Last week I stated my preference for companies with success against the S&P 500 Index over a long period of time. This week, I will discuss another criterion: The company must be free of long-term problems.
When considering the purchase of a company that you will hold for decades, a long-term approach must be taken. As noted last week, all companies will occasionally go through rough times. When we are looking at a solid, quality company, these periods are buying opportunities.
However, it is important to distinguish between a bump in the road and a serious long-term difficulty. A dip in the current price does not necessarily mean that the company will recover immediately, so one must understand the nature of the problem to determine if the current pitfall is of a short-term or long-term nature. Here are two illustrations:
In 1997, I was considering an investment in Enron (NYSE: ENE), and I noted the dip that had taken place in the stock's price. Current share price is not one of the things that I consider when looking at a company as a possible Drip, but I wanted to know if the declining price was symptomatic of a long-term condition.
Upon researching the situation, I realized that Enron had encountered a onetime charge (the J-Block contract), which had taken a toll on earnings for a quarter. This problem came about because of the aggressiveness that had served them so well in the past. This happens to the best of companies, and everything else I had researched told me that Enron was in this class.
The cost of my initial share late in 1997 was a split-adjusted $20. The price is currently about $65. Taking advantage of a temporary dip has definitely paid off.
On the other hand, consider Philip Morris (NYSE: MO). Its price has fallen dramatically since the onslaught of litigation against the company started to become successful. Were it a company that was temporarily on hard times, the stock price would look favorable — actually, not just favorable, but downright delightful to the potential buyer.
However, the suits against Philip Morris are an ongoing occurrence. The states have settled their litigation against the company, but individuals continue to file claims. Punitive damages have yet to be determined from the Florida suit. Additionally, proceedings by foreign countries are beginning to appear. Depending on the success of these suits, the company could be in for extended litigation throughout the world.
Were the lawsuits to go away any time in the foreseeable future, the company might be worth considering. However, as this is not the case, serious long-term difficulties will make this company a tough sell. Although Philip Morris appears to be moving in the right direction as it attempts to show the public that it offers more than tobacco products, only time will tell if these efforts will influence the stock price.
Adding the above conditions to the already stringent requirements we demand of our companies, one must remember that the successful Dripper will be seeking the best of the best. A company that passes the tests we set forward will be a worthy candidate indeed.
Now that we have gone through the process, from consideration of the Drip as a strategy through company selection, we will focus next week on what to do once a company has been chosen.