What a Bad Business Looks Like

What a Bad Business Looks Like
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What a Bad Business Looks Like by John Szramiak was originally published on Vintage Value Investing

This article was originally published on SleepyCapital.com by Chris Spanel.

From The Ten Commandments for Business Failure by Donald Keough, there is a great section covering Coca Cola’s diversification into the wine business.

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For years, Coca Cola met with consultants who would pitch acquisition ideas to diversify their business. They said the “core business of soft drinks and juices gave [coke] no hedge against the future and the comany needed to look around to acquires businesses that were compatible but different. From there, they were pitched a nice wine business and they bought it. Robert Woodruff, the former president of the Company (and also the one who made Coca-Cola the cultural icon it is today), decided to take a “personal look at this wine business “his” company had gotten into.” Below is the excerpt of what Woodruff told Keough after visiting the winery.

“Well, the wine business is interesting. I went out to California to see the vineyards. It seems that it takes five or six years for a vine to be mature enough before you can start harvesting grapes. During those years you’ve got quite a few people tending to the vines and praying for the right kind of weather so they yield a good crop. Finally, though, if everything works out, they pick the grapes and they take them to the plant where they squeeze them and put them into these great, hugely expensive stainless-steel tanks where they ferment. From these expensive tanks the wine goes into many small caskets made out of equally expensive French oak. The casket cost fifty-five dollars each. The wine then ages and for some time in the many small expensive casks. Meanwhile, about 15 percent of the wine is lost through evaporation.Soon, however, after aging quite awhile, the wine goes into bottles. They pay a tax at that time on each bottle and then put the bottles away for more aging. You keep the bottles for years, and if everything has gone well during the process and you have a reasonably good vintage, then you finally send the bottles into retail stores where there are hundreds of different kinds of wines on the shelves. At that point, you hope to God that out of that whole array of similar bottles someone is going to buy yours.

Now I grew up in a business where you bottle it in the morning and sell it in the afternoon and in a lot of places there is no other competition. Seems to me that’s the kind of business we want to be in!”

Shortly after, in 1981, Coca-Cola sold the wine business just after they had taken assignments to lead the company.

With regard to the winery deal, Keough said, “Take your eyes off the bull and you will fail. I did.”

This excerpt makes you think about what type of business characteristics you should look for when making an investment. Looking at an investment is like owning a piece of a business (or the whole business, for that matter). It’s not difficult to see that the wine business is not the ideal business to be in. Yes, there are thousands of wineries out there. Some wineriess have 15+ generations on their slab of land and they have been extremely successful in running it over many years. But the amount of risk, variability, high costs and time that is involved in producing wine makes it difficult to be a strong investment. Diversification for the sake of diversification, is something to be careful of. This is both in a business sense, as well as investing.

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Ben Graham, the father of value investing, wasn’t born in this century. Nor was he born in the last century. Benjamin Graham – born Benjamin Grossbaum – was born in London, England in 1894. He published the value investing bible Security Analysis in 1934, which was followed by the value investing New Testament The Intelligent Investor in 1949. Warren Buffett, the value investing messiah and Graham’s most famous and successful disciple, was born in 1930 and attended Graham’s classes at Columbia in 1950-51. And the not-so-prodigal son Charlie Munger even has Warren beat by six years – he was born in 1924. I’m not trying to give a history lesson here, but I find these dates very interesting. Value investing is an old strategy. It’s been around for a long time, long before the Capital Asset Pricing Model, long before the Black-Scholes Model, long before CLO’s, long before the founders of today’s hottest high-tech IPOs were even born. And yet people have very short term memories. Once a bull market gets some legs in it, the quest to get “the most money as quickly as possible” causes prices to get bid up. Human nature kicks in and dollar signs start appearing in people’s eyes. New methodologies are touted and fundamental principles are left in the rear view mirror. “Today is always the dawning of a new age. Things are different than they were yesterday. The world is changing and we must adapt.” Yes, all very true statements but the new and “fool-proof” methods and strategies and overleveraging and excess risk-taking only work when the economic environmental conditions allow them to work. Using the latest “fool-proof” investment strategy is like running around a thunderstorm with a lightning rod in your hand: if you’re unharmed after a while then it might seem like you’ve developed a method to avoid getting struck by lightning – but sooner or later you will get hit. And yet value investors are for the most part immune to the thunder and lightning. This isn’t at all to say that value investors never lose money, go bust, or suffer during recessions. However, by sticking to fundamentals and avoiding excessive risk-taking (i.e. dumb decisions), the collective value investor class seems to have much fewer examples of the spectacular crash-and-burn cases that often are found with investors’ who employ different strategies. As a result, value investors have historically outperformed other types of investors over the long term. And there is plenty of empirical evidence to back this up. Check this and this and this and this out. In fact, since 1926 value stocks have outperformed growth stocks by an average of four percentage points annually, according to the authoritative index compiled by finance professors Eugene Fama of the University of Chicago and Kenneth French of Dartmouth College. So, the value investing philosophy has endured for over 80 years and is the most consistently successful strategy that can be applied. And while hot stocks, over-leveraged portfolios, and the newest complicated financial strategies will come and go, making many wishful investors rich very quick and poor even quicker, value investing will quietly continue to help its adherents fatten their wallets. It will always endure and will always remain classically in fashion. In other words, value investing is vintage. Which explains half of this website’s name. As for the value part? The intention of this site is to explain, discuss, ask, learn, teach, and debate those topics and questions that I’ve always been most interested in, and hopefully that you’re most curious about, too. This includes: What is value investing? Value investing strategies Stock picks Company reviews Basic financial concepts Investor profiles Investment ideas Current events Economics Behavioral finance And, ultimately, ways to become a better investor I want to note the importance of the way I use value here. It’s not the simplistic definition of “low P/E” stocks that some financial services lazily use to classify investors, which the word “value” has recently morphed into meaning. To me, value investing equates to the term “Intelligent Investing,” as described by Ben Graham. Intelligent investing involves analyzing a company’s fundamentals and can be characterized by an intense focus on a stock’s price, it’s intrinsic value, and the very important ratio between the two. This is value investing as the term was originally meant to be used decades ago, and is the only way it should be used today. So without much further ado, it’s my very good honor to meet you and you may call me…
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