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Conservative Investment
In order to comprehend what needs to be present in a conservative investment it is important to show one side of the characteristics we need to make sure is there.
In order to be a real conservative investment company, in the case of all or almost all of its product lines, it needs to be the lowest cost producer or around as low a cost producer as possible as other competitors. This company is also required to promise to keep on doing so in the future. This is the only way that it will provide the owners of the company with a broad enough margin between the costs and the selling price in order to bring about two very important circumstances. One of these circumstances has to do with having enough flexibility under the break even point of most competition. In cases where there are difficult years, the prices are not likely to stay for a long time underneath the break even point. While they do remain there though, the losses for a lot of the higher cost competition will be so great that in some cases the competitors will see themselves in a situation in which they have to stop production. When this occurs, it pretty much right away brings up the profits of the low cost companies that have lived through because they benefits financially from the increased production that comes to them as they occupy and supply the demand that used to be provided by the plants that were then forced to close down. Low cost companies benefit even more so when the decreased supply from its competitors allows it to do more business as well as increase prices as excess supplies are not pressing on the market anymore.
Something else that places a company in the place of a conservative company is that the greater than average profit margin should allow a company to make enough in order to generate inside a big part or even all of the funds that are needed for increase of financing. This prevents a lot of or even all of the necessity for coming up with more long term capital that can effect into shares being issued and diluting the value of the already outstanding shares or it can also create an extra load of debt with fixed interest payments and fixed maturities that increase the risk of the common stock owners a great deal.
Keep in mind though that just like the amount to which a company is a low cost company producer enhances the security and conservatism of the investment, in a boom stage of a bullish market will in lose its exploratory magnetism. The percentage that always increases during those periods will always be a lot more for the high cost and risky marginal companies and it is very simple to understand why.
If you were to look at two different companies that have the same size and that during normal times were selling pens at ten cents per piece. Company 1 has a profit of five cents per pen and Company 2 has a profit of 2 cents per pen. Let’s imagine that the costs stay the same however a momentary extra demand for pens makes the price go up to thirteen cents, and Company 1 and 2 remain at the same size. The stronger company has added profits from five cents per pen to seven cents which would be an increase of fifty percent; however the high cost company has actually made a three hundred percent profit gain and has actually tripled its profits. This can explain why it is that sometimes the high cost company is able to at times increase a lot more when there is a boom and additionally why, a few years later, whenever harsh times come around and the pens go back down to nine cents for example, the strong company will continue to make a reduced but still a nice amount of profit. If the high cost company does not go into bankruptcy, it will very possibly bring about another batch of investors that lost and that are certain something is wrong with the system and do not look at themselves.