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Discounting Short-Term Performance

George L Smyth

When Krispy Kreme Doughnuts (Nasdaq: KREM) went public, its stock shot skyward with a successful Initial Public Offering (IPO). Having eaten its doughnuts when I worked in downtown Washington, D.C., I can attest to the unique melt-in-the-mouth flavor of the Krispy Kreme product.

However, I was rather confused when I read that some people, attracted by the hot early performance, were wondering if this company had a Drip plan. Even the mere consideration that one might make a commitment to a decade of purchases based on such a short-term event does not resonate with me.

Since I tend to run baseball analogies in my mind, the case of Ron Necciai jumped into my brain. In 1952, Ron accomplished an individual performance that has not been equaled in more than one million professional baseball games since the league's inception. Not only did Ron pitch a no-hitter for his Bristol team, he also struck out 27 batters -- every out in the game. There has never been a short-term performance that has equaled his, and I seriously doubt that there ever will be again.

So, why have you never heard of Ron Necciai? Branch Rickey (the owner who signed Jackie Robinson) called him one of two players that he had seen who was destined for greatness (the other was Dizzy Dean) as he brought him up to the major leagues. Unfortunately, Ron only won one game (losing seven), injured his arm, and was never heard from again.

Sticking with baseball for now, some fans might remember Joe Charboneau. In 1980, Joe had a great season his rookie year with Cleveland, and he was voted the American League Rookie of the Year. There were songs in the city of Super Joe, as they celebrated their new star.

If you don't recognize his name, don't worry -- he only played 70 more games before dropping out of Major League Baseball, with a batting average never reaching 0.215. (That's weak by any measure over 70 games.)  This was a case of great short-term performance in the first year, but one where the management was glad that they had not signed a long-term contract, because by the next season it was over.

When looking for a company to add to a Drip portfolio, in a sense we are looking to sign them to a long-term contract. Building a group of companies we expect to purchase regularly over the ensuing decade, we do not have the luxury of selecting every possibility that comes to mind. As our resources are finite, anything sent to the wrong company is done at the expense of sending money to the right company. This is why it is so important to take a great deal of time to ensure that the right companies are selected.

This fact is one reason that excellent long-term performance is crucial when I evaluate possibilities for my Drip portfolio. With the understanding that there are no promises (actually, that goes for everything), I believe companies that have exhibited outstanding performance in the past are more likely to continue this outstanding performance in the future -- as we talked about last week.

The question that must be answered is whether the numbers actually support such a statement. I have put together another study that examines this issue. Although studies of this sort are supposed to answer questions, I have a feeling that this one will produce more questions and give support to both sides of the topic.