Sunday, March 17, 2013

Trading Tips from John D. Rockefeller

John D. Rockefeller was America's first billionaire. After the civil war Rockefeller had a good amount of money with which to invest. He (correctly) believed railroads would become the primary means to transport agricultural products and would open up the vast western lands to eastern markets, trends that didn't bode well for his own produce shipping. He began to look for other business ventures that could be profitable and found a fledgling sector poised to take off.....the oil industry.

However, where he and his partners entered was not in oil production, but its refining. The same railroads that would eclipse his shipping business would help launch his refining venture, as Cleveland enjoyed not the usual one rail line, but two. Transportation costs would be lower and thus his refinery products more competitive.

By the late 1860s, only five years after getting into the oil business, Rockefeller's refining company was the largest in the world. A major reason for his success was a business model that today we call vertical integration. Rockefeller knew that in order to keep costs down, he would have to control both the upstream and the downstream. For example, he even bought his own woodlands for lumber to make his own oil barrels, and built kilns on site to dry the lumber and save shipping weight on its way to (his own) cooperage. His attention to cost cutting was painstaking.

So, can we learn from Rockefeller and put the lessons he learned to work for us in our modern day trading?

Let's try.

Trading like Rockefeller.....

1. Lower your costs. Lower costs mean higher margins and much more resilience during bad times. Rockefeller famously reduced from 40 to 39 the number of drops of solder to close the lids of kerosene cans, saving the company hundreds of thousands of dollars in the long run. He'd also ask for financial statements down to three decimal places, the better to spot inefficiencies in his supply chain and fix them.As investors, follow in Rockefeller's footsteps by investing in companies with low costs, but also reduce the cost basis in the stocks you own.

2. Have you checked lately whether you're getting the best deal from your brokerage? Don't be afraid to take your business somewhere else. Every advantage counts in this fast moving world.

3. Also, are you making the most out of your portfolio? Could you do more with it? It's a good idea to invest a portion (and we do mean just a portion) of your portfolio in equities that can offer higher reward for higher risk. This is especially true if your portfolio is heavy in capital.

4. When the market is turning against you, move on. Had Rockefeller stuck to his grain shipping business, he'd likely not even made a ripple on the pages of financial history. When he spotted opportunity in the up and coming oil industry, he wasn't afraid to abandon what had been a good thing and to take the leap.For us, this advice means sometimes selling companies that are under performing. Knowing when it's time to cut our losses and to turn our capital toward more profitable ventures. The tricky part is knowing when to be patient and hold and when to recognize a true shift in the marketplace....and that comes from reading the signs from Mr. Market.

5. Vertical integration is a hallmark among many strong companies. Part of the reason Rockefeller could edge out his competitors was the fact that he controlled his own supply chain. He noticed very early on that if he did not control many aspects of his production, he would be at a disadvantage when it came to negotiations. And as he expanded his business, he purchased companies that could make the entire refinery process smoother, including pipelines, railroads, and even those woodlands we mentioned.Thus, if we want blue chip companies that will perform well for us over the long term, we should look for firms that are vertically integrated within their own sectors.

6. Patience is key. Rockefeller kept his discipline when he landed in a tough job market after school. As investors, we're looking for companies that can pay good dividends in the long run. However, we must be wary of overpaying for stocks. Being patient, letting the market come to us rather than chase it ourselves, will give us the best bang for our buck.

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