover,
and rightfully so. One such event is the announcement of a regulatory
investigation by an organization such as the Securities and Exchange
Commission or the Department of Justice. While such announcements by
themselves by no means predict impending doom, who knows what nasty surprises
may lurk for investors as regulators start turning over rocks? Plenty of
investors have been burned badly by the results of such investigations--just
ask the shareholders of Enron, Tyco TYC, or WorldCom.
Another item to be wary of is a significant lawsuit. Corporate litigation is
almost everywhere you look (these days, it's almost a normal part of doing
business), and estimates of any significant legal damage are usually already
priced into a stock. However, lawsuits often attract others, which could place
very large uncertainties on a company's performance.
A great example of how such legal issues can affect the true value of a
company is occurring at the time of this writing. Bellwether drug manufacturer
Merck MRK is experiencing a double-whammy related to litigation. Vioxx,
Merck's arthritis-pain-relieving drug that was once perceived as a
blockbuster, has been linked to heart problems in patients taking it. The
company had to recall Vioxx from the market, and it is facing serious legal
liabilities. Shortly thereafter, a court ruling shortened the patent life on
Merck's number-two-selling drug Fosamax, meaning competitors can introduce a
substitute much quicker than previously thought. Both situations have the
ability to seriously reduce Merck's future cash flows.
The Bottom Line
Successful investing requires you to keep a steady hand. Your patience and
willpower will get regularly tested as the stock market reacts to news,
sometimes justifiably, other times not. Just remember that not every bump in
the road is the edge of a cliff. If you react by racing to sell your stocks on
every little piece of bad news, you will find yourself trading far too
frequently (with the requisite taxes and commissions), and often selling at
the worst possible time. But by using focused discipline in separating the
news that matters from the noise that doesn't, you should emerge with
satisfactory investment results.
Course 204:
Start Thinking Like an Analyst
Investing is far more than just learning basic accounting and crunching
numbers; it is also about observing the world around us. It is about
recognizing trends and what those trends will ultimately mean in terms of
dollars.
Thinking like an analyst can help because it can provide some organized ways
in which to observe the world. We all have analytical skills, but the degree
to which these skills are developed depends on the individual. Honing your
analytical skills can help you organize some of the information that
overwhelms you each day.
For example, it's hard not to notice how fast food restaurants are all located
near one another. Maybe this is an obvious question, but why is that? Clearly
those restaurants located at the only exit for 50 miles in the middle of
Kansas don't have much choice, and certainly business and residential zoning
regulations dictate locations to some extent. But why do all of the
quick-service restaurants locate near one another when alternatives are
available? After all, what good does it do for some of these restaurants to be
located in clusters? What happens to McDonald's MCD if Wendy's WEN is right
next door?
Four Basic Questions
The answers to these questions for restaurants, or for any business, can be
found by asking four very general questions to kick-start the analyst thought
process:
1. What is the goal of the business?
2. How does the business make money?
3. How well is the business actually doing?
4. How well is the business positioned relative to its competitors?
Once you start thinking in these terms, and sharpen your observational skills,
you'll be well on your way to thinking like an analyst, constantly on the hunt
for investment opportunities.
The goal of restaurants, for example, is to feed customers. This seems pretty
straightforward--although some restaurants have also tried to combine meals
with entertainment to mixed success--but don't just assume a business's
purpose is obvious. Be sure you have a good idea of what it's really trying to
achieve. Then ask if it makes sense for this business to try to achieve this
objective. Does it make sense for a restaurant to also entertain customers,
for example?
Once you have a good idea of what the business is trying to do, think about
how it makes money. In our restaurant example, how much does the food in the
restaurant actually cost? Can the restaurant charge more for its food because
of a pleasant ambiance or because it is providing entertainment? Is the
restaurant trying to sell a lot of meals at a low price, or is it attempting
to sell fewer meals but at a much higher profit per meal?
Then ask yourself, "How well is the business doing?" Don't worry about picking
up any financial statements just yet; rather, focus on observing what you can
about the business. Back to our restaurant example, think about where you
choose to eat and why. Has your favorite place been around a long time? Are
there lots of locations for your favorite restaurant? Are they busy, with
people in line or in the parking lot? Are they in good locations? Do they seem
to get a lot of repeat business? Do they seem to have a better caliber of wait
staff? How fancy are the interiors? As a potential investor in this or similar
businesses, all this stuff counts.
If you think you have a pretty good understanding of the business's
performance, at least as an observer, spend some time thinking about how well
it functions in its industry. In other words, assess the competition.
Is there a lot of competition in its industry? With restaurants, there
certainly seem to be a lot of choices, but what about an entirely different
industry, like computers? Are there as many types of computer companies as
there are restaurants? Not by a long shot. Does that mean that the computer
industry isn't as competitive as the restaurant industry? Not necessarily.
Instead it might mean that competition functions very differently. Since it
takes a ton of capital to start up a computer company, and not so much to
start up a restaurant, maybe there is more risk in computer manufacturing?
Maybe finding new products is also more difficult? Maybe one of the only ways
to compete in the industry is on price? Asking these kinds of questions can
give you a good idea of how well a specific business is positioned to cope
with the challenges it may encounter.
At this point it may seem like we're going a little nuts generating questions,
but thinking like an analyst involves observing the business world and asking
questions to understand how it works. Thankfully, there are also experts who
have done a lot of this thinking already, and many of them have developed
useful frameworks to help organize our thinking even more.
If we think back on the four questions we mentioned earlier, we should be able
to get a good handle on a business's goals and on its performance just by
reading about it and studying its financial statements. It's really the last
question, the one in which we consider how well a company is positioned
relative to its competitors, where we might need some more help.
Finding a Framework: Moats
It's a bit strange to think that an image typically associated with England
and the Middle Ages might offer a framework for stock analysis. As we've
already seen, in order to really think like an analyst, it's important to
consider factors beyond just the numbers. After all, our quest is to find
exceptional companies delivering outstanding performance, in which case we may
need to put forth extra effort to find that "Holy Grail."
One helpful concept is that of an "economic moat." And while you may not hear
it used as often as terms such as P/E ratio or operating profit, the concept
of an economic moat is a guiding principle in Morningstar's stock analysis and
valuation. Eventually the idea may gain more of a following since we think it
is the foundation for identifying companies that create shareholder value over
the long term. In the meantime, we'll just consider ourselves lucky to have a
framework that can separate really great companies from the merely good ones.
What Is an Economic Moat?
Quite simply, an economic moat is a long-term competitive advantage that
allows a company to earn oversized profits over time. The term was coined by
one of our favorite investors of all time, Warren Buffet, who realized that
companies that reward investors over the long term have a durable competitive
advantage. Assessing that advantage involves understanding what kind of
defense, or competitive barrier, the company has been able to build for itself
in its industry.
Moats are important from an investment perspective because any time a company
develops a useful product or service, it isn't long before other firms try to
capitalize on that opportunity by producing a similar--if not better--product.
Basic economic theory says that in a perfectly competitive market, rivals will
eventually eat up any excess profits earned by a successful business. In other
words, competition makes it difficult for most firms to generate strong growth
and profits over an extended period of time since any advantage is always at
risk of imitation.
The strength and sustainability of a company's economic moat will determine
whether the firm will be able to prevent a competitor from taking business
away or eroding its earnings. In our view, companies with wide economic moats
are best positioned to keep competitors at bay over the long term, but we also
use the terms "narrow" and "none" to describe a company's moat. We don't often
talk about the depth of a moat, yet it's a good way of thinking about how much
money a company can make with its advantage.
To determine whether or not a company has an economic moat, follow these four
steps:
1. Evaluate the firm's historical profitability. Has the firm been able to
generate a solid return on its assets and on shareholder equity? This is
probably the most important component to identifying whether or not a company
has a moat. While much about assessing a moat is qualitative, the bedrock of
analyzing a company still relies on solid financial metrics.
2. Assuming that the firm has solid returns on its capital and is consistently
profitable, try to identify the source of those profits. Is the source an
advantage that only this company has, or is it one that other companies can
easily imitate? The harder it is for a rival to imitate an advantage, the more
likely the company has a barrier in its industry and a source of economic
profit.
3. Estimate how long the company will be able to keep competitors at bay.
We refer to this time period as the company's competitive advantage period,
and it can be as short as several months or as long as several decades. The
longer the competitive advantage period, the wider the economic moat.
4. Think about the industry's competitive structure. Does it have many
profitable firms or is it hypercompetitive with only a few companies
scrounging for the last dollar? Highly competitive industries will likely
offer less attractive profit growth over the long haul.
Types of Economic Moats
After researching hundreds of companies, we've identified four main types of
economic moats.
Low-Cost Producer. Companies that can deliver their goods or services at a low
cost, typically due to economies of scale, have a distinct competitive
advantage because they can undercut their rivals on price.
Wal-Mart WMT is a great example of a low-cost producer, and its low costs
allow it to price its products the most attractively. As a dominant player in
retailing, the company's size provides it with enormous scale efficiencies, or
operating leverage, that it uses to keep costs low. Scale allows Wal-Mart to
do its own purchasing more efficiently since it has roughly 5,000 large stores
worldwide, and it gives the company tremendous bargaining power with its
suppliers. Since the company positions itself as a low-cost retailer, it wants
to ensure it gives the lowest prices to its customers. This can translate into
tough bargaining terms for those firms that want to sell their products on
Wal-Mart's shelves. As a result, Wal-Mart is able to offer prices that
competitors have a difficult time matching--one reason why you don't see too
many Kmarts around anymore.
High Switching Costs. Switching costs are those one-time inconveniences or
expenses a customer incurs in order to switch over from one product to
another. If you've ever taken the time to move all of your account information
from one bank to another, you know what a hassle it can be--so there would
have to be a really good reason, like a package deal on an account and
mortgage for example, for you to consider switching again.
Companies aim to create high switching costs in order to "lock in" customers.
The more customers are locked in, the more likely a company can pass along
added costs to them without risking customer loss to a competitor.
Surgeons encounter these switching costs when they train to do procedures
using specific medical devices, such as the artificial joint products from
medical-device companies Biomet BMET or Stryker SYK. After training to learn
to use a specific product, switching to another would require the surgeon to
forgo comfort and familiarity--and what patient, much less surgeon, would want
that? Additionally, because the surgeon would have to be trained to use a new,
competing product, he or she would also have to contend with lost time and
money resulting from not performing as many surgical procedures. Clearly, with
certain products and services, the switching costs can be quite high.
The Network Effect. The network effect is one of the most powerful competitive
advantages, and it is also one of the easiest to spot. The network effect
occurs when the value of a particular good or service increases for both new
and existing users as more people use that good or service.
For example, the fact that there are literally millions of people using eBay
makes the company's service incredibly valuable and all but impossible for
another company to duplicate. For anyone wanting to sell something online via
an auction, eBay EBAY provides the most potential buyers and is the most
attractive. Meanwhile, for buyers, eBay has the widest selection. This
advantage feeds on itself, and eBay's strength only increases as more users
sign on.
Intangible Assets. Some companies have an advantage over competitors because
of unique nonphysical, or "intangible," assets. Intangibles are things such as
intellectual property rights (patents, trademarks, and copyrights), government
approvals, brand names, a unique company culture, or a geographic advantage.
In some cases, whole industries derive huge benefits from intangible assets.
Consumer-products manufacturers are one example. They build profits on the
power of brands to distinguish their products. Well-known PepsiCo PEP is a
leader in salty snacks and sports drinks, and the firm boasts a lineup of
strong brands, innovative products, and an impressive distribution network.
The company's investment in advertising and marketing distinguishes its
products on store shelves and allows PepsiCo to command premium prices.
Consumers will pay more for a bag of Frito-Lay chips than for a bag of generic
chips. As the value of a brand increases, the manufacturer is also often able
to be more demanding in its distribution relationships. To a large degree,
brand power creates demand for those chips and secures their placement on
store shelves.
One final thought about economic moats: It is possible for some companies to
have more than one type of moat. For example, many companies that use the
network effect also benefit from economies of scale, because these companies
tend to grow so large that they dwarf smaller competitors. In general, the
more types of economic moat a company has--and the wider those moats are--the
better.
The Bottom Line
Successful long-term investing involves more than just identifying solid
businesses, or finding businesses that are growing rapidly, or buying cheap
stocks. We believe that successful investing also involves evaluating whether
a business will stand the test of time.
Moats are a useful framework to help answer this question. Identifying a moat
will take a little more effort than looking up a few numbers, but we think
understanding a company's competitive position is an important process for
determining its long-term profitability. And as we stated earlier in this
book, how well a company's stock performs is directly related to the profits
the firm can generate over the long haul.
205-Economic Moats
Course 205:
Economic Moats
In earlier lessons of this series, we introduced the concept of an economic
moat and the role it plays in identifying whether a business will stand the
test of time. To define, an economic moat is a long-term competitive advantage
that allows a company to earn oversized profits over time. Quite simply,
companies with a wide moat will create value for themselves and their
shareholders over the long haul, and these are the companies you should focus
your attention on.
The term "moat" in regard to finance was coined by one of our favorite
investors of all time, Warren Buffett, who realized that companies that reward
investors over the long term most often have a durable competitive advantage.
Assessing that advantage involves understanding what kind of defense, or
competitive barrier, the company has been able to build for itself in its
industry.
Moats are important from an investment perspective because any time a company
develops a useful product or service, it isn't long before other firms try to
capitalize on that opportunity by producing a similar--if not better--product.
Basic economic theory says that in a perfectly competitive market, rivals will
eventually eat up any excess profits earned by a successful business. In other
words, competition makes it difficult for most firms to generate strong growth
and profits over an extended period of time since any advantage is always at
risk of imitation. The strength and sustainability of a company's economic
moat will determine whether the firm will be able to prevent a competitor from
taking business away or eroding its earnings.
How to Build a Moat
There are a number of ways a company can build a sustainable competitive
advantage in its industry. Among the more qualitative measures commonly used
to assess a firm's economic moat:
Creating real or perceived product differentiation
Driving costs down and being a low-cost leader
Locking in customers by creating high switching costs
Locking out competitors by creating high barriers to entry or high barriers
to success
Thankfully we've been able to whittle down all of the types of advantages in
the marketplace. In Lesson 204, we identified the four main types of economic
moats, and below we provide a bit more detail, using examples. The more types
of moats a company can build, the better.
Low-Cost Producer or Economies of Scale
Companies that can deliver their goods or services at a low cost, typically
from economies of scale, have a distinct competitive advantage because they
can undercut their rivals on price. Likewise, companies with low costs can
price their products at the same level as competitors, but make a higher
profit while doing so.
This type of moat creates a significant barrier to entry, since a
prohibitively large amount of capital is often required to achieve a size
needed to be competitive in a market.
