Cost Cutting Not Good for Stock Investors

Imagine you're a runner, looking for an edge in your race. Imagine you're allowed to wear your adult-sized Heelys and you can now shave a full minute off your 5K time. And they're a bargain at $150! How many races will you win next year owing to this great technological advance? Five? Ten? As many as you enter?

How about zero?


There's an interesting article over at Fool.com that covers the "Paradox of Thrift." Based on the experience of Warren Buffet, the theory is that most major cost cutting moves at a company will not help investors in the long term.

The idea is that a company could, for example, outsource manufacturing to China and cut its costs. Theoretically, they could see massive increases in profits then by simply keeping their prices steady. That increase in profits would boost the stock price.

The problem is that those same cost cutting moves are availble to the company's competitors, too. Once they cut costs, price erosion will begin. As prices come down, so do profits. And with lower prices, they may also see even lower revenue or lower profit margins, neither of which is good for the stock price.

So consumers may benefit. And these cost cutting moves may be necessary to survive in the business. But by themselves, they will not help stock investors.

Read more here.

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