Chipotle Mexican Grill, Inc. (CMG) & The Coca-Cola Company (KO) Investing Lessons from Star Trek’s Ferengi

Rule 59: Free advice is seldom cheap.
Rule 190: Hear all, trust nothing.
Rule 218*: Always know what you’re buying.

The hot stock tip that you heard at that party from your friend’s former roommate’s brother-in-law never turns out to be as good as you imagine. Keep your ears open for new investment ideas from a variety of sources, but don’t blindly throw your money at a company without doing your own homework and research first.

Rule 44*: Never confuse wisdom with luck.

A study published last year showed that most mutual fund managers’ success can be attributed to luck. Bryant University professor Jack Trifts says, “We think this occurs because ‘superior performance’ is really just random luck. Mutual fund managers who have high performance early in their careers are branded stars, while those with poor performance tend to disappear from the industry.”

But mutual fund managers are actually at a disadvantage.  They don’t control the inflow and outflow of money into their funds, and fickle, reactionary customers’ money movements can force managers to buy and sell at the wrong times.  And they must show good short term results, or else they speed up the vicious cycle of investors selling.  An individual investor with the conviction to ignore the herd mentality and stick by their companies in good times and bad can beat the mutual funds in the long run.

The Ferengi on a Long-Term Investing Outlook

Rule 54*: Rate divided by time equals profit.
Rule 89*: Ask not what your profits can do for you, but what you can do for your profit

Dividend growth investing can lead to good things when you buy, hold, and reinvest your dividends. Reinvesting dividends sows the seeds for harvesting even bigger dividends down the road. Look for companies that increase their dividend annually like The Coca-Cola Company (NYSE:KO). While its current yield is modest at around 2.8%, The Coca-Cola Company (NYSE:KO) has raised its dividend consistentlyevery year for 50 years.  With its dominant position as the ubiquitous, number one brand in the beverage industry, the company has been able to consistently increase their cash flow, allowing it to reward shareholders by consistently increasing its dividend. The reliable dividend growth, in turn, makes the company more valuable to investors looking for income, and those investors keep the share price growing at a market-beating pace, whether the economy has too much fizz or is flat.

Rule 34: War is good for business.
Rule 35: Peace is good for business.
Rule 162*: Even in the worst of times, someone turns a profit.

People spend too much time trying to guess how macroeconomic factors like war, peace, and election results will affect the stock market. Concentrate on solid companies that will thrive in any environment and leave the speculating to others.

At a time when other retailers were struggling through the recession in 2008 and 2009, Costco Wholesale Corporation (NASDAQ:COST) retained customers and made sales gains. The chain targets upper-middle class shoppers who are not hurt as much by recessions and who give Costco some amount of regular, predictable income with their annual membership fees.  Those customers are attracted to the store by low prices on food and other household staples, for which demand never drops.  Those values on the essentials get people in the door, where they often end up shopping for higher ticket items too.  It’s no coincidence that even if you’re just planning to quickly pop in for a cubic yard of toilet paper, the store layout in every Costco leads you directly past televisions, electronics, and jewelry as soon as you set foot in the store.

Think about the last hundred years and of all the things that have happened in the United States: multiple wars, economic ups and downs, crises in energy, banking, and politics, the cold war, and more.  Then look at what the stock market has done over the long run in that same time period.  It makes a good case for long term buy and hold investing in solid companies, and leaving the worrying about the crisis of the day to others.

The Ferengi on Risk

Rule 62: The riskier the road, the greater the profit.
Rule 68*: Risk doesn’t always equal reward.

Two seemingly contradictory rules.  Risky stocks have a high upside. A stock can only lose 100% of its value, but it has infinite potential for gains. This means that one or two big winners can make up for a lot of smaller losers. It’s good to own a handful of potential blockbuster companies, but not a whole portfolio of them.

Sometimes after you research a company, you may decide that the company is too hard to understand, the risk is too hard to quantify, and it just isn’t worth the trouble.  That’s fine.  Don’t recklessly invest in high risk companies out of fear of missing “the next big thing.” There’s always another “next big thing” coming down the pike.

And if you do get lucky, remember not to suddenly think you’re wise (see rule 44) and start making bigger bets on even riskier companies.

Rule 8*: Small print leads to large risk.

If a company is trying to obfuscate or hide things in small print, it’s usually not in your best interest. Companies intentionally use tiny print, all capital letters, and tiny line spacing to make their warranties and disclaimers intentionally difficult to read and headache-inducing.

In investing, there is a similar risk in investing in complex companies with obfuscated ownership and management structures. If the explanations in the company’s annual report read like the warranty book that came with your last smartphone, consider stepping away. Invest in companies that communicate with their shareholders in plain language. Peter Lynch once said that for every stock you own, you should be able to explain what that company does during a 30 second elevator ride. Sticking to that guidance will save you a lot of headaches.

The Ferengi on Socially Responsible Investing… Or Not

Rule 261*: A wealthy man can afford anything except a conscience.

A Ferengi might not care about having a conscience in business, but here on Earth, a conscience can be profitable. Case in point: Whole Foods Market, Inc. (NASDAQ:WFM), where CEO John Mackey is a leader in the Conscious Capitalism movement. Mackey’s company uses socially responsible business practices to gain a competitive advantage. Whole Foods treats employees well, leading to improved customer service and lower employee turnover, meaning lower costs for training and recruiting new employees. Whole Foods also has a higher purpose of improving the eating habits of its customers, not just a Ferengi-like obsession with quarterly profits. The company’s embrace of this business model and corporate identity has helped shareholders who stuck with it earn over 900% in gains since the depths of the recession in 2008.

Rule 94: Females and finances don’t mix.

Studies on investor psychology show that women tend to do more research on their investments, trade less often, and avoid herd-like mentality in the market better than their male counterparts. Even the great Warren Buffett invests like a girl, using these traits to build Berkshire Hathaway Inc.’s (NYSE: BRK-B) portfolio of publicly traded stocks and wholly-owned subsidiaries into an economic powerhouse. Buffett has said (to string a few quotes together) that his “favorite holding period is forever” and his approach is “profiting from lack of change” because “time is the friend of the wonderful business.”  He does his research, doesn’t invest in companies he doesn’t understand, and intends to stick with the companies he does pick for the long haul. That mentality has increased Berkshire Hathaway’s book value 586,817% (19.7% annualized) since 1965.  Looks like the Ferengi are wrong on this one.

(Most of the rules are considered canon by virtue of appearing in the Star Trek: Deep Space Nine TV series. *The ones with asterisks are from the Star Trek books, considered non-canon by some fans. **There are many lists of the Rules on the web, mostly the same, but there are some differences from list to list; I only found the one with a double-asterisk documented here.)

Mike Steele owns shares of Berkshire Hathaway, Costco Wholesale, and Whole Foods Market. The Motley Fool recommends Berkshire Hathaway, Chipotle Mexican Grill, Coca-Cola, Costco Wholesale, and Whole Foods Market. The Motley Fool owns shares of Berkshire Hathaway, Chipotle Mexican Grill, Costco Wholesale, and Whole Foods Market.