Dell
Dell's DELL success is due to the company's famous build-to-order direct-sales
business model, which eliminates expensive middlemen, lowers working-capital
investments, and provides real-time market information to management. The
direct model's low-overhead advantage allows Dell to undercut rivals without
sacrificing features or profitability. The firm has consistently improved
margins and increased revenue, in good times and bad, by replicating the model
across several new markets. Most recently the firm has moved into consumer
electronics, which is typically a lower-profit-margin market. But given Dell's
low-cost structure, it may succeed here as well. Along the way, Dell's
competitive advantage in building computers, servers, and notebooks at the
lowest possible prices has made life extremely difficult for other
manufacturers, particularly Gateway GTW and HP Compaq HPQ. The cyclicality of
the IT industry carries some risks, but Dell's robust cash flow and strong
balance sheet help mitigate those risks.
Wal-Mart
Wal-Mart WMT is perhaps the most salient example of a company benefiting from
economies of scale, and for good reason. As a dominant player in retailing,
the company's size provides it with enormous efficiencies that it uses to keep
costs low. For example, its size allows Wal-Mart to do its own purchasing more
efficiently since it has roughly 5,000 large stores worldwide. This gives the
company tremendous bargaining power with its suppliers.
Not only does it get its products cheaper, but its size allows it more
inexpensive distribution. In addition, it has an enormous amount of
information concerning consumer likes and dislikes, and it can spread its best
practices across its entire store base.
To see economies of scale in action, let's assume that Wal-Mart can acquire a
DVD from a supplier for $5, while it costs one of Wal-Mart's smaller
competitors $6. It also costs Wal-Mart $4 to distribute the DVD and pay for
the overhead costs of the stores, while it costs the smaller competitor $5 to
do the same. Wal-Mart can then sell the DVD for $9.50, and still make a $0.50
profit. The smaller competitor can't charge that little, because at a cost of
$11 per DVD, it would be losing money.
High Switching Costs
Switching costs are those one-time inconveniences or expenses a customer
incurs in order to switch over from one product to another, and they can make
for a very powerful moat. Companies that make it tough for customers to switch
to a competitor are in a position to increase prices year after year to
deliver hefty profits. Companies aim to create high switching costs in order
to "lock in" customers. The more customers are locked in, the more likely a
company can pass along added costs to them without risking customer loss to a
competitor.
Autodesk
Autodesk ADSK dominates architecture and construction-design software with its
market-leading AutoCAD product. With roughly 6 million loyal users, it has a
wide economic moat--high switching costs make it tough for customers to get
comparable products elsewhere or do their jobs without the help of Autodesk.
Because customers are essentially required to understand its software to be
successful in their careers, it is nearly impossible for competitors to take
meaningful market share from Autodesk.
Autodesk's software is also relatively affordable, making it somewhat immune
when the economy turns south. While some software costs millions of dollars,
Autodesk's products cost much less; the initial price of AutoCAD is only a few
thousand dollars. This makes the company less susceptible to cutbacks in
information-technology spending. In addition, using its software reduces
expenses by shortening the design and manufacturing processes. The firm has
also incorporated subscription sales, which add more predictability to its
business model and further "lock in" its customers. As with many technology
companies, uncertainty remains regarding its new product development cycle and
adoption of new products, but Autodesk's committed customer base give the firm
a wide economic moat.
Citigroup
If you've ever taken the time to move all of your account information from one
bank to another, you know what a hassle it can be. Even if another bank is
offering the same services for $1 less per month or maybe a slightly higher
interest rate on deposits, is all the extra effort needed to switch really
worth it?
You may also want to look at your wallet and think about your credit cards.
How long have you had some of those cards, and why do you keep them? Surely a
better deal could be had elsewhere. But perhaps you have built up
frequent-flier miles on your cards, have your utility bills automatically
charged, or enjoy the familiarity that having the same account for a long time
offers.
Clearly, banks and credit card companies enjoy the benefits of the high
switching costs their customers would incur by leaving. As the largest credit
card issuer in the world, Citigroup C is one of the beneficiaries. It is also
worth noting that Citigroup enjoys switching costs across a large number of
its other financial services businesses, making for an impressive firmwide
moat.
The Network Effect
The network effect occurs when the value of a particular good or service
increases for both new and existing users as more people use that good or
service. It can also occur when other firms design products that complement an
existing product, thereby enhancing that product's value. The network effect
is arguably one of the most potent competitive advantages, and it can also
quickly catapult firms to the lead in new industries.
Adobe
Like Autodesk, Adobe ADBE actually enjoys two economic moats. The firm's
Acrobat software has become the standard for reading and creating documents
electronically. Because customers, such as graphic designers, are trained
early in their careers to use products like Photoshop and Illustrator, it's
nearly impossible for competitors to take meaningful market share. High
switching costs make it tough for customers to get comparable products
elsewhere or do their job without Adobe.
As if switching costs weren't enough, Adobe also benefits from the network
effect. With more than 500 million copies downloaded, Acrobat has a foothold
on computer desktops everywhere. As its network effect increases, and more
designers and readers use Adobe's software, its position as a standard-bearer
grows.
eBay
When the online auction market was just getting started, eBay EBAY was the
largest. As the site with the most sellers, it had the widest selection of
products. This attracted the most buyers. Because it had the most buyers, it
attracted more sellers.
The cycle just continued to feed on itself, and now eBay is essentially the
only real online auction site of size. It was able to capture this position
even though some large, well-known, and well-financed Internet companies such
as Yahoo YHOO and Amazon AMZN tried to make a frontal assault on eBay in the
late 1990s with very little success.
Intangible Assets
This category incorporates several types of competitive advantages including
intellectual property rights (patents, trademarks, and copyrights), government
approvals, brand names, a unique company culture, or a geographic advantage.
It may be difficult to assess the durability of some of these advantages, so
be sure you have a grasp of how long this type of competitive advantage might
last. Brand equity, for example, can be damaged or slowly erode over time,
while government approval can be revoked. Try to understand how susceptible a
firm might be should this kind of advantage be disrupted.
Moody's
Moody's MCO plays an important role in the capital markets by evaluating the
risk associated with borrowers and debt instruments. The rating process is
hardly ever easy. The federal government has created a designation--nationally
recognized statistical rating organization--that a company must acquire before
moving into the market. Achieving this designation is very challenging,
meaning that the rating business is basically a government-sanctioned
oligopoly with a limited number of competitors.
The government protection Moody's enjoys is virtually priceless. Operating
profit margins have been higher than 50% over the past couple of years, thanks
to growth in international and structured finance, where pricing is especially
sweet. These high margins lead to excellent cash flow from operations. The
company requires very little in the way of capital investment, so its leverage
is low and free cash flow is strong.
Harley-Davidson
Anytime people are willing to tattoo a company's logo onto their arms, it is a
surefire sign of a powerful brand. The firm, the only continuous survivor from
the original American motorcycle industry, is more than 100 years old. The
brand built over this time has allowed Harley HDI dealers to sell motorcycles
at or above manufacturer's suggested retail price for years. Despite selling
essentially the same steel, chrome, and rubber as its competitors, it can
charge premium prices for its products. And as we'll see in later lessons,
Harley's brand has translated into solid financial results for the company.
The Bottom Line
While having these four types of moats, or competitive advantages, as
guidelines is helpful, there is still a lot of art to determining whether a
firm has a moat. At the heart of it, the harder it is for a firm's advantage
to be imitated, the more likely it is to have a barrier to entry in its
industry and a defensible source of profit.
Course 206:
More on Competitive Positioning
In the previous lesson, we reviewed the different types of defenses (economic
moats) and offered examples of wide-moat firms. Understanding moats, and
determining whether or not a firm has a moat is a tricky process. In this
lesson we'll examine the mental model that underpins our moat framework and
explore some of the nuances of wide moats, narrow moats, and deep moats.
Porter's Five Forces
Michael E. Porter's Competitive Strategy, originally published in 1980, is a
definitive work on industry competition. In the book, the Harvard professor
provides a framework for understanding competitor behavior and a firm's
strategic positioning in its industry. Much of Porter's framework should be
familiar as it underpins our thinking about economic moats.
In essence, Porter provided a framework of five forces that can be used to
understand an industry's structure. Since firms strive for competitive
advantage, the first four forces at work help to assess the fifth, an
industry's level of rivalry:
Barriers to Entry. How easy is it for new firms to start competing in a
market? Higher barriers are better.
Buyer (Customer) Power. Similar to switching costs, what keeps customers
locked in or causes them to jump ship if prices were to increase? Lower
power is better.
Supplier Power. How well can a company control the costs of its goods and
services? Lower power is better.
Threat of Substitutes. A company may be the best widget maker, but what if
widgets will soon become obsolete? Also, are there cheaper or better
alternatives?
Degree of Rivalry. Including the four factors above, just how competitive is
a company's industry? Are companies beating one another bloody over every
last dollar? How often are moats trying to be breached and profits being
stolen away?
Porter's five forces considered together can help you to determine whether a
firm has an economic moat. The framework is particularly useful for examining
a firm's external competitive environment. After all, if a company's
competitors are weak, it may not take much of a moat to keep them at bay.
Likewise, if a company is in a cutthroat industry, it may require a much wider
moat to defend its profits.
A Five Forces Example: Consumer Products
The five forces concept is perhaps best explained through example. (Porter's
work is nothing short of excellent, but it is a heavy read.) Let's briefly
examine the household consumer-products industry by considering rival firms
Clorox CLX, Kimberly-Clark KMB, Colgate-Palmolive CL, and Procter & Gamble PG
in terms of Porter's five forces:
Buyer Power. Consumer-products companies face weak buyer power because
customers are fragmented and have little influence on price or product. But if
we consider the buyers of consumer products to be retailers rather than
individuals, then these firms face very strong buyer power. Retailers like
Wal-Mart WMT and Target TGT are able to negotiate for pricing with companies
like Clorox because they purchase and sell so much of Clorox's products.
Verdict: Strong buyer power from retailers.
Supplier Power. More than likely, consumer-products companies face some amount
of supplier power simply because of the costs they incur when switching
suppliers. On the other hand, suppliers that do a large amount of business
with these companies--supplying Kimberly-Clark with raw materials for its
diapers, for instance--also are somewhat beholden to their customers, like
Kimberly-Clark. Nevertheless, bargaining power for both the firms and their
suppliers is probably limited. Verdict: Limited supplier power.
Threat of New Entrants. Given the amount of capital investment needed to enter
certain segments in household consumer products, such as manufacturing
deodorants, we suspect the threat of new entrants is fairly low in the
industry. In some segments within the household consumer-products industry,
this may not be the case since a small manufacturer could develop a superior
product, such as a detergent, and compete with Procter & Gamble. The test is
whether the small manufacturer can get its products on the shelves of the same
retailers as its much larger rivals. Verdict: Low threat of new entrants.
Threat of Substitutes. Within the consumer-products industry, brands succeed
in helping to build a competitive advantage, but even the pricing power of
brands can be eroded with substitutes such as store-branded private-label
offerings. In fact, some of these same store-brand private-label products are
manufactured by the large consumer-products firms. The firms believe that if
they can manufacture and package a lower-price alternative themselves, they
would rather accept the marginal revenue from their lower-priced items than
risk completely losing the sale to a private-label competitor. Verdict: High
threat of substitutes.
Degree of Rivalry. Consumers in this category enjoy a multitude of choices for
everything from cleaning products to bath washes. While many consumers prefer
certain brands, switching costs in this industry are quite low. It does not
cost anything for a consumer to buy one brand of shampoo instead of another.
This, along with a variety of other factors, including the forces we've
already examined, makes the industry quite competitive. Verdict: High degree
of rivalry.
Examining an industry through the framework of Porter's five forces helps
illustrate the different dynamics at work. It's not always clear-cut, either,
so one wouldn't expect all of the firms in this industry to fall into one big
bucket labeled wide moat or narrow moat. Instead, there are firms with
distinct, long-term advantages and wide moats, like Procter & Gamble and
Colgate, while others have advantages that we think may be less sustainable,
such as Clorox and Kimberly-Clark.
Getting Back to Moats
Porter's framework makes scouring an industry for great investment ideas much
easier. Understanding an industry helps us find the great businesses with
economic moats that will withstand the inevitable economic, competitive, and
random other challenges that often cripple weaker businesses.
Once we have a collection of great businesses from which to choose, finding
those that meet our criteria and deliver above-average returns on invested
capital over the long term becomes even easier. (We will discuss returns on
invested capital more in Lesson 305.)
Generally speaking, we believe investors should steer clear of companies that
have no moat (those with a Morningstar moat rating of "none") because they
have very few, if any, competitive advantages and can't keep rivals from
eating away at their profits. (Lots of these companies don't even have any
profits.) For example, we don't think Delta Air Lines DAL, Albertson's ABS,
and Goodyear Tire & Rubber GT have moats around their respective businesses.
More than likely, we wouldn't want to hold a no-moat company for the long
haul, so we probably wouldn't buy stock in one of these firms to begin with.
Some people are shrewd enough to buy no-moat stocks on a dip, hold them for a
short term, and make a profit. As long-term investors this isn't a game we
like to play. We think the rewards are far better, and the risks much lower,
for those who spend a little effort to find strong companies to hold for a
long time.
Types of Narrow Moats
There are certainly gradations of moat width, and we here at Morningstar
describe companies with milder competitive advantages as having "narrow"
moats. From our point of view, far more companies have narrow moats than wide
ones. Narrow-moat firms are, on average, of a much higher quality than no-moat
companies. Generally, narrow-moat companies generate lower returns on invested
capital than wide-moat companies but still have returns slightly above their
cost of capital. (We will talk about return on invested capital and cost of
capital extensively in coming lessons.) Narrow-moat companies typically come
in two varieties:
Firms with Eroding Moats. These companies have competitive advantages, but
they are eroding due to a shifting industry landscape. This scenario is faced
by some of the consumer-products companies, like those we just examined. For
example, we consider both General Mills GIS and Kellogg K to be narrow-moat
firms. The pricing power they once enjoyed is eroding as a result of increased
competition and an ever-consolidating retail landscape that is increasing
buyer power. The Baby Bells, such as SBC SBC and Verizon VZ, are another
example; their economic moats are also slowly eroding. In future years, they
won't enjoy the monopoly pricing power they once did because of the increased
use of wireless phones and, of course, the Internet.
Firms with Structural Industry Challenges. A company in this category
dominates its peers, but resides in an industry where wide moats are nearly
impossible to create. For example, in the airline industry, it's pretty much
impossible to create pricing power, and even being a low-cost provider doesn't
always bring stable profits because the industry itself is just too
commodified. People tend to just book the cheapest fare, with little regard to
brand. One of our favorite firms in the airline industry, Southwest Airlines
LUV, is a good example of a narrow-moat firm that has a solid low-cost
positioning, but still faces serious industry challenges, such as volatile
fuel prices.
Wide Moats
All things equal, we'd choose a wide-moat company over one with a narrow-moat
rating for the significant competitive advantages that should enable the
wide-moat firm to earn more than its cost of capital for many years to come.
