"Trust me, this is a great business." – My dentist while giving me a root canal, and talking about a business whose annual report he's never read.
I hear a lot of stock tips from unlikely sources. Cabbies. My dentist. Family of high school friends I haven't seen in ages.
Most of the tips are terrible. And it's not just because the tipster usually knows little more than a ticker: It's because the kinds of companies that get tipped often (e.g. biotechs and speccy miners) are where capital goes to die.
Tipsters are quick to label a business great, even when it is really just good (or even much worse). Allow me to explain the difference.
Good companies grow earnings. Great companies grow free cash flow.
Good companies reward growth. Great companies reward growth in per-share terms.
Good companies focus on returns on equity. Great companies focus on returns on invested capital.
Good companies cut costs. Great companies innovate.
Good companies repackage good products and, voila, call it a new product. Great companies actually create new products.
Good companies design good products, and think they will sell themselves. Great companies know that even great products don't sell themselves.
Good companies offer competitive benefits. Great companies offer autonomy.
Good companies reward effort. Great companies reward results.
Good companies are fast followers. Great companies blaze new trails.
Good companies never fail. Great companies reward calculated risk taking, and fail quickly and falling forward.
Good companies have professional managers. Great companies are led by founders.
Good companies squeeze suppliers. Great companies treat suppliers as valued partners.
Good companies treat customers like annuities. Great companies never take success for granted.
Good companies acquire their way into markets. Great companies invent new markets.
Good companies pride themselves on paying their fair share of taxes. Great companies defer and minimise.
Good companies engage with their shareholders. Great companies are so honest and clear that shareholders need not pick up the phone.
Good companies pay dividends, rain or shine. Great companies allocate capital to wherever will maximise the present value of cash flow to shareholders.
Good writers tie an article's conclusion back to its introduction. Great writers don't give tips.
