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Chapter 38: Specific Reasons for Questioning or Rejecting the Past Record

·         In analyzing an individual company, each of the governing elements in the operating results (physical volume of goods sold, price per unit, cost of raw materials, cost of labor, depreciation, etc) must be scrutinized for signs of possible unfavorable changes in the future.

·         In mining industry, the governing elements are (1) the life of the mine (2) annual output (3) production costs and (4) selling price. Output and costs may be affected adversely if the ore to be mined in the future differs from that previously mined in location, character or grade.

·         Graham gives the example of Freeport where future profits were now expected from a new project. The project was not yet equipped and in operation, and hence subject to many hazards that attach to enterprises in development stage. Hence, he suggests that the past record here is not relevant to its future history. He further shows that the market is in effect placing a valuation of some $20 million or more upon a new enterprise in which only $3 million was to be invested. Since the project was based on a lease from oil companies who might have driven as hard a bargain as possible, expecting these sort of returns from this investment would be imprudent.

·         Evidently the stock market – like the heart – has reasons all its own. In the writer’s view, where these reasons depart violently from sound sense and business experience, common-stock buyers must inevitably lose money in the end, even though large speculative gains may temporarily accrue, and even though certain fortunate purchases may turn out to be permanently profitable.

·         The above considered the rate of output and operating costs upon which the past record is based. We must also consider any indications as may be available in regard to the future selling price of the product. This must ordinarily enter the field of prophecy and the analyst can truthfully say very little about future prices, except that they fall outside the realm of sound prediction.

·         Change in the status of low cost producers. In 1914 a number of low cost copper producers have succeeded in reducing extraction costs through metallurgical improvements. This lowered the center of gravity of production costs for the entire industry. Other things being equal, this would make for a lower selling price in the future than obtained in the past. The analyst would have to allow for these developments in his calculations, by taking a cautious view of future copper prices.

Where there is an upper limit of earnings or value is fixed, there is usually a danger that the actual figure will less than the maximum.
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