Most wide-moat companies have some sort of structural advantage versus
competitors. By "structural," we mean a fundamental advantage in the company's
business model that wouldn't go away even if the current management team did.
With a structural advantage, a company isn't dependent on having a great
management team to remain profitable. To paraphrase Peter Lynch, these are
companies that could turn a profit even with a monkey running them, and it's a
good thing, because at some point that may happen.
We hate to sound like a broken record here, but the four types of moats that
we identified in the previous lesson are incredibly useful when thinking about
structural advantages a company may or may not possess. Keep the four types of
moats in mind:
Low-Cost Producer or Economies of Scale
High Switching Costs
Network Effect
Intangible Assets
Wide Moats Versus Deep Moats
With the concept of a wide moat firmly in place, it's also important to
realize that the width of a firm's moat, or how broad and numerous its
competitive advantages are, matters more than the moat's depth, or how
impressive any individual advantage is. Discerning between width and depth can
be difficult, however.
First, it's absolutely critical to understand not only what an economic moat
is, but also how it translates to above-average returns on capital. Many
investors easily surmise the first point about moats--that a competitive
advantage is required--but they miss the importance of the second point,
above-average returns. If the business doesn't throw off attractive returns,
then who cares if it has a competitive advantage? Autos and airlines are two
businesses with some barriers to entry, but few new competitors are trying to
crash the party in a race for single-digit ROEs or bankruptcy.
Over the years, Warren Buffett has frequently referred to his desire to widen
the moats of his companies, but it's rare to see him refer to a moat's depth.
Buffett's frequent talk of moat width--and silence on moat depth--speaks
volumes. Michael E. Porter has said, "Positions built on systems of activities
are far more sustainable than those built on individual activities."
Unfortunately, no company is going to tell you if it has a moat, much less
whether that moat is of the wide or deep variety. If a firm has a competitive
advantage, it behooves it to not tell you how its moat has been built. After
all, you just might emulate it.
Still, it can be worth investors' time to ponder whether the stocks they're
invested in have one really fantastic competitive advantage that, while deep,
may lack width, or if they're invested in firms with a series of advantages
that can sustain above-average returns on capital over the long haul.
Consider well-run giant conglomerates like General Electric GE or Citigroup C.
Finance theory tells us that these decades-old firms should have seen their
returns on capital dribble down to their cost of capital ages ago due to
rivals competing away the excess returns. (We'll talk much more about returns
on capital and cost of capital in coming lessons.) Yet, Citigroup's ROEs are
still in the upper teens even in a bad year.
Why haven't competitors captured these profits? Quite simply, these firms are
pretty good at an awful lot of things. If Citigroup is hobbled by problems in
its private banking unit or regulatory scandals on its trading desks, it can
rely on its impressive credit card operations and retail banking business to
carry the day. At GE, if new competition from cable hurts the NBC network or
its insurance division posts lackluster returns, it can rely on a cadre of
numerous other good businesses to pick up the slack. Like stacked plywood,
each of these businesses is strong in its own right, but virtually
indestructible together.
The Bottom Line
This and the preceding lesson have covered a lot of material about moats and
the qualitative aspects of a company's positioning. Though this step in
identifying attractive companies for investment is an important one, it is
only the first step. In coming lessons in this book, we will show you how to
quantitatively confirm that a company has a moat, as well as show you how to
value stocks so that you don't blindly pay too much for a quality company.
Management Structure
Technically, the management team of a public company works for and reports to
the board of directors, who represent the company's owners: its shareholders.
In the U.S., companies typically hold annual elections at which shareholders
vote (or assign their vote to someone else, called a proxy) to elect directors
to the board. In theory, then, shareholders can wield great influence over the
management and direction of the companies whose shares they own. In practice,
as corporate and investing cultures have evolved, the relationship between
shareholders and company managers has become ritualized and more distant.
So how should investors close the gap? We believe that by identifying and
investing in companies that have demonstrated their commitment to treat
shareholders well, individual investors can reassert their influence on the
day-to-day choices and priorities that companies set.
What do we mean by "demonstrated commitment to shareholders?" Perhaps an
analogy will help. Imagine you have decided to start a lemonade stand with
your neighbor. When you meet at the appointed time to go over your plans, your
neighbor brings a pound of sugar for the lemonade. Such a gesture demonstrates
your neighbor's commitment to doing business with you.
Similarly, when you view a home for sale, you expect it to be orderly, and
that the owner will make arrangements for you to see it. In this small way,
the seller has demonstrated his or her commitment to doing the things that are
necessary to sell you the home. If it's a hassle to view the home, or it's
disorderly when you view it, that should prompt questions about how the later
stages of negotiation and closing will be handled.
Buying a Business
Now imagine that you are considering buying part of a business, potentially to
keep and to profit from for a long time. What signs should you look for that
the company's directors and managers are interested in doing business with
you?
Investors should look for companies that offer clear communication about the
business, have established a clear separation between business and personal
relationships, and have set clear goals for measuring progress in conducting
the business. In practice, these goals often involve raising barriers or
instituting policies meant to inhibit human nature. By snooping around the
edges and examining the outward signs of how a company's management team
behaves and rewards itself, we can surmise how committed they are to honoring
their role as stewards of investor capital.
While it would be impractical for every private shareholder to visit
management and dig around for scuttlebutt, this doesn't mean that individual
investors should simply give up on investigating the people who run their
businesses. On the contrary, through a handful of public sources, investors
can begin to crack the nut around one of the most subjective elements of stock
research: management.
We will refer to the host of topics surrounding management as "stewardship."
Fisher describes the qualities he looks for in managers as trusteeship. Others
refer to these issues as corporate governance, fiduciary responsibilities, and
other names. We call it stewardship because we look for managers who see
themselves as stewards of investors' capital and who have signaled their
self-image to us in verifiable ways. We find the alternative--managers who see
the company they run as their personal piggy-bank--repugnant.
The Proxy: A Management Information Goldmine
The primary source for information about how a company's shareholders,
directors, and management have arranged their affairs is its annual proxy
filing, or Schedule DEF14a, which serves as a notice of, invitation to, and
background reading for the annual shareholders' meeting. The proxy details the
board's activities, managers' compensation, and any shareholder or management
proposals that require a vote by shareholders. It also contains director and
manager biographies, information about managers' and directors' compensation
and ownership of shares, and often a description of any related-party
transactions or other relationships that the company's top management team or
directors may have that could present them with a conflict of interest.
Next, we will discuss the sources we here at Morningstar check most often to
find information that we use to evaluate management's stewardship. Of course,
you should try to soak up as much information as you can from as many sources
as you can.
Within the proxy, we pay attention to the report of the compensation committee
of the board. Although often bland, this report gives some insight into how
pay is set in the executive suite. (The blander the report, the more likely we
think that the CEO effectively sets his own pay, which is a problem.) We also
recommend that investors read management's discussion (usually a rebuttal) of
shareholder proposals attached to the proxy--these can shed light on
management's priorities and consideration for shareholder interests, depending
on the merits of the proposal.
We also check other public sources for information relevant to evaluating
management. We read management's discussion and analysis in the annual report
(10-K) for many reasons, one of which is to ascertain the level of exposition
company managers provide about how they see the business. The annual financial
filing also discusses litigation and risk factors, as well as a record of
options granted in recent years. In the quarterly report (10-Q) filed
immediately after the annual shareholders' meeting, we look at the results of
the shareholder vote. This allows us to evaluate how seriously the board takes
shareholder proposals that pass by a majority, even though these are often not
even binding.
Increasingly, companies post all of the above information on their Web sites.
On the company Web page, look for a link to "Investor Relations," and from
there, look for a section dedicated to "Corporate Governance." By looking at
all these sources and following the flow of information concerning how the
company's profits are allocated to management, we can learn much more than by
just poring through cookie-cutter articles of incorporation.
Therefore, when we evaluate management, we split our areas of inquiry into
three main topics:
Transparency. Paramount among outward commitments, public dissemination of
information about the business and its finances reflects strongly on
management's respect for investors. Without adequate and reliable accounting
practices and overall disclosure, investors would be entirely at the mercy of
insiders.
Shareholder Friendliness. To assess the power of shareholders relative to
management and how the board and management treat other shareholders, we
evaluate the firm's share-class structure and assignment of CEO and board
chair roles, and take particular note of any takeover defenses or
related-party transactions.
Incentives, Ownership, and Overall Stewardship. In this area we ask whether
management's and employees' incentives are aligned with shareholders'
interests. In particular, we focus on whether management's compensation is "at
risk" alongside the results of the firm, and whether it is structured to
motivate long-term value creation. Investors should penalize those firms that
change management goals midstream, issue too many options, overcompensate
executives, or have low levels of equity ownership.
20 Questions
Here's the fun part. If you liked 20 questions as a parlor game, you may enjoy
using the same 20 questions that Morningstar's stock analysts currently use to
evaluate the three main areas of stewardship at the companies they cover. As
you will see, some of these require a working knowledge of accounting and the
company's track record. Nonetheless, familiarizing yourself with the subject
matter of even a handful of these inquiries will bring you closer to
evaluating management on your own behalf.
Transparency
1. Does the company overuse "one-time" charges or write-offs? In public
announcements, does it consistently disregard GAAP earnings and point to pro
forma numbers (i.e., figures "excluding charges...")?
2. Does the firm have aggressive accounting? For example, has there been a
major change to accounting practices, such as revenue recognition, during the
past three years that may have been intended to hide something?
3. Has the company recently restated earnings for any reason other than
compliance with an accounting rule change? Has the company had an unexplained
delay in making regulatory filings or reporting quarterly results?
4. Does the company grant options without expensing them?
5. Does the company choose not to provide any balance sheet with its quarterly
earnings release?
6. Bonus: Does the company's disclosure go above and beyond what its
competitors provide?
Shareholder Friendliness
7. Does the company have a separate voting class of shares that an insider
controls?
8. Does the company have takeover defenses in place that, if exercised, would
significantly dilute existing shareholders or favor the interests of
management over shareholders in a takeover situation?
9. Has a majority vote of shareholders on a proposal been thwarted by any of
the following: (a) management inaction; (b) management interference in the
ballot process; or (c) the existence of a supermajority provision?
10. Are the chairman of the board and the CEO the same person?
11. Has the board or management engaged in significant related-party
transactions that cast doubt on its ability to act in shareholders' best
interests?
12. Bonus: Is there cumulative voting (i.e., are shareholder votes equal to
shares owned times number of directors)?
Incentives, Ownership, and Stewardship
13. Has the board agreed to a compensation structure that rewards management
merely for being employed, rather than for making value-enhancing decisions?
14. Over the past three years, has the firm given away more than 3% of shares
annually as options?
15. In bad times, has the board granted "one-time" "retention bonuses,"
redefined management goals midstream, repriced options, or bestowed other
"extraordinary" perks?
16. Is the CEO's equity stake in the company (including options) too small to
align his or her interests with shareholders'?
17. Do directors receive a substantial portion of their compensation in cash,
rather than stock?
18. Do the goals set out for top management by the board's compensation
committee encourage short-term actions rather than long-term value creation?
Is the board's disclosure of such goals insufficient, too generic, or too
fuzzy to allow you to answer the preceding question?
19. Given the company's financial performance, the board's and management's
past actions, and the above factors, is management inappropriately motivated
and/or rewarded?
20. Bonus: Does the board and management have a substantial track record of
doing right by shareholders?
We do not weigh all of these questions equally, and sometimes the details
necessitate the exercise of judgment. Of all these questions, we place the
greatest emphasis on Question 11 because related-party transactions can be
especially harmful to shareholders and are a decent indicator of bigger
governance problems. Frequent and egregious lapses are a leading indicator
that a given company's inner sanctum has too easily rationalized putting its
self-interest over shareholders' interests. Caveat emptor.
To illustrate an egregious related-party transaction, consider Sinclair
Broadcasting SBGI. This television broadcasting company reported in its proxy
that it made a large investment in a car dealership in which its CEO and
chairman already held a significant stake. We don't see how this deal served
Sinclair shareholders. Moreover, the fact that it had to be reported did not
hamper the management team from completing the deal, which we also see as a
warning sign. A glance at the company's stock chart reveals that investors
have caught on to what value management has and has not created for
shareholders over the years. Morningstar's analysts have compiled lots of
egregious examples of related-party transactions just like this.
Morningstar Stewardship Grades
Morningstar has already done a lot of management investigation for you! For
the 1,500-plus companies that we cover, Premium subscribers to Morningstar.com
have access to analyst-driven Stewardship Grades based on the topics discussed
in this lesson. Like in school, the grades are "A" through "F," with "C" being
the most common grade.
Morningstar stock analysts base the Stewardship Grades on public filings,
previous management actions, conversations with company officials, and their
own expertise. We assign the grades on an absolute scale--not on a curve or on
an industry-peer basis. Therefore, if a company engages in practices that
Morningstar analysts think do not reflect good stewardship of investors'
capital, it will receive a poor grade regardless of how other firms may have
scored.
The Bottom Line
Though competitive positioning remains extremely important to a company's
long-term fortunes, quality of management matters, too. After all, even the
most attractive ship can be run ashore by an incompetent skipper, or be
pillaged by a pirate. The whole reason it is worthwhile to go through these
exercises is to make sure you are investing your money with people you can
trust.
Course 201:
Stocks and Taxes
Unlike death, taxation can at least be minimized. In this lesson, we will
examine the basic framework of individual taxation in the United States as it
relates to stock investing and review some simple steps you can take to be a
more tax-efficient investor.
The information in this lesson is not necessarily exclusive to stock
investing; much of it is also relevant to mutual fund investing. Nevertheless,
if you are going to invest in any asset class, including stocks, it is
imperative to understand exactly how taxes work so you may keep as many
dollars as possible in your pocket and away from Uncle Sam.
Ordinary Income Versus Capital Gains
Capital gains--the difference between what you sell a stock for versus what
you paid for it--are "tax preferred," or taxed at lower rates than ordinary
income. Ordinary income includes items such as wages and interest income.
Capital gains arise when you sell a capital asset, such as a stock, for more
than its purchase price, or basis. Capital gains are further subdivided into
short term and long term. If a stock is sold within one year of purchase, the
gain is short term and is taxed at the higher ordinary income rate. On the
other hand, if you hold the stock for more than a year before selling, the
gain is long term and is taxed at the lower capital gains rate.
Conversely, you realize a capital loss when you sell the asset for less than
its basis. While it's never fun to lose money, you can reduce your tax bill by
using capital losses to offset capital gains. Also, to the extent that capital
losses exceed capital gains, you can deduct the losses against your other
income up to an annual limit of $3,000. Any additional loss above the $3,000
threshold is carried over to the be used in subsequent years. (Note that due
to the IRS' wash-sale rule, you cannot claim a loss if you purchase
substantially identical securities 30 days before or after the sale.)
