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The Secret Ingredient in all Successful Investments

By A. Raj Kumar          March 25, 2008

             Usually every terrific recipe has a secret ingredient that makes all the difference to the end product.  Investing is no different.  Every single great investment also possesses a secret ingredient.  Let me describe an amazing stock investment, which may help you identify this secret ingredient.

 

              Most investors wish they had bought Microsoft stock when it first came public in March 1986 at a split-adjusted price of 8 cents.  With the current price of $33, this stock is up by a factor of 412!

If we had invested just $10,000 then, our investment would be worth over $4.12 million now.  Obviously that would have been an incredible investment. 

 

             But at that time there were other PC software companies that were considered much better than Microsoft since it only sold an operating system (DOS) that was not user friendly.  Lotus Development had the #1 software product with its Lotus 1-2-3 spreadsheet.  Ashton-Tate had the best database software with its Dbase II and later with Dbase III.  For word processing most users utilized WordPerfect.  The most popular graphics program was Harvard Graphics. 

 

             If I had been picking stocks back then (early 1980’s), I probably would have bought the stocks of Lotus Development and Ashton-Tate since they were both the dominant software companies in their niches.  But Lotus later missed the boat with Windows and as a result allowed Microsoft Excel to supplant Lotus 1-2-3 as the most popular spreadsheet.  Lotus never recovered and was eventually bought out by IBM.  Ashton-Tate, I believe, went bankrupt.  These stocks would not have been huge winners.  So what eventually made Microsoft stock the big winner?  What is the secret ingredient?

 

             All great companies have a great executive management team at the top.  This team is responsible for choosing a business model with which to run the company, setting the business strategy and for executing the strategy.  They are directly responsible for the company’s success.  In short, a great management team makes success happen!  They increase their sales and profits year in and year out.  They control costs.  They steal market share from their competitors and many times they put their weakest competitors out of business.  As an example, consider Home Depot which forced Channel, Rickels and other hardware stores into bankruptcy.  An executive team that executes well is extremely rare.  They are the secret ingredient. 

 

             Identifying a great executive management team in advance at a small company is difficult but not impossible.  The CEO and his/her team are smart and driven to succeed.  They share a vision of where they want their company to be in five years and then they execute their business plan to get there. They hold themselves accountable.  They are a management team with integrity.  They are honest with shareholders and with themselves.  They discuss both their successes and defeats in their shareholder’s letter.  They present financial statements that are transparent and accurate.  The business accounting is clear and conservative.  A quick way to determine whether a top executive team is honest is to look at their compensation in the proxy statement.  If they are overpaying themselves, then they don’t have the shareholders’ interest as their top priority.  Warren Buffett is an example of an honest and responsible CEO; his salary has been stuck at $100,000 for decades!

 

             We have an advantage now in buying the stocks of great companies.  As a result of the recent downside market volatility all stocks are down including those of companies with great top management.  We know which companies have awesome management because these companies are the ones who are consistently delivering great results.  Shouldn’t we be buying the stocks of these great companies now at these lower levels?  Don’t we all love to get a bargain?