Editor’s Note: Brad Thomas here…

As a subscriber to Wide Moat Research, I’m reaching out with an important update from Porter Stansberry, CEO of Marketwise (the parent company of Wide Moat Research).

Specifically…

On July 30, Porter will reveal how making just ONE simple change to the way you follow our research could dramatically change everything about your results.

If you’ve never seen a presentation by Porter Stansberry, you’re in for a treat.

And if you know his name, you already understand – Porter is in a league of his own.

So, when he steps forward with a major update, I pay close attention.

That’s why I’ll be tuning in to what he is sharing on July 30 at 10 a.m. Eastern time… and I strongly recommend you do the same.

Now, back to Stephen with today’s Intelligent Income Daily…

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In the winter of 1916, Sol Price was born in The Bronx to Jewish immigrants from a small village in Belarus. These humble beginnings in New York City would lead to the creation of several American business empires. And a long – and still growing – list of billionaires.

Sol was originally a lawyer in San Deigo with clients in the wholesale business. He realized the warehouses made as much as the jewelry retailers. And it was a much easier business with less competition.

He quickly called his family and friends, and combined with a $10,000 investment from his law firm, the ground was laid for what would become FedMart.

Source: Rationalwalk.com. The first FedMart location in San Diego, California.

To shop there, customers had to pay a $2 lifetime membership fee. To keep costs and prices as low as possible, items were displayed in improvised fixtures or pallets. In its first year of operation, Sol’s first store generated $3 million in revenue.

Adjusted for inflation, that’s $95.2 million today. And that was just the beginning.

Two decades later, Sol and several friends founded Price Club with an investment of $2.5 million. That later merged with Costco (COST), which is now worth $378 billion. In fact, the original Price Club warehouse is now Costco location 401 in San Diego. It was a converted airplane hangar.

It’s no exaggeration that Sol Price invented the discount warehouse model and modern retail altogether. Today’s Sam’s Club is a replica of Sol Price’s model. Sam Walton of the famous Walmart brand, to his credit, admitted as much.

Sam Walton was known to personally spy on Sol’s stores to learn his secrets. When Sol learned an employee had confiscated Sam Walton’s tape recorder, he mailed it back. He loved sharing his knowledge, even with competitors.

In Sam Walton’s book Made in America, he said “I guess I’ve stolen – I actually prefer the word ‘borrowed’ – as many ideas from Sol Price as from anybody else in the business.”

Jim Sinegal, Sol’s protégé, met with Jeff Bezos right after the dot-com bust in the early 2000s. Jeff Bezos was down on his luck and looking for guidance. Jim explained Sol’s key principles, including that the focus is on creating value for customers, not extracting it from them.

Shortly thereafter, Bezos sent a company-wide email about the company’s new direction.

Specifically, he said:

There are two kinds of retailers: there are those folks who work to figure how to charge more, and there are companies that work to figure out how to charge less, and we are going to be the second, full-stop.

This redesign of Amazon’s business in line with Sol’s method changed everything. Amazon is now one of the most valuable companies in history.

There are almost infinite lessons we can take from Sol’s incredible legacy. Today, I want to focus on three.

Never Lose Money

At all of Sol’s stores, he had rules. The first was sustainable margins. Not so high that it drove customers to competitors, but not so low that there wasn’t profit. Costco famously maintains an 11% margin on most of what it sells.

Sol didn’t believe in “loss leader” products. Breakeven was fine if there was a good reason, but everything needed to earn its place on the shelf. A lot of companies today, especially in technology, believe that revenue growth makes up for profitability.

Businesses do have stages, and early on, most revenue may need to be reinvested. That’s okay as long as the core business has good margins. But for investors, it’s best to avoid it until the company becomes a business, not an experiment using other people’s money.

Stay in Your Area of Expertise

Costco and the other Sol-affiliated companies are hesitant to grow for the sake of it. He recognized that expanding into new areas is risky. Many firms like to vertically integrate as they grow. An example would be ExxonMobil (XOM) building gas stations to sell the gasoline and diesel they refine. Or a high-end clothing company buying a cotton farm.

While vertical integration certainly has potential benefits, it should be done cautiously. A lot of companies enter new markets because they’ve run out of good ideas.

A good example might be General Electric (GE). The company famous for lightbulbs and advanced engineering became notorious for making questionable acquisitions and expansions. Some of these were in line with GE’s core business. Others, not so much…

The two famous examples were the acquisition of NBCUniversal and GE Capital. Both sounded good on paper. But NBC was eventually sold to Comcast. And General Electric took almost a decade (2013-2021) to finally shed GE Capital.

Bottom line: When a company in one industry decides to enter a whole new one, management’s explanation should be extremely convincing. Otherwise, it’s a red flag.

Promote from Within

Costco’s current CEO doesn’t have an MBA from Harvard. And he didn’t come from Wall Street. He joined Costco in 1984 as a forklift driver. There is no substitute for experience, and that includes within companies.

While outside advice is valuable, it’s no replacement for people who know the company at every level like Costco’s CEO. In my experience, it’s ideal for at least most of the management team to be promoted internally. Whenever most of the executive team is from outside firms (and usually Ivy League schools), that’s a situation I avoid. Too many times, people with fancy degrees and “consulting” or private equity experience come in and destroy the company’s reputation.

Scott Thompson joined Yahoo! as CEO when the company was already in hot water. Scott’s background included being fired from Barclays. Less than two weeks after becoming CEO, the Board was actively trying to fire him, and the stock price tanked further.

John Sculley was President of PepsiCo before taking the CEO role at Apple (AAPL) in 1983. Can you guess what he’s most famous for? Firing Steve Jobs. He later almost destroyed the company permanently by trying to sell it in pieces to Goldman Sachs. To be fair to John, Apple grew its revenue 10x under his tenure, but it’s arguable who is really responsible for that?

Conclusion

It’s true that investing requires looking over financials carefully. But the principles of sound investing go far beyond just number crunching. At Wide Moat Research, we spend hours reviewing earnings reports but also analyzing the themes we’ve discussed today. We even named our company “Wide Moat” because of the importance of the non-financial aspects of a company (like its competitive advantages known as a “moat” on Wall Street).

Ultimately, it’s people that run businesses. Revenue and profit are downstream of decision making. Remembering that and following Sol Price’s proven doctrine can do wonders for your portfolio.

After all, the companies he created or inspired are now worth over $2.9 trillion. Combined, they’d be the most valuable company in the world. 

Regards,

Stephen Hester
Analyst, Wide Moat Research