Jobs & Growth Tax Relief Reconciliation Act of 2003
Among other things, the 2003 tax cut (known affectionately as JGTRRA) lowered
the tax rate for both long-term capital gains and qualified dividends to 15%
for most taxpayers, and to 5% for taxpayers whose income places them in the
10% or 15% income tax brackets.
Since the basic idea behind the dividend tax cut was to reduce the burden of
"double taxation," or taxation of the same profits at both the corporate and
shareholder level, any dividends paid out of profits not subject to corporate
taxation will not be considered "qualified dividends" eligible for the reduced
tax rate. Therefore, one notable exception is dividends from real estate
investment trusts, or REITs, which are typically still taxed at ordinary
income rates. In addition, to qualify for the reduced dividend tax rate, you
must have held a stock for at least 60 days out of the 120-day period
beginning 60 days before the ex-dividend date (the date on which you must be
holding a stock to receive the dividend).
Unless the provisions of the 2003 tax cut are extended, the lower rates for
long-term capital gains and qualified dividends will expire in 2009. In that
year, the old 20% and 10% rates for capital gains will return, and all
dividends will again be taxed at ordinary income rates. However, in 2008, the
special 5% tax rate for lower-income taxpayers will drop to 0%.
Tax-Advantaged Accounts
One easy way to become a more tax-efficient stock investor is to utilize
tax-advantaged accounts such as 401(k)s and individual retirement accounts
(IRAs). These special accounts allow you to enjoy either tax-deferred or
tax-free growth of your investments.
Tax deferral can lead to significant savings over time. Let's assume two
investors each start with $10,000 and earn a 10% annual return for 30 years.
One has 100% of her gains tax-deferred, while the other realizes the full
amount of his capital gains each year and pays a 20% tax on those gains. Under
this scenario, the tax-deferred investor ends up with almost $75,000 more at
the end than the investor with the taxable gains.
Clearly, it is worthwhile to learn about the types of tax-advantaged accounts
available. Below are some of the most popular:
401(k)s
401(k) plans, so named after a section of the Internal Revenue Code, are set
up by employers as a retirement-savings vehicle. The primary advantage of a
401(k) is tax deferral. First, employees can contribute a percentage of their
income from each paycheck to their own 401(k) accounts on a pretax basis. This
means the amount you contribute to your 401(k) is exempt from current federal
income tax. For example, if you are in the 25% income tax bracket, a $100
contribution will reduce your current tax burden by $25. Second, dividends and
capital gains earned inside a 401(k) are not subject to current taxation. In
short, 401(k) plans allow you to defer taxation on dividends, capital gains,
and a portion of your wages until you begin withdrawing from the plan,
presumably during retirement, when you may be in a lower tax bracket. (All
withdrawals are taxed at ordinary income rates.)
The amount you can contribute to your 401(k) plan is limited to $14,000 in
2005 and $15,000 in 2006. Thereafter, the annual contribution limit can be
adjusted in $500 increments to account for inflation. You also must begin
mandatory withdrawals from your 401(k) when you reach age 70 1/2. Withdrawals
made before you turn 59 1/2 are taxed as ordinary income, and you may be
subject to an additional 10% penalty.
Traditional IRAs
Individual retirement accounts are another vehicle for tax deferral. When you
contribute to a traditional IRA, the IRS allows you to take an income tax
deduction up to the amount of the contribution, subject to income limitations.
In addition, dividends and capital gains earned inside a traditional IRA are
not subject to tax until withdrawal.
However, there are some important limitations to remember. First, you must be
age 70 1/2 or under with earned income to contribute to a traditional IRA.
Second, the annual contribution limit is $4,000 from 2005 to 2007. The limit
rises to $5,000 in 2008, and thereafter can be adjusted in $500 increments to
account for inflation. If you are age 50 or older, you can make additional
"catch-up" contributions of $500 in 2005 and $1,000 from 2006 onward. Finally,
like 401(k) plans, you must begin mandatory withdrawals when you reach age 70
1/2. Withdrawals made before you turn 59 1/2 are taxed and may be subject to
an additional 10% penalty.
Roth IRAs
These are typically the best retirement account option for many taxpayers. As
with traditional IRAs, interest income, dividends, and capital gains
accumulate tax-free. However, the main feature of Roth IRAs is that they are
funded with aftertax dollars (contributions are not tax deductible). The
upside of this is that qualified distributions from a Roth IRA are exempt from
federal taxation.
The Roth IRA has the same annual contribution limits and "catch-up" provisions
as a traditional IRA, but you must meet certain income requirements to
contribute to a Roth IRA. Generally, single filers with income up to $95,000
and joint filers with income up to $150,000 are eligible to make the full
annual contribution to a Roth IRA. Contributions to a Roth IRA can be
withdrawn at any time without paying taxes or penalties, but withdrawal of
earnings may be subject to income taxation and a 10% early withdrawal penalty
if made before you turn 59 1/2.
In addition, the distribution must also be made after a five-tax-year period
from the time a conversion or contribution is first made into any Roth IRA.
So, if you open your first Roth IRA and make your first contribution on April
15, 2005, for the 2004 tax year, your five-year period starts on Jan. 1, 2004.
Assuming you meet the other requirements, distributions made in this case
after Dec. 31, 2008, from any Roth IRA will receive tax-free treatment.
Tax Planning 101
Besides taking advantage of 401(k) and IRA accounts, you can also follow a few
basic planning strategies for investments held in taxable accounts. However,
you should keep in mind that your goal as an investor should be to achieve the
highest aftertax rate of return, not to avoid paying taxes. Taxes are a
consideration, but they should not control your investment decisions.
The Value of Deferral and Stepped-Up Basis
All things being equal, it is better to pay taxes later than sooner.
Therefore, you should endeavor to defer taxation as long as possible. An
investor who purchases the shares of sound businesses and patiently holds them
will not only enjoy the benefits of tax-free compounding, but will also save
on brokerage commissions. At the least, toward the end of the year, you should
consider delaying the realization of capital gains until January to defer your
tax liability until the following year.
If you are extremely patient and die still owning a stock, your beneficiaries
will receive the stock with a "stepped-up" basis, or a basis equal to the
market value on the date of your death. Your beneficiaries can then sell the
stock and owe no tax on the capital gains accumulated during your lifetime.
There are special limitations on basis step-up if you happen to die in 2010,
but after that year, the rule returns in its current form.
Wait for Long-Term Capital Gain Treatment
If you purchased a stock on Jan. 1, 2005, selling it for a gain on Dec. 31,
2005, is likely not to be a smart tax move. In this case, your capital gain is
short term and taxed at ordinary income rates. Had you sold the same stock a
few days later on Jan. 2, 2006, the gain would have been treated as long term
and taxed at the lower 15% or 5% rate, and in addition would be delayed
another year.
Take Short-Term Losses
If you happen to have both short-term and long-term capital gains, you may
want to consider realizing short-term capital losses on stocks you have held
for less than one year. These short-term losses will offset your short-term
gains, which are taxed at higher ordinary income rates. This will give you the
most tax mileage for your capital loss.
Timing Capital Gains and Losses
When faced with large capital gains and losses, it may be advantageous for you
to realize both in the same year. Suppose you have $30,000 of capital gains
and $30,000 of capital losses. If you realize the gain in 2005, you will have
to pay tax on the entire $30,000. If you decide to realize your loss in 2006,
you'd have no capital gains to offset it, and you could only deduct $3,000
against your other income. The remaining $27,000 loss must be carried over
into future years. Instead of delaying the tax benefits of your loss, you
could choose to realize both the capital gain and loss in the same year. Since
they completely offset each other, you would not owe any taxes. On the other
hand, if you do not have a large capital loss to offset, you should generally
time the realization of long-term capital gains--which will be taxed at
favorable rates--for years when you do not realize any capital losses. Then
you can realize your future capital losses in years when you can immediately
deduct them against other income that may be taxed at higher ordinary income
rates.
The Bottom Line
As you can see, taxes can have a meaningful impact on your long-term
investment performance. Investing in stocks without regard to the tax impact
can greatly reduce your return. But by understanding the basic framework of
investment taxation and using a few simple tax-planning strategies, you can
work to maximize the only number that matters in the end: the amount of money
that goes into your pocket.
10.Using Financial Services Wisely--Choose Broker
分类:晨星投资课程 2008.4.3 11:28 作者：v2 | 评论：0 | 阅读：181202-Using Financial Services Wisely--Choose Broker
Course 202:
Using Financial Services Wisely
Once you consider taxes and decide what type of investment account you'd like
to open, the next nuts-and-bolts decision involves actually choosing a broker.
When thinking about a stockbroker, a picture of Charlie Sheen from the movie
"Wall Street" often comes to mind. Thoughts of cold calls interrupting your
dinner and pushy salesmen trying to sell the latest "hot stock" can scare
investors away from buying stocks. In reality, however, it isn't so bad, and
there are many options to choose from. In this lesson, we'll aim to provide
the information you need to pick a broker that will help you reach your
financial goals.
Think of a broker as the middleman between you and the person you are buying
your stock from or selling your stock to. When you place an order to either
buy or sell a stock, your broker will find a party that is willing to take the
other side of your transaction. Of course, the broker will charge a fee
(commission) for this service. There are hundreds of brokers and other
financial advisors, and they provide varying levels of service. For the
purpose of this book, however, we'll focus on three types of service
providers: full-service brokers, fee-based financial planners, and discount
brokers.
Full-Service Brokers
Full-service brokers provide handholding through the investment process that
often gives investors reassurance that they are not going it alone. They
provide personalized service, as well as advice on what to buy and sell. This
is the greatest benefit to full-service brokers, but the benefits can be
outweighed by the costs--literally. This handholding does not come cheap, and
the commissions charged by a full-service provider can quickly eat away at any
investment gains your portfolio makes. It is difficult enough to achieve
success at investing; we don't need another obstacle. We think investors would
be well served to avoid these high fees if possible.
Another concern with full-service brokers is the inherent conflict of interest
that drives many of the recommendations they give clients. Many brokers are
compensated by trading activity, not performance. For example, most
full-service brokers are paid based on a commission they receive for executing
sales and purchases. So the more you trade, the more your broker will make.
One of the reasons frequent trading is generally a bad idea is that it leads
to higher commissions that will eat into your returns. It can also cause you
to pay higher taxes on realized short-term capital gains.
So while it is against your best interest to trade often, a full-service
broker has an incentive to encourage frequent trading, just to rake in the
fees. At the end of the day, even the well-intentioned commission-based
brokers face a conflict with your interests. If you decide to use a
full-service broker, make sure to seek out those upstanding professionals who
are willing to look beyond this conflict and put your interests ahead of their
own.
Fee-Based Planners
If you still find the need for personalized, professional investment advice
but want to avoid the conflicts of interest at full-service brokers, fee-based
planners can be a worthy consideration. Fee-based planners usually charge
their clients based on a variety of factors, and the way they get paid does
not have a large inherent conflict of interest.
In general, planners and advisors get paid in one of three ways. First, they
may charge you a percentage of your assets on an ongoing basis (say, 1% a
year, not including brokerage costs or any expenses associated with mutual
funds). Other planners charge a dollar rate on a per-job or hourly basis.
Finally, others earn commissions on any products they sell you. Some planners
may use a combination of these fee structures--for example, a planner might
charge you an hourly rate to set up your plan and also put you in funds on
which he or she earns a commission. The upshot is that most planners do not
have the incentive to encourage frequent trading, but they can be just as (if
not more) expensive as full-service brokers.
Discount Brokers
To avoid the pitfalls of full-service brokers and the costs of fee-based
planners, using a discount broker is often the best option. Discount brokers
differ from their full-service counterparts in that they offer bare-bones
brokerage services, and typically do not offer advice. Investors with discount
brokers don't have to worry about aggressive sales tactics or the conflicts of
interest we discussed above. Instead, discount brokers such as Charles Schwab
SCH, E*Trade ET, and Ameritrade AMTD allow investors to make their own
decisions regarding what to invest in.
Most importantly, the commissions that investors pay to discount brokers are
significantly cheaper than the commissions charged by full-service brokers.
Whereas a full-service brokerage may charge a commission in the hundreds of
dollars per trade, a discount broker's commissions are often a fraction of
this. And with the advent of the Internet, Web-based discount brokers make it
easier than ever for individuals to maintain their own stock portfolios.
Although discount brokers make investing easier, picking which broker to use
can be difficult. In the following sections, we'll tell you what to look for
when choosing a discount broker.
Costs
When looking for a discount broker, cost should be a major focal point. We've
already established that discount brokers are significantly less expensive
than full-service brokers, but there is a wide range of price options within
the discount broker arena as well. For example, commissions can range anywhere
from $30 to less than $10, depending on the broker. Obviously, the less you
have to pay in commissions, the better. But there are also many other factors
you should consider. Many brokers charge lower per-trade commissions for
"active traders." For example, a brokerage house can require that investors
make more than 20 or 30 trades a quarter or month before they qualify for the
lower commissions. We've said it before and we'll say it again: All else
equal, frequent trading will eat away at your returns over the long run.
Peripheral Services
Brokers sometimes charge higher commissions because they offer investors a
variety of other useful services. For example, many brokerages offer
third-party research for stocks. (With a subscription to Morningstar.com's
Premium Membership, you wouldn't need to worry about paying up for research.
We have insightful independent Analyst Reports for more than 1,500 stocks.)
Although we think most investors are capable of making their own investment
decisions, even the most experienced investors will eventually have a question
or two about their accounts. This is why it's important to look for a broker
that provides good customer service. Some companies have satellite offices in
neighborhood strip malls, while others may provide 24-hour phone support. It's
certainly worthwhile to look into a broker's customer service before making a
decision.
A more recent trend is for brokers to also provide other financial services,
such as retail banking (checking and savings accounts) and loans. These
services may be attractive for those looking for a "one-stop shop" for all
their financial needs. The range of these services can vary, but they are also
worth looking into.
After you've opened an account with your broker of choice, you have a variety
of investing options and strategies at your fingertips. At Morningstar, we
believe that a long-term investing strategy is the best way to achieve
financial success, but it is important to understand some of the mechanics and
options involved in trading and investing in stocks.
Market and Limit Orders
Investors can trade stocks through a broker using several methods, some of
which offer them more control or the opportunity to juice their returns--with
added risk, of course.
Placing an order to buy or sell shares of a company is relatively
straightforward. There are various methods you can use, however, if you want
to execute a trade at a specific price.
A market order is the most straightforward method of placing a trade. A market
order tells the broker to buy or sell at the best price he or she can get in
the market, and the trades are usually executed immediately. Since we
recommend a long-term investing philosophy, fretting over a few pennies here
and there doesn't make sense to us, and a market order is best in most cases.
A limit order means you can set the maximum price you are willing to pay for a
stock, or a minimum price you'd be willing to sell a stock for. If the stock
is trading anywhere below your maximum purchase price, or above the minimum
selling price, the trade will be executed. However, because there are
limitations when a limit order is placed, the trade might not be executed
immediately. Also, some brokers charge extra when a limit order is requested.
Buying on Margin
Buying on margin is a risky way to pump up the potential return on your
investment. Margin trades involve borrowing money from your broker to purchase
an investment. Let's run through an example of how buying on margin can be
profitable and also how it can be a risky game:
Let's say you want to buy 100 shares of fictional company Illini Basketballs
Inc. Each share costs $10, so your total cost would be $1,000 (we'll ignore
commissions for now). If those shares go up to $12 after you buy, your return
would be 20%, or $200 (100 shares x $2 per share profit).
Now let's say you bought those 100 shares on margin. Instead of using $1,000
of your own money, you borrow $500 and use only $500 of your own money. Now if
the stock goes up to $12, your return jumps to 40% ($200 profit/$500 initial
investment).
Of course nothing is free, so you'd have to pay interest on the $500 you
borrowed. Nevertheless, it's easy to see how buying shares of a company on
margin can really juice your returns. But below is an example of how buying on
margin can turn ugly. We'll use the same example as above, but with a twist:
You've borrowed $500 and used $500 of your own money to buy 100 shares of
Illini Basketballs Inc. at $10. If Illini's shares drop to $8, you've suddenly
lost 40% of your investment, and you still owe your broker the $500 it lent
you.
If stock bought on margin keeps going down, you might even eventually get a
dreaded "margin call." This means your broker is getting nervous that you
might not have enough money to pay back the loan. If you get a margin call,
you'd have to contribute more cash to your account, or sell some of your
stocks to reduce your loan. Typically, these sales happen at precisely the
wrong time--when stocks are down and at bargain-basement prices. Brokerage
houses usually have set requirements that dictate how much of your own cash
you need to have in your portfolio when trading on margin. Buying on margin is
not for beginners, so tread carefully.
Shorting
It may sound funny, but investors can actually profit when a stock goes down
in price. Shorting stocks involves selling borrowed shares with the intent of
repurchasing them at a lower price. Instead of trying to buy low and sell
high, you are simply reversing the order. Once again, let's go through an
example:
You've been tracking fictional company Badgers Bricks Corp. and think its
newest products are going to flop. The company is already on the ropes
financially, and you think that this may be the last straw. You decide to
short 100 shares of the company. After an order to short Badgers Bricks
Corp.'s stock is placed, your broker will find 100 shares that it can lend to
you. You immediately sell those shares on the marketplace for $10 and receive
proceeds of $1,000. If the stock drops to $8, you can buy the shares for $800
and return them to your broker. Your profit is $200 ($1,000 minus $800).
This sounds easy enough, but no investment is foolproof. If you make the wrong
bet when shorting a stock, your downside is potentially unlimited. In a
best-case scenario, the stock you short will go down to $0 and your profit
equals all the cash you received from selling the borrowed shares. On the
downside, the stock you short could increase in price, and there is no limit
on how high it may go. Remember, those shares are borrowed and eventually will
have to be returned. If the price keeps going up, you'll be stuck paying a lot
more to buy the stock back, perhaps much more than you could have made if the
stock went to zero. The important thing to remember is that the potential
downside in shorting stocks is unlimited. As with buying on margin, be
careful.
The Bottom Line
The mechanics of trading are really not very difficult to grasp. But to be a
successful investor, it is certainly worthwhile to use financial services
wisely by paying attention to fees and commissions, which will inevitably eat
into your returns. Minimizing your fees, like minimizing your taxes, is an
extremely worthwhile endeavor.
11.Understanding the News
分类:晨星投资课程 2008.4.3 15:12 作者：v2 | 评论：0 | 阅读：230 203-Understanding the NewsCourse 203: Understanding the News
"The Dow fell 71 points today…"
"The S&P 500 continued its recent climb…"
"ABC Company missed its quarterly earnings target…"
"XYZ Company's shares jumped $2 as a result of analyst upgrades…"
These are common statements you may hear on any given day as you flip past a
financial news channel on your TV or scan the headlines in your newspaper. But
what are the Dow and the S&P 500? What is the Nasdaq? What happens when a
company misses earnings targets or gets upgraded or downgraded by analysts?
What does any of this stuff mean to you, as an investor?
In this lesson, we are going to focus on building an understanding of some of
the things you may typically hear in the financial news. Then we are going to
learn how to separate what actually matters from what is nothing more than
"noise."
Stock Indexes
A stock index is simply a grouping or a composite of a number of different
stocks, often with similar characteristics. Stock indexes are typically used
to discuss the overall performance of the stock market, in terms of changes in
the market price of the stocks as well as how much trading activity there is
in any particular period. Three of the most widely followed indexes are the
Dow Jones Industrial Average, the S&P 500, and the Nasdaq Composite.
The Dow Jones Industrial Average
Known as just the "Dow" for short, this index is not really an average, nor
does it exclusively track heavy industry anymore. The index is composed of 30
large stocks from a wide spectrum of industries. General Motors GM and General
Electric GE are the only two companies that have been part of the Dow Jones
Industrial Average since it was created in 1928. The latest change to the Dow
was the addition of insurance company American International Group AIG,
pharmaceutical firm Pfizer PFE, and telecommunications company Verizon VZ in
April 2004, while AT&T T, Eastman Kodak EK, and International Paper IP were
dropped to make room.
At the close of business on Jan. 1, 2005, the Dow stood at 10,783. How is this
figure calculated?
The index is calculated by taking the 30 stocks in the average, adding up
their prices, and dividing by a divisor. This divisor was originally equal to
the number of stocks in the average (to give the average price of a stock),
but this divisor has shrunk steadily over the years. It dropped below one in
1986 and was equal to 0.135 in January 2005. This shrinkage is needed to
offset arbitrary events such as stock splits and changes in the roster of
companies. With the divisor at 0.135, the effect is to multiply the sum of the
prices by about 7.4. (The numeral one divided by 0.135 is approximately 7.4.)
To look at it another way, each dollar of price change in any of the 30 Dow
stocks represents a roughly 7.4-point change in the Dow.
Because the Dow includes only 30 companies, one company can have much more
influence on it than on more broad-based indexes. Also, since the prices of
the 30 stocks are added and divided by the common denominator, stocks with
larger prices have more weight in the index than stocks with lower prices.
Thus, the Dow is a price-weighted index. It's also useful to remember that the
30 stocks that make up the Dow are picked by the editors of The Wall Street
Journal, rather than by any quantitative criteria. The editors try to pick
stocks that represent the market, but there's an inevitable element of
subjectivity (and luck) in such a method.
Despite its narrower focus, the Dow tracks quite well with broader indexes
such as the S&P 500 over the long run.
The S&P 500
The Dow Jones Industrial Average usually gets most of the attention, but the
S&P 500 Index is much more important to the investment world. Index funds that
track the S&P 500 hold hundreds of billions of dollars, and thousands of fund
managers and other financial professionals track their performance against
this ubiquitous index. But what exactly is the S&P 500, anyway?
The Standard & Poor's 500 as we know it today came into being on March 4,
1957. The makers of that first index retroactively figured its value going
back to 1926, and they decided to use an arbitrary base value of 10 for the
average value of the index during the years 1941 through 1943. This meant that
in 1957 the index stood at about 45, which was also the average price of a
share of stock. The companies in the original S&P 500 accounted for about 90%
of the value of the U.S. stock market, but this percentage has shrunk to just
more than 80% today as the number of stocks being traded has expanded.
Although it's usually referred to as a large-cap index, the S&P 500 does not
just consist of the 500 largest companies in the U.S. The companies in the
index are chosen by a committee at investment company Standard & Poor's. The
committee meets monthly to discuss possible changes to the list and chooses
companies on the basis of "market size, liquidity, and group representation."
New members are added to the 500 only when others drop out because of mergers
or (less commonly) a faltering business.
Some types of stocks are explicitly excluded from the index, including real
estate stocks and companies that primarily hold stock in other companies. For
example, Berkshire Hathaway BRK.B, the holding company of Warren Buffett,
arguably the world's greatest investor, isn't included, despite having one of
the largest market values of all U.S. companies. Also, the index is composed
exclusively of U.S. companies today.
Size matters with the S&P 500. Because the companies chosen for the index tend
to be leaders in their industries, most are large firms. But the largest of
the large-capitalization stocks have a much greater effect on the S&P 500 than
the smaller companies do. That's because the index is market-cap-weighted, so
that a company's influence on the index is proportional to its size.
(Remember, a company's market cap is determined by multiplying the number of
shares outstanding by the price for each share.) Thus, General Electric and
ExxonMobil XOM, with the two biggest market caps among U.S. companies,
accounted for 3.4% and 2.9%, respectively, of the S&P 500 as of the beginning
of 2005. In contrast, other smaller companies can account for less than 0.1%
of the index.
The Nasdaq Composite
The Nasdaq Composite was formed in 1971 and includes the stocks of more than
3,000 companies today. It includes stocks that are listed on the
technology-company-heavy Nasdaq stock exchange, one of the market's largest
exchanges. (Other major stock exchanges include the New York Stock Exchange,
or the NYSE, and the American Stock Exchange, or AMEX.) Like the S&P 500, the
Nasdaq is a market-cap-weighted index. For a stock to be included in the
Nasdaq Composite, it must trade on the Nasdaq stock exchange and meet other
specific criteria. If a company fails to meet all of the criteria at any time,
it is then removed from the composite.
"Noise" Versus News
Anyone interested in keeping up with current business events has plenty of
opportunity. Walk into any newsstand, and you'll see all kinds of newspapers
and magazine titles dedicated to the business world. Cable television offers
several business news channels. And the Internet provides countless business
and financial Web sites.
Oftentimes, events in the news cause stock prices to move both up and down,
sometimes dramatically. Sometimes the market's reaction to the headlines is
warranted; many other times, it's not. For an investor, the real challenge is
deciphering all of the headlines and stories to determine what is really
relevant for your stocks.
Here at Morningstar, we practice the discipline of scouting out great
companies with long-term competitive advantages that we expect will create
shareholder value for the foreseeable future. Then we wait until their stocks
become cheap before investing in them for the long haul. In keeping a watchful
eye out for solid investment opportunities, we constantly monitor and evaluate
the ever-changing business environment. As we digest the events that affect
any given company, we continually ask ourselves, "Does this information affect
the long-term competitive advantages and resulting cash flow of this company?
Does it change the stock's long-term investing prospects?"
This is key to understanding the investment process. Periodically, news will
break that does not affect a company's long-term competitive advantages, but
its stock price will fall anyway. This may lead to a buying opportunity.
Remember, "Mr. Market" tends to be quite temperamental, and not always
rightfully so.
Negative Earnings Surprises
Wall Street is full of professionals whose job is to analyze companies and
provide opinions about them and estimates about their future financial
results. While most of them are very intelligent individuals who have a wealth
of information and experience, they tend to be much too shortsighted. These
analysts typically will come up with "earnings estimates" for the upcoming
three-month period. If a company's actual results fall short of analysts'
expectations, this is known as a "negative earnings surprise." On such
disappointing news, the company's stock price may fall. (Conversely, if a
company performs better than what analysts expect, it will have a "positive
earnings surprise," which may cause the stock price to increase.)
Let's pretend that Wal-Mart WMT announced earnings that fell short of
analysts' estimates by a measly two cents a share because it didn't sell as
many widgets during the holiday season as people expected. Let's also assume
that the stock fell on the disappointment. Does this disappointing shopping
season mean that Wal-Mart's long-term competitive advantages have been eroded?
Probably not. Wal-Mart remains the largest retailer in the world, with great
economies of scale and a remarkable distribution network, which allows the
company to pass huge cost savings on to customers, which, in turn, keeps
customers coming back. So it fell slightly below analysts' estimates in one
particular quarter…big deal!
Analyst Upgrades/Downgrades
In addition to providing estimates of what they think a company's sales and
earnings will be, Wall Street analysts also provide recommendations for stocks
they cover, such as "Buy," "Hold," or "Sell." When an analyst changes his or
her rating for a company's stock, the stock price often moves in the direction
of the change. Does this upgrade or downgrade affect the business prospects of
the company? No, the opinion of one person does not alter the intrinsic value
of the firm, which is determined by the company's cash flows. But maybe the
analyst made the change because he or she thought the company's business
prospects have deteriorated. Maybe that's right, maybe not. Check it out, and
decide for yourself.
Newsworthy Events
Other times investors will hear about events that have them running for cover,
and rightfully so. One such event is the announcement of a regulatory
investigation by an organization such as the Securities and Exchange
Commission or the Department of Justice. While such announcements by
themselves by no means predict impending doom, who knows what nasty surprises
may lurk for investors as regulators start turning over rocks? Plenty of
investors have been burned badly by the results of such investigations--just
ask the shareholders of Enron, Tyco TYC, or WorldCom.
Another item to be wary of is a significant lawsuit. Corporate litigation is
almost everywhere you look (these days, it's almost a normal part of doing
business), and estimates of any significant legal damage are usually already
priced into a stock. However, lawsuits often attract others, which could place
very large uncertainties on a company's performance.
A great example of how such legal issues can affect the true value of a
company is occurring at the time of this writing. Bellwether drug manufacturer
Merck MRK is experiencing a double-whammy related to litigation. Vioxx,
Merck's arthritis-pain-relieving drug that was once perceived as a
blockbuster, has been linked to heart problems in patients taking it. The
company had to recall Vioxx from the market, and it is facing serious legal
liabilities. Shortly thereafter, a court ruling shortened the patent life on
Merck's number-two-selling drug Fosamax, meaning competitors can introduce a
substitute much quicker than previously thought. Both situations have the
ability to seriously reduce Merck's future cash flows.
The Bottom Line
Successful investing requires you to keep a steady hand. Your patience and
willpower will get regularly tested as the stock market reacts to news,
sometimes justifiably, other times not. Just remember that not every bump in
the road is the edge of a cliff. If you react by racing to sell your stocks on
every little piece of bad news, you will find yourself trading far too
frequently (with the requisite taxes and commissions), and often selling at
the worst possible time. But by using focused discipline in separating the
news that matters from the noise that doesn't, you should emerge with
satisfactory investment results.
12.Start Thinking Like an Analyst
分类:晨星投资课程 2008.4.3 17:21 作者：v2 | 评论：0 | 阅读：281 204-Start Thinking Like an AnalystCourse 204:
Start Thinking Like an Analyst
Investing is far more than just learning basic accounting and crunching
numbers; it is also about observing the world around us. It is about
recognizing trends and what those trends will ultimately mean in terms of
dollars.
Thinking like an analyst can help because it can provide some organized ways
in which to observe the world. We all have analytical skills, but the degree
to which these skills are developed depends on the individual. Honing your
analytical skills can help you organize some of the information that
overwhelms you each day.
For example, it's hard not to notice how fast food restaurants are all located
near one another. Maybe this is an obvious question, but why is that? Clearly
those restaurants located at the only exit for 50 miles in the middle of
Kansas don't have much choice, and certainly business and residential zoning
regulations dictate locations to some extent. But why do all of the
quick-service restaurants locate near one another when alternatives are
available? After all, what good does it do for some of these restaurants to be
located in clusters? What happens to McDonald's MCD if Wendy's WEN is right
next door?
Four Basic Questions
The answers to these questions for restaurants, or for any business, can be
found by asking four very general questions to kick-start the analyst thought
process:
1. What is the goal of the business?
2. How does the business make money?
3. How well is the business actually doing?
4. How well is the business positioned relative to its competitors?
Once you start thinking in these terms, and sharpen your observational skills,
you'll be well on your way to thinking like an analyst, constantly on the hunt
for investment opportunities.
The goal of restaurants, for example, is to feed customers. This seems pretty
straightforward--although some restaurants have also tried to combine meals
with entertainment to mixed success--but don't just assume a business's
purpose is obvious. Be sure you have a good idea of what it's really trying to
achieve. Then ask if it makes sense for this business to try to achieve this
objective. Does it make sense for a restaurant to also entertain customers,
for example?
Once you have a good idea of what the business is trying to do, think about
how it makes money. In our restaurant example, how much does the food in the
restaurant actually cost? Can the restaurant charge more for its food because
of a pleasant ambiance or because it is providing entertainment? Is the
restaurant trying to sell a lot of meals at a low price, or is it attempting
to sell fewer meals but at a much higher profit per meal?
Then ask yourself, "How well is the business doing?" Don't worry about picking
up any financial statements just yet; rather, focus on observing what you can
about the business. Back to our restaurant example, think about where you
choose to eat and why. Has your favorite place been around a long time? Are
there lots of locations for your favorite restaurant? Are they busy, with
people in line or in the parking lot? Are they in good locations? Do they seem
to get a lot of repeat business? Do they seem to have a better caliber of wait
staff? How fancy are the interiors? As a potential investor in this or similar
businesses, all this stuff counts.
If you think you have a pretty good understanding of the business's
performance, at least as an observer, spend some time thinking about how well
it functions in its industry. In other words, assess the competition.
Is there a lot of competition in its industry? With restaurants, there
certainly seem to be a lot of choices, but what about an entirely different
industry, like computers? Are there as many types of computer companies as
there are restaurants? Not by a long shot. Does that mean that the computer
industry isn't as competitive as the restaurant industry? Not necessarily.
Instead it might mean that competition functions very differently. Since it
takes a ton of capital to start up a computer company, and not so much to
start up a restaurant, maybe there is more risk in computer manufacturing?
Maybe finding new products is also more difficult? Maybe one of the only ways
to compete in the industry is on price? Asking these kinds of questions can
give you a good idea of how well a specific business is positioned to cope
with the challenges it may encounter.
At this point it may seem like we're going a little nuts generating questions,
but thinking like an analyst involves observing the business world and asking
questions to understand how it works. Thankfully, there are also experts who
have done a lot of this thinking already, and many of them have developed
useful frameworks to help organize our thinking even more.
If we think back on the four questions we mentioned earlier, we should be able
to get a good handle on a business's goals and on its performance just by
reading about it and studying its financial statements. It's really the last
question, the one in which we consider how well a company is positioned
relative to its competitors, where we might need some more help.
Finding a Framework: Moats
It's a bit strange to think that an image typically associated with England
and the Middle Ages might offer a framework for stock analysis. As we've
already seen, in order to really think like an analyst, it's important to
consider factors beyond just the numbers. After all, our quest is to find
exceptional companies delivering outstanding performance, in which case we may
need to put forth extra effort to find that "Holy Grail."
One helpful concept is that of an "economic moat." And while you may not hear
it used as often as terms such as P/E ratio or operating profit, the concept
of an economic moat is a guiding principle in Morningstar's stock analysis and
valuation. Eventually the idea may gain more of a following since we think it
is the foundation for identifying companies that create shareholder value over
the long term. In the meantime, we'll just consider ourselves lucky to have a
framework that can separate really great companies from the merely good ones.
What Is an Economic Moat?
Quite simply, an economic moat is a long-term competitive advantage that
allows a company to earn oversized profits over time. The term was coined by
one of our favorite investors of all time, Warren Buffet, who realized that
companies that reward investors over the long term have a durable competitive
advantage. Assessing that advantage involves understanding what kind of
defense, or competitive barrier, the company has been able to build for itself
in its industry.
Moats are important from an investment perspective because any time a company
develops a useful product or service, it isn't long before other firms try to
capitalize on that opportunity by producing a similar--if not better--product.
Basic economic theory says that in a perfectly competitive market, rivals will
eventually eat up any excess profits earned by a successful business. In other
words, competition makes it difficult for most firms to generate strong growth
and profits over an extended period of time since any advantage is always at
risk of imitation.
The strength and sustainability of a company's economic moat will determine
whether the firm will be able to prevent a competitor from taking business
away or eroding its earnings. In our view, companies with wide economic moats
are best positioned to keep competitors at bay over the long term, but we also
use the terms "narrow" and "none" to describe a company's moat. We don't often
talk about the depth of a moat, yet it's a good way of thinking about how much
money a company can make with its advantage.
To determine whether or not a company has an economic moat, follow these four
steps:
1. Evaluate the firm's historical profitability. Has the firm been able to
generate a solid return on its assets and on shareholder equity? This is
probably the most important component to identifying whether or not a company
has a moat. While much about assessing a moat is qualitative, the bedrock of
analyzing a company still relies on solid financial metrics.
2. Assuming that the firm has solid returns on its capital and is consistently
profitable, try to identify the source of those profits. Is the source an
advantage that only this company has, or is it one that other companies can
easily imitate? The harder it is for a rival to imitate an advantage, the more
likely the company has a barrier in its industry and a source of economic
profit.
3. Estimate how long the company will be able to keep competitors at bay.
We refer to this time period as the company's competitive advantage period,
and it can be as short as several months or as long as several decades. The
longer the competitive advantage period, the wider the economic moat.
4. Think about the industry's competitive structure. Does it have many
profitable firms or is it hypercompetitive with only a few companies
scrounging for the last dollar? Highly competitive industries will likely
offer less attractive profit growth over the long haul.
Types of Economic Moats
After researching hundreds of companies, we've identified four main types of
economic moats.
Low-Cost Producer. Companies that can deliver their goods or services at a low
cost, typically due to economies of scale, have a distinct competitive
advantage because they can undercut their rivals on price.
Wal-Mart WMT is a great example of a low-cost producer, and its low costs
allow it to price its products the most attractively. As a dominant player in
retailing, the company's size provides it with enormous scale efficiencies, or
operating leverage, that it uses to keep costs low. Scale allows Wal-Mart to
do its own purchasing more efficiently since it has roughly 5,000 large stores
worldwide, and it gives the company tremendous bargaining power with its
suppliers. Since the company positions itself as a low-cost retailer, it wants
to ensure it gives the lowest prices to its customers. This can translate into
tough bargaining terms for those firms that want to sell their products on
Wal-Mart's shelves. As a result, Wal-Mart is able to offer prices that
competitors have a difficult time matching--one reason why you don't see too
many Kmarts around anymore.
High Switching Costs. Switching costs are those one-time inconveniences or
expenses a customer incurs in order to switch over from one product to
another. If you've ever taken the time to move all of your account information
from one bank to another, you know what a hassle it can be--so there would
have to be a really good reason, like a package deal on an account and
mortgage for example, for you to consider switching again.
Companies aim to create high switching costs in order to "lock in" customers.
The more customers are locked in, the more likely a company can pass along
added costs to them without risking customer loss to a competitor.
Surgeons encounter these switching costs when they train to do procedures
using specific medical devices, such as the artificial joint products from
medical-device companies Biomet BMET or Stryker SYK. After training to learn
to use a specific product, switching to another would require the surgeon to
forgo comfort and familiarity--and what patient, much less surgeon, would want
that? Additionally, because the surgeon would have to be trained to use a new,
competing product, he or she would also have to contend with lost time and
money resulting from not performing as many surgical procedures. Clearly, with
certain products and services, the switching costs can be quite high.
The Network Effect. The network effect is one of the most powerful competitive
advantages, and it is also one of the easiest to spot. The network effect
occurs when the value of a particular good or service increases for both new
and existing users as more people use that good or service.
For example, the fact that there are literally millions of people using eBay
makes the company's service incredibly valuable and all but impossible for
another company to duplicate. For anyone wanting to sell something online via
an auction, eBay EBAY provides the most potential buyers and is the most
attractive. Meanwhile, for buyers, eBay has the widest selection. This
advantage feeds on itself, and eBay's strength only increases as more users
sign on.
Intangible Assets. Some companies have an advantage over competitors because
of unique nonphysical, or "intangible," assets. Intangibles are things such as
intellectual property rights (patents, trademarks, and copyrights), government
approvals, brand names, a unique company culture, or a geographic advantage.
In some cases, whole industries derive huge benefits from intangible assets.
Consumer-products manufacturers are one example. They build profits on the
power of brands to distinguish their products. Well-known PepsiCo PEP is a
leader in salty snacks and sports drinks, and the firm boasts a lineup of
strong brands, innovative products, and an impressive distribution network.
The company's investment in advertising and marketing distinguishes its
products on store shelves and allows PepsiCo to command premium prices.
Consumers will pay more for a bag of Frito-Lay chips than for a bag of generic
chips. As the value of a brand increases, the manufacturer is also often able
to be more demanding in its distribution relationships. To a large degree,
brand power creates demand for those chips and secures their placement on
store shelves.
One final thought about economic moats: It is possible for some companies to
have more than one type of moat. For example, many companies that use the
network effect also benefit from economies of scale, because these companies
tend to grow so large that they dwarf smaller competitors. In general, the
more types of economic moat a company has--and the wider those moats are--the
better.
The Bottom Line
Successful long-term investing involves more than just identifying solid
businesses, or finding businesses that are growing rapidly, or buying cheap
stocks. We believe that successful investing also involves evaluating whether
a business will stand the test of time.
Moats are a useful framework to help answer this question. Identifying a moat
will take a little more effort than looking up a few numbers, but we think
understanding a company's competitive position is an important process for
determining its long-term profitability. And as we stated earlier in this
book, how well a company's stock performs is directly related to the profits
the firm can generate over the long haul.
205-Economic Moats
Course 205:
Economic Moats
In earlier lessons of this series, we introduced the concept of an economic
moat and the role it plays in identifying whether a business will stand the
test of time. To define, an economic moat is a long-term competitive advantage
that allows a company to earn oversized profits over time. Quite simply,
companies with a wide moat will create value for themselves and their
shareholders over the long haul, and these are the companies you should focus
your attention on.
The term "moat" in regard to finance was coined by one of our favorite
investors of all time, Warren Buffett, who realized that companies that reward
investors over the long term most often have a durable competitive advantage.
Assessing that advantage involves understanding what kind of defense, or
competitive barrier, the company has been able to build for itself in its
industry.
Moats are important from an investment perspective because any time a company
develops a useful product or service, it isn't long before other firms try to
capitalize on that opportunity by producing a similar--if not better--product.
Basic economic theory says that in a perfectly competitive market, rivals will
eventually eat up any excess profits earned by a successful business. In other
words, competition makes it difficult for most firms to generate strong growth
and profits over an extended period of time since any advantage is always at
risk of imitation. The strength and sustainability of a company's economic
moat will determine whether the firm will be able to prevent a competitor from
taking business away or eroding its earnings.
How to Build a Moat
There are a number of ways a company can build a sustainable competitive
advantage in its industry. Among the more qualitative measures commonly used
to assess a firm's economic moat:
Creating real or perceived product differentiation
Driving costs down and being a low-cost leader
Locking in customers by creating high switching costs
Locking out competitors by creating high barriers to entry or high barriers
to success
Thankfully we've been able to whittle down all of the types of advantages in
the marketplace. In Lesson 204, we identified the four main types of economic
moats, and below we provide a bit more detail, using examples. The more types
of moats a company can build, the better.
Low-Cost Producer or Economies of Scale
Companies that can deliver their goods or services at a low cost, typically
from economies of scale, have a distinct competitive advantage because they
can undercut their rivals on price. Likewise, companies with low costs can
price their products at the same level as competitors, but make a higher
profit while doing so.
This type of moat creates a significant barrier to entry, since a
prohibitively large amount of capital is often required to achieve a size
needed to be competitive in a market.
Dell
Dell's DELL success is due to the company's famous build-to-order direct-sales
business model, which eliminates expensive middlemen, lowers working-capital
investments, and provides real-time market information to management. The
direct model's low-overhead advantage allows Dell to undercut rivals without
sacrificing features or profitability. The firm has consistently improved
margins and increased revenue, in good times and bad, by replicating the model
across several new markets. Most recently the firm has moved into consumer
electronics, which is typically a lower-profit-margin market. But given Dell's
low-cost structure, it may succeed here as well. Along the way, Dell's
competitive advantage in building computers, servers, and notebooks at the
lowest possible prices has made life extremely difficult for other
manufacturers, particularly Gateway GTW and HP Compaq HPQ. The cyclicality of
the IT industry carries some risks, but Dell's robust cash flow and strong
balance sheet help mitigate those risks.
Wal-Mart
Wal-Mart WMT is perhaps the most salient example of a company benefiting from
economies of scale, and for good reason. As a dominant player in retailing,
the company's size provides it with enormous efficiencies that it uses to keep
costs low. For example, its size allows Wal-Mart to do its own purchasing more
efficiently since it has roughly 5,000 large stores worldwide. This gives the
company tremendous bargaining power with its suppliers.
Not only does it get its products cheaper, but its size allows it more
inexpensive distribution. In addition, it has an enormous amount of
information concerning consumer likes and dislikes, and it can spread its best
practices across its entire store base.
To see economies of scale in action, let's assume that Wal-Mart can acquire a
DVD from a supplier for $5, while it costs one of Wal-Mart's smaller
competitors $6. It also costs Wal-Mart $4 to distribute the DVD and pay for
the overhead costs of the stores, while it costs the smaller competitor $5 to
do the same. Wal-Mart can then sell the DVD for $9.50, and still make a $0.50
profit. The smaller competitor can't charge that little, because at a cost of
$11 per DVD, it would be losing money.
High Switching Costs
Switching costs are those one-time inconveniences or expenses a customer
incurs in order to switch over from one product to another, and they can make
for a very powerful moat. Companies that make it tough for customers to switch
to a competitor are in a position to increase prices year after year to
deliver hefty profits. Companies aim to create high switching costs in order
to "lock in" customers. The more customers are locked in, the more likely a
company can pass along added costs to them without risking customer loss to a
competitor.
Autodesk
Autodesk ADSK dominates architecture and construction-design software with its
market-leading AutoCAD product. With roughly 6 million loyal users, it has a
wide economic moat--high switching costs make it tough for customers to get
comparable products elsewhere or do their jobs without the help of Autodesk.
Because customers are essentially required to understand its software to be
successful in their careers, it is nearly impossible for competitors to take
meaningful market share from Autodesk.
Autodesk's software is also relatively affordable, making it somewhat immune
when the economy turns south. While some software costs millions of dollars,
Autodesk's products cost much less; the initial price of AutoCAD is only a few
thousand dollars. This makes the company less susceptible to cutbacks in
information-technology spending. In addition, using its software reduces
expenses by shortening the design and manufacturing processes. The firm has
also incorporated subscription sales, which add more predictability to its
business model and further "lock in" its customers. As with many technology
companies, uncertainty remains regarding its new product development cycle and
adoption of new products, but Autodesk's committed customer base give the firm
a wide economic moat.
Citigroup
If you've ever taken the time to move all of your account information from one
bank to another, you know what a hassle it can be. Even if another bank is
offering the same services for $1 less per month or maybe a slightly higher
interest rate on deposits, is all the extra effort needed to switch really
worth it?
You may also want to look at your wallet and think about your credit cards.
How long have you had some of those cards, and why do you keep them? Surely a
better deal could be had elsewhere. But perhaps you have built up
frequent-flier miles on your cards, have your utility bills automatically
charged, or enjoy the familiarity that having the same account for a long time
offers.
Clearly, banks and credit card companies enjoy the benefits of the high
switching costs their customers would incur by leaving. As the largest credit
card issuer in the world, Citigroup C is one of the beneficiaries. It is also
worth noting that Citigroup enjoys switching costs across a large number of
its other financial services businesses, making for an impressive firmwide
moat.
The Network Effect
The network effect occurs when the value of a particular good or service
increases for both new and existing users as more people use that good or
service. It can also occur when other firms design products that complement an
existing product, thereby enhancing that product's value. The network effect
is arguably one of the most potent competitive advantages, and it can also
quickly catapult firms to the lead in new industries.
Adobe
Like Autodesk, Adobe ADBE actually enjoys two economic moats. The firm's
Acrobat software has become the standard for reading and creating documents
electronically. Because customers, such as graphic designers, are trained
early in their careers to use products like Photoshop and Illustrator, it's
nearly impossible for competitors to take meaningful market share. High
switching costs make it tough for customers to get comparable products
elsewhere or do their job without Adobe.
As if switching costs weren't enough, Adobe also benefits from the network
effect. With more than 500 million copies downloaded, Acrobat has a foothold
on computer desktops everywhere. As its network effect increases, and more
designers and readers use Adobe's software, its position as a standard-bearer
grows.
eBay
When the online auction market was just getting started, eBay EBAY was the
largest. As the site with the most sellers, it had the widest selection of
products. This attracted the most buyers. Because it had the most buyers, it
attracted more sellers.
The cycle just continued to feed on itself, and now eBay is essentially the
only real online auction site of size. It was able to capture this position
even though some large, well-known, and well-financed Internet companies such
as Yahoo YHOO and Amazon AMZN tried to make a frontal assault on eBay in the
late 1990s with very little success.
Intangible Assets
This category incorporates several types of competitive advantages including
intellectual property rights (patents, trademarks, and copyrights), government
approvals, brand names, a unique company culture, or a geographic advantage.
It may be difficult to assess the durability of some of these advantages, so
be sure you have a grasp of how long this type of competitive advantage might
last. Brand equity, for example, can be damaged or slowly erode over time,
while government approval can be revoked. Try to understand how susceptible a
firm might be should this kind of advantage be disrupted.
Moody's
Moody's MCO plays an important role in the capital markets by evaluating the
risk associated with borrowers and debt instruments. The rating process is
hardly ever easy. The federal government has created a designation--nationally
recognized statistical rating organization--that a company must acquire before
moving into the market. Achieving this designation is very challenging,
meaning that the rating business is basically a government-sanctioned
oligopoly with a limited number of competitors.
The government protection Moody's enjoys is virtually priceless. Operating
profit margins have been higher than 50% over the past couple of years, thanks
to growth in international and structured finance, where pricing is especially
sweet. These high margins lead to excellent cash flow from operations. The
company requires very little in the way of capital investment, so its leverage
is low and free cash flow is strong.
Harley-Davidson
Anytime people are willing to tattoo a company's logo onto their arms, it is a
surefire sign of a powerful brand. The firm, the only continuous survivor from
the original American motorcycle industry, is more than 100 years old. The
brand built over this time has allowed Harley HDI dealers to sell motorcycles
at or above manufacturer's suggested retail price for years. Despite selling
essentially the same steel, chrome, and rubber as its competitors, it can
charge premium prices for its products. And as we'll see in later lessons,
Harley's brand has translated into solid financial results for the company.
The Bottom Line
While having these four types of moats, or competitive advantages, as
guidelines is helpful, there is still a lot of art to determining whether a
firm has a moat. At the heart of it, the harder it is for a firm's advantage
to be imitated, the more likely it is to have a barrier to entry in its
industry and a defensible source of profit.
14. More on Competitive Positioning
分类:晨星投资课程 2008.4.7 13:23 作者：v2 | 评论：0 | 阅读：351 206-More on Competitive PositioningCourse 206:
More on Competitive Positioning
In the previous lesson, we reviewed the different types of defenses (economic
moats) and offered examples of wide-moat firms. Understanding moats, and
determining whether or not a firm has a moat is a tricky process. In this
lesson we'll examine the mental model that underpins our moat framework and
explore some of the nuances of wide moats, narrow moats, and deep moats.
Porter's Five Forces
Michael E. Porter's Competitive Strategy, originally published in 1980, is a
definitive work on industry competition. In the book, the Harvard professor
provides a framework for understanding competitor behavior and a firm's
strategic positioning in its industry. Much of Porter's framework should be
familiar as it underpins our thinking about economic moats.
In essence, Porter provided a framework of five forces that can be used to
understand an industry's structure. Since firms strive for competitive
advantage, the first four forces at work help to assess the fifth, an
industry's level of rivalry:
Barriers to Entry. How easy is it for new firms to start competing in a
market? Higher barriers are better.
Buyer (Customer) Power. Similar to switching costs, what keeps customers
locked in or causes them to jump ship if prices were to increase? Lower
power is better.
Supplier Power. How well can a company control the costs of its goods and
services? Lower power is better.
Threat of Substitutes. A company may be the best widget maker, but what if
widgets will soon become obsolete? Also, are there cheaper or better
alternatives?
Degree of Rivalry. Including the four factors above, just how competitive is
a company's industry? Are companies beating one another bloody over every
last dollar? How often are moats trying to be breached and profits being
stolen away?
Porter's five forces considered together can help you to determine whether a
firm has an economic moat. The framework is particularly useful for examining
a firm's external competitive environment. After all, if a company's
competitors are weak, it may not take much of a moat to keep them at bay.
Likewise, if a company is in a cutthroat industry, it may require a much wider
moat to defend its profits.
A Five Forces Example: Consumer Products
The five forces concept is perhaps best explained through example. (Porter's
work is nothing short of excellent, but it is a heavy read.) Let's briefly
examine the household consumer-products industry by considering rival firms
Clorox CLX, Kimberly-Clark KMB, Colgate-Palmolive CL, and Procter & Gamble PG
in terms of Porter's five forces:
Buyer Power. Consumer-products companies face weak buyer power because
customers are fragmented and have little influence on price or product. But if
we consider the buyers of consumer products to be retailers rather than
individuals, then these firms face very strong buyer power. Retailers like
Wal-Mart WMT and Target TGT are able to negotiate for pricing with companies
like Clorox because they purchase and sell so much of Clorox's products.
Verdict: Strong buyer power from retailers.
Supplier Power. More than likely, consumer-products companies face some amount
of supplier power simply because of the costs they incur when switching
suppliers. On the other hand, suppliers that do a large amount of business
with these companies--supplying Kimberly-Clark with raw materials for its
diapers, for instance--also are somewhat beholden to their customers, like
Kimberly-Clark. Nevertheless, bargaining power for both the firms and their
suppliers is probably limited. Verdict: Limited supplier power.
Threat of New Entrants. Given the amount of capital investment needed to enter
certain segments in household consumer products, such as manufacturing
deodorants, we suspect the threat of new entrants is fairly low in the
industry. In some segments within the household consumer-products industry,
this may not be the case since a small manufacturer could develop a superior
product, such as a detergent, and compete with Procter & Gamble. The test is
whether the small manufacturer can get its products on the shelves of the same
retailers as its much larger rivals. Verdict: Low threat of new entrants.
Threat of Substitutes. Within the consumer-products industry, brands succeed
in helping to build a competitive advantage, but even the pricing power of
brands can be eroded with substitutes such as store-branded private-label
offerings. In fact, some of these same store-brand private-label products are
manufactured by the large consumer-products firms. The firms believe that if
they can manufacture and package a lower-price alternative themselves, they
would rather accept the marginal revenue from their lower-priced items than
risk completely losing the sale to a private-label competitor. Verdict: High
threat of substitutes.
Degree of Rivalry. Consumers in this category enjoy a multitude of choices for
everything from cleaning products to bath washes. While many consumers prefer
certain brands, switching costs in this industry are quite low. It does not
cost anything for a consumer to buy one brand of shampoo instead of another.
This, along with a variety of other factors, including the forces we've
already examined, makes the industry quite competitive. Verdict: High degree
of rivalry.
Examining an industry through the framework of Porter's five forces helps
illustrate the different dynamics at work. It's not always clear-cut, either,
so one wouldn't expect all of the firms in this industry to fall into one big
bucket labeled wide moat or narrow moat. Instead, there are firms with
distinct, long-term advantages and wide moats, like Procter & Gamble and
Colgate, while others have advantages that we think may be less sustainable,
such as Clorox and Kimberly-Clark.
Getting Back to Moats
Porter's framework makes scouring an industry for great investment ideas much
easier. Understanding an industry helps us find the great businesses with
economic moats that will withstand the inevitable economic, competitive, and
random other challenges that often cripple weaker businesses.
Once we have a collection of great businesses from which to choose, finding
those that meet our criteria and deliver above-average returns on invested
capital over the long term becomes even easier. (We will discuss returns on
invested capital more in Lesson 305.)
Generally speaking, we believe investors should steer clear of companies that
have no moat (those with a Morningstar moat rating of "none") because they
have very few, if any, competitive advantages and can't keep rivals from
eating away at their profits. (Lots of these companies don't even have any
profits.) For example, we don't think Delta Air Lines DAL, Albertson's ABS,
and Goodyear Tire & Rubber GT have moats around their respective businesses.
More than likely, we wouldn't want to hold a no-moat company for the long
haul, so we probably wouldn't buy stock in one of these firms to begin with.
Some people are shrewd enough to buy no-moat stocks on a dip, hold them for a
short term, and make a profit. As long-term investors this isn't a game we
like to play. We think the rewards are far better, and the risks much lower,
for those who spend a little effort to find strong companies to hold for a
long time.
Types of Narrow Moats
There are certainly gradations of moat width, and we here at Morningstar
describe companies with milder competitive advantages as having "narrow"
moats. From our point of view, far more companies have narrow moats than wide
ones. Narrow-moat firms are, on average, of a much higher quality than no-moat
companies. Generally, narrow-moat companies generate lower returns on invested
capital than wide-moat companies but still have returns slightly above their
cost of capital. (We will talk about return on invested capital and cost of
capital extensively in coming lessons.) Narrow-moat companies typically come
in two varieties:
Firms with Eroding Moats. These companies have competitive advantages, but
they are eroding due to a shifting industry landscape. This scenario is faced
by some of the consumer-products companies, like those we just examined. For
example, we consider both General Mills GIS and Kellogg K to be narrow-moat
firms. The pricing power they once enjoyed is eroding as a result of increased
competition and an ever-consolidating retail landscape that is increasing
buyer power. The Baby Bells, such as SBC SBC and Verizon VZ, are another
example; their economic moats are also slowly eroding. In future years, they
won't enjoy the monopoly pricing power they once did because of the increased
use of wireless phones and, of course, the Internet.
Firms with Structural Industry Challenges. A company in this category
dominates its peers, but resides in an industry where wide moats are nearly
impossible to create. For example, in the airline industry, it's pretty much
impossible to create pricing power, and even being a low-cost provider doesn't
always bring stable profits because the industry itself is just too
commodified. People tend to just book the cheapest fare, with little regard to
brand. One of our favorite firms in the airline industry, Southwest Airlines
LUV, is a good example of a narrow-moat firm that has a solid low-cost
positioning, but still faces serious industry challenges, such as volatile
fuel prices.
Wide Moats
All things equal, we'd choose a wide-moat company over one with a narrow-moat
rating for the significant competitive advantages that should enable the
wide-moat firm to earn more than its cost of capital for many years to come.
Most wide-moat companies have some sort of structural advantage versus
competitors. By "structural," we mean a fundamental advantage in the company's
business model that wouldn't go away even if the current management team did.
With a structural advantage, a company isn't dependent on having a great
management team to remain profitable. To paraphrase Peter Lynch, these are
companies that could turn a profit even with a monkey running them, and it's a
good thing, because at some point that may happen.
We hate to sound like a broken record here, but the four types of moats that
we identified in the previous lesson are incredibly useful when thinking about
structural advantages a company may or may not possess. Keep the four types of
moats in mind:
Low-Cost Producer or Economies of Scale
High Switching Costs
Network Effect
Intangible Assets
Wide Moats Versus Deep Moats
With the concept of a wide moat firmly in place, it's also important to
realize that the width of a firm's moat, or how broad and numerous its
competitive advantages are, matters more than the moat's depth, or how
impressive any individual advantage is. Discerning between width and depth can
be difficult, however.
First, it's absolutely critical to understand not only what an economic moat
is, but also how it translates to above-average returns on capital. Many
investors easily surmise the first point about moats--that a competitive
advantage is required--but they miss the importance of the second point,
above-average returns. If the business doesn't throw off attractive returns,
then who cares if it has a competitive advantage? Autos and airlines are two
businesses with some barriers to entry, but few new competitors are trying to
crash the party in a race for single-digit ROEs or bankruptcy.
Over the years, Warren Buffett has frequently referred to his desire to widen
the moats of his companies, but it's rare to see him refer to a moat's depth.
Buffett's frequent talk of moat width--and silence on moat depth--speaks
volumes. Michael E. Porter has said, "Positions built on systems of activities
are far more sustainable than those built on individual activities."
Unfortunately, no company is going to tell you if it has a moat, much less
whether that moat is of the wide or deep variety. If a firm has a competitive
advantage, it behooves it to not tell you how its moat has been built. After
all, you just might emulate it.
Still, it can be worth investors' time to ponder whether the stocks they're
invested in have one really fantastic competitive advantage that, while deep,
may lack width, or if they're invested in firms with a series of advantages
that can sustain above-average returns on capital over the long haul.
Consider well-run giant conglomerates like General Electric GE or Citigroup C.
Finance theory tells us that these decades-old firms should have seen their
returns on capital dribble down to their cost of capital ages ago due to
rivals competing away the excess returns. (We'll talk much more about returns
on capital and cost of capital in coming lessons.) Yet, Citigroup's ROEs are
still in the upper teens even in a bad year.
Why haven't competitors captured these profits? Quite simply, these firms are
pretty good at an awful lot of things. If Citigroup is hobbled by problems in
its private banking unit or regulatory scandals on its trading desks, it can
rely on its impressive credit card operations and retail banking business to
carry the day. At GE, if new competition from cable hurts the NBC network or
its insurance division posts lackluster returns, it can rely on a cadre of
numerous other good businesses to pick up the slack. Like stacked plywood,
each of these businesses is strong in its own right, but virtually
indestructible together.
The Bottom Line
This and the preceding lesson have covered a lot of material about moats and
the qualitative aspects of a company's positioning. Though this step in
identifying attractive companies for investment is an important one, it is
only the first step. In coming lessons in this book, we will show you how to
quantitatively confirm that a company has a moat, as well as show you how to
value stocks so that you don't blindly pay too much for a quality company.
15.Weighting Management Quality
分类:晨星投资课程 2008.4.8 14:27 作者：v2 | 评论：0 | 阅读：188207-Weighting Management Quality
Course 207:
Weighting Management Quality
Because people run companies, any investment opinion about a company is an
opinion about the likely outcome of the combined efforts of the people who
work for and manage it.
Keeping this in mind when you evaluate companies as investment opportunities
can provide valuable perspective on some of the qualitative factors you should
focus on. This lesson will cover some of the most important questions to ask
and the sources you can use to evaluate the people who run public companies.
Why Management Matters
In his groundbreaking work Common Stocks and Uncommon Profits, Philip Fisher
argues that because company managers are much closer to a company's assets
than stockholders, they wield considerable day-to-day influence over the
arrangement and disposition of the company's affairs. (For more on Fisher, see
Lesson 505.) According to Fisher, "Without breaking any laws, the number of
ways in which those in control can benefit themselves and their families at
the expense of the ordinary stockholders is almost infinite."
Fisher suggests that investors should accumulate as much background
information on companies and their managers as possible by talking to people
in the industry. He refers to the process as gathering "scuttlebutt." Visiting
management in person, and interviewing line managers, competitors, customers,
and suppliers are most stock analysts' preferred means for gathering such
information, and the impressions they garner during these visits can have a
strong, yet subtle impact on their view of the company's prospects. This type
of research is typically not realistic for nonprofessional investors with
limited time, but there are still things you can do to get a sense of the
quality of a company's management.
Ultimately, it boils down to trust: As an investor, can you trust this
management team to develop and execute the right business plan and perform
their duties in your best interest?
Investors can easily familiarize themselves with the backgrounds and
qualifications of the managers of the companies they invest in by checking
their biographies on company Web sites or in the annual proxy statements sent
to shareholders (and filed with the SEC as Schedule DEF 14a). Part of
answering the question, "Can I trust this team?" certainly hinges on basic
information like, "Is the team qualified?" But often enough in corporate
America, managers have grown up with a company, and their resumes won't say
much about what they've done recently, and they won't tell you much about
whether to trust these individuals with your money.
We believe that in the grand scheme, people respond to the incentives they are
given or set for themselves. In some ways, this represents the kernel of the
American Dream: Regardless of your background, if you prove yourself and work
hard, you can do anything. The promise of financial reward accompanies most
versions of the American Dream we've heard of. This is the angle from which we
here at Morningstar approach the question about trusting management. We assume
the team is qualified (whether by pedigree, education, or hard knocks), but we
question the motivation and reward system that the team (including the board
of directors) has put in place and by which they measure their own
performance.
Management Structure
Technically, the management team of a public company works for and reports to
the board of directors, who represent the company's owners: its shareholders.
In the U.S., companies typically hold annual elections at which shareholders
vote (or assign their vote to someone else, called a proxy) to elect directors
to the board. In theory, then, shareholders can wield great influence over the
management and direction of the companies whose shares they own. In practice,
as corporate and investing cultures have evolved, the relationship between
shareholders and company managers has become ritualized and more distant.
So how should investors close the gap? We believe that by identifying and
investing in companies that have demonstrated their commitment to treat
shareholders well, individual investors can reassert their influence on the
day-to-day choices and priorities that companies set.
What do we mean by "demonstrated commitment to shareholders?" Perhaps an
analogy will help. Imagine you have decided to start a lemonade stand with
your neighbor. When you meet at the appointed time to go over your plans, your
neighbor brings a pound of sugar for the lemonade. Such a gesture demonstrates
your neighbor's commitment to doing business with you.
Similarly, when you view a home for sale, you expect it to be orderly, and
that the owner will make arrangements for you to see it. In this small way,
the seller has demonstrated his or her commitment to doing the things that are
necessary to sell you the home. If it's a hassle to view the home, or it's
disorderly when you view it, that should prompt questions about how the later
stages of negotiation and closing will be handled.
Buying a Business
Now imagine that you are considering buying part of a business, potentially to
keep and to profit from for a long time. What signs should you look for that
the company's directors and managers are interested in doing business with
you?
Investors should look for companies that offer clear communication about the
business, have established a clear separation between business and personal
relationships, and have set clear goals for measuring progress in conducting
the business. In practice, these goals often involve raising barriers or
instituting policies meant to inhibit human nature. By snooping around the
edges and examining the outward signs of how a company's management team
behaves and rewards itself, we can surmise how committed they are to honoring
their role as stewards of investor capital.
While it would be impractical for every private shareholder to visit
management and dig around for scuttlebutt, this doesn't mean that individual
investors should simply give up on investigating the people who run their
businesses. On the contrary, through a handful of public sources, investors
can begin to crack the nut around one of the most subjective elements of stock
research: management.
We will refer to the host of topics surrounding management as "stewardship."
Fisher describes the qualities he looks for in managers as trusteeship. Others
refer to these issues as corporate governance, fiduciary responsibilities, and
other names. We call it stewardship because we look for managers who see
themselves as stewards of investors' capital and who have signaled their
self-image to us in verifiable ways. We find the alternative--managers who see
the company they run as their personal piggy-bank--repugnant.
The Proxy: A Management Information Goldmine
The primary source for information about how a company's shareholders,
directors, and management have arranged their affairs is its annual proxy
filing, or Schedule DEF14a, which serves as a notice of, invitation to, and
background reading for the annual shareholders' meeting. The proxy details the
board's activities, managers' compensation, and any shareholder or management
proposals that require a vote by shareholders. It also contains director and
manager biographies, information about managers' and directors' compensation
and ownership of shares, and often a description of any related-party
transactions or other relationships that the company's top management team or
directors may have that could present them with a conflict of interest.
Next, we will discuss the sources we here at Morningstar check most often to
find information that we use to evaluate management's stewardship. Of course,
you should try to soak up as much information as you can from as many sources
as you can.
Within the proxy, we pay attention to the report of the compensation committee
of the board. Although often bland, this report gives some insight into how
pay is set in the executive suite. (The blander the report, the more likely we
think that the CEO effectively sets his own pay, which is a problem.) We also
recommend that investors read management's discussion (usually a rebuttal) of
shareholder proposals attached to the proxy--these can shed light on
management's priorities and consideration for shareholder interests, depending
on the merits of the proposal.
We also check other public sources for information relevant to evaluating
management. We read management's discussion and analysis in the annual report
(10-K) for many reasons, one of which is to ascertain the level of exposition
company managers provide about how they see the business. The annual financial
filing also discusses litigation and risk factors, as well as a record of
options granted in recent years. In the quarterly report (10-Q) filed
immediately after the annual shareholders' meeting, we look at the results of
the shareholder vote. This allows us to evaluate how seriously the board takes
shareholder proposals that pass by a majority, even though these are often not
even binding.
Increasingly, companies post all of the above information on their Web sites.
On the company Web page, look for a link to "Investor Relations," and from
there, look for a section dedicated to "Corporate Governance." By looking at
all these sources and following the flow of information concerning how the
company's profits are allocated to management, we can learn much more than by
just poring through cookie-cutter articles of incorporation.
Therefore, when we evaluate management, we split our areas of inquiry into
three main topics:
Transparency. Paramount among outward commitments, public dissemination of
information about the business and its finances reflects strongly on
management's respect for investors. Without adequate and reliable accounting
practices and overall disclosure, investors would be entirely at the mercy of
insiders.
Shareholder Friendliness. To assess the power of shareholders relative to
management and how the board and management treat other shareholders, we
evaluate the firm's share-class structure and assignment of CEO and board
chair roles, and take particular note of any takeover defenses or
related-party transactions.
Incentives, Ownership, and Overall Stewardship. In this area we ask whether
management's and employees' incentives are aligned with shareholders'
interests. In particular, we focus on whether management's compensation is "at
risk" alongside the results of the firm, and whether it is structured to
motivate long-term value creation. Investors should penalize those firms that
change management goals midstream, issue too many options, overcompensate
executives, or have low levels of equity ownership.
20 Questions
Here's the fun part. If you liked 20 questions as a parlor game, you may enjoy
using the same 20 questions that Morningstar's stock analysts currently use to
evaluate the three main areas of stewardship at the companies they cover. As
you will see, some of these require a working knowledge of accounting and the
company's track record. Nonetheless, familiarizing yourself with the subject
matter of even a handful of these inquiries will bring you closer to
evaluating management on your own behalf.
Transparency
1. Does the company overuse "one-time" charges or write-offs? In public
announcements, does it consistently disregard GAAP earnings and point to pro
forma numbers (i.e., figures "excluding charges...")?
2. Does the firm have aggressive accounting? For example, has there been a
major change to accounting practices, such as revenue recognition, during the
past three years that may have been intended to hide something?
3. Has the company recently restated earnings for any reason other than
compliance with an accounting rule change? Has the company had an unexplained
delay in making regulatory filings or reporting quarterly results?
4. Does the company grant options without expensing them?
5. Does the company choose not to provide any balance sheet with its quarterly
earnings release?
6. Bonus: Does the company's disclosure go above and beyond what its
competitors provide?
Shareholder Friendliness
7. Does the company have a separate voting class of shares that an insider
controls?
8. Does the company have takeover defenses in place that, if exercised, would
significantly dilute existing shareholders or favor the interests of
management over shareholders in a takeover situation?
9. Has a majority vote of shareholders on a proposal been thwarted by any of
the following: (a) management inaction; (b) management interference in the
ballot process; or (c) the existence of a supermajority provision?
10. Are the chairman of the board and the CEO the same person?
11. Has the board or management engaged in significant related-party
transactions that cast doubt on its ability to act in shareholders' best
interests?
12. Bonus: Is there cumulative voting (i.e., are shareholder votes equal to
shares owned times number of directors)?
Incentives, Ownership, and Stewardship
13. Has the board agreed to a compensation structure that rewards management
merely for being employed, rather than for making value-enhancing decisions?
14. Over the past three years, has the firm given away more than 3% of shares
annually as options?
15. In bad times, has the board granted "one-time" "retention bonuses,"
redefined management goals midstream, repriced options, or bestowed other
"extraordinary" perks?
16. Is the CEO's equity stake in the company (including options) too small to
align his or her interests with shareholders'?
17. Do directors receive a substantial portion of their compensation in cash,
rather than stock?
18. Do the goals set out for top management by the board's compensation
committee encourage short-term actions rather than long-term value creation?
Is the board's disclosure of such goals insufficient, too generic, or too
fuzzy to allow you to answer the preceding question?
19. Given the company's financial performance, the board's and management's
past actions, and the above factors, is management inappropriately motivated
and/or rewarded?
20. Bonus: Does the board and management have a substantial track record of
doing right by shareholders?
We do not weigh all of these questions equally, and sometimes the details
necessitate the exercise of judgment. Of all these questions, we place the
greatest emphasis on Question 11 because related-party transactions can be
especially harmful to shareholders and are a decent indicator of bigger
governance problems. Frequent and egregious lapses are a leading indicator
that a given company's inner sanctum has too easily rationalized putting its
self-interest over shareholders' interests. Caveat emptor.
To illustrate an egregious related-party transaction, consider Sinclair
Broadcasting SBGI. This television broadcasting company reported in its proxy
that it made a large investment in a car dealership in which its CEO and
chairman already held a significant stake. We don't see how this deal served
Sinclair shareholders. Moreover, the fact that it had to be reported did not
hamper the management team from completing the deal, which we also see as a
warning sign. A glance at the company's stock chart reveals that investors
have caught on to what value management has and has not created for
shareholders over the years. Morningstar's analysts have compiled lots of
egregious examples of related-party transactions just like this.
Morningstar Stewardship Grades
Morningstar has already done a lot of management investigation for you! For
the 1,500-plus companies that we cover, Premium subscribers to Morningstar.com
have access to analyst-driven Stewardship Grades based on the topics discussed
in this lesson. Like in school, the grades are "A" through "F," with "C" being
the most common grade.
Morningstar stock analysts base the Stewardship Grades on public filings,
previous management actions, conversations with company officials, and their
own expertise. We assign the grades on an absolute scale--not on a curve or on
an industry-peer basis. Therefore, if a company engages in practices that
Morningstar analysts think do not reflect good stewardship of investors'
capital, it will receive a poor grade regardless of how other firms may have
scored.
The Bottom Line
Though competitive positioning remains extremely important to a company's
long-term fortunes, quality of management matters, too. After all, even the
most attractive ship can be run ashore by an incompetent skipper, or be
pillaged by a pirate. The whole reason it is worthwhile to go through these
exercises is to make sure you are investing your money with people you can
trust.
课程:证券与投资.题目:用50万去投资?
晨星是什么意思啊？
长春晨星人才交流中心
神魔之子 晨星
关于晨星注册的烘培网
晨星投影机的生产厂家联系方式
3+2课程是什么
东阳晨星影业有限公司怎么走？
请问徐晨星的星座是什么啊?
想进入房地产投资开发公司工作,需要学什么课程,对本科毕业生的要求如何?
那里有培训怎样投资买卖二手房买卖课程的地方？或书，或前辈的联系电话！
我比较喜欢干投资，请问应该具备那些能力才行，应该学些什么课程
2万元怎么投资
我想投资2-3万
"晨星理荒秽,带月荷锄归"是什么意思,表达作者什么思想
徐晨星到底是不是春春表哥啊？？？？
QQ幻想“晨星之光”能卖多少啊？
《神魔之子》的作者晨星喜欢什么样的地方？？？
帮我起个英文名，发音同：“晨星”的
哪里可以看 晨星的《神魔之子》
神魔之子 晨星 17章以后的
什么是晨星开放基指?它是如何计算的？
全国计算机等级考试2级应学那些课程
初2课程有点跟不上 提意见啊