Competitive Advantage: How to Find Stocks With Competitive Advantage

Investing

Competitively Advantaged
The successful investor only invests in a business with clear competitive advantage. Warren Buffett depicted competitive advantage as a moat, whereby competitors could not breach it to penetrate a business’s fortress. A business enjoys competitive advantage by creating a strong brand, possessing pricing power, offering niche customer service, or operating in an oligopoly, among others. In effect, a competitively advantaged business attracts and retains loyal customers. For example, Coca Cola is widely consumed as a result of its strong brand recognition. If one were to receive $1 billon from a venture capitalist, would he be able destroy Coca Cola’s market share in the soft drink industry? Absolutely not. Similarly, Wal-Mart is widely known to have the lowest prices in the industry. Consumers flock loyally to Wal-Mart, not Zellers. To stress then is that the successful investor invests in competitively advantaged businesses because he knows consumer loyalty to those businesses is like an addicts addiction; predictable and virtually impossible to break. Moreover, most favourable, however difficult to find, is a business that enjoys several competitive advantages.

Case Study: Competitive Advantage of a Strong Brand
Establishing competitive advantage in the clothing retail industry is incredibly difficult, which is why malls are so popular. Consumers likely visit multiple stores in order to find a top or pair of jeans, demonstrating no loyalty to one store. These clothing retailers then operate much like commodity businesses. However, there are juggernauts in the clothing retail industry. These juggernauts strategically established luxury brand appeal, a clear competitive advantage, to ensure consumer loyalty. For example, some consumers consistently seek Gucci, Coach or Louis Vitton products. Price is no barrier. One will never find a 60% off sale for a Gucci purse because there are people that will pay $500 for a Gucci purse, time and time again.

Case Study: Competitive Advantage of Pricing Power
The successful investor does not invest in a business with little or no pricing power, for he knows one of the most detrimental forces to a business is inflation, which can average 3% annually. A business that can raise its prices annually by more than inflation, such as Starbucks, is then competitively advantaged. Could McDonald’s harness the same pricing power for its coffee that Starbucks enjoys? Absolutely not. And yet, in 2008, common investor sentiment was McDonald’s new McCafe would rapidly entrench on Starbucks core business model. The successful investor shrugged off this negative sentiment, however, for he knew Starbucks customers well, reasoning they would not migrate to McDonald’s coffee based solely on lower prices. The common investor also discounted Starbucks during the financial crisis, forecasting consumers would tighten their belts and forever spend less, in turn declaring Starbucks doomed with its $5 Frappuccino. However, the successful investor simply visited several Starbucks locations to discover business was booming.

Case Study: Competitive Advantage in Niche Customer Service
North West Company Fund manages a portfolio of general department stores that, with the exception of one, most have likely never heard of: Northern, North Mart, AC Value Centre, and Giant Tiger. Aside from Giant Tiger, these department stores operate in the remote, northern regions of Canada. Indeed, North West Company Fund possesses clear competitive advantage in that no other business wants to operate in those remote regions of Canada. From this, North West Company was able to develop a strong relationship with its primarily Native Canadian customers. Further, selling to Native Canadians ensures North West Company almost guaranteed growth since the Canadian government subsidizes the income of Native Canadians. In essence then, North West Company consistently collects that government subsidized income when Native Canadians shop at its stores.

Case Study: Competitive Advantage of the Oligopoly
Canadian banks are undoubtedly the world’s most secure banks. The big five – TD, RBC, CIBC, ScotiaBank and BMO – weathered the storm that was the financial crisis from 2007 to 2009. Canadian banks are secure because its management is disciplined. For instance, investments are cautiously pursued, complex derivatives are largely avoided, mortgage policies are stringent, and most importantly, Canadian banks do not employ cowboys with itchy trigger fingers, unlike U.S. banks. However, Canadian banks charge high fees on accounts, chequing, withdrawals, over draft, trades, and the list goes on. And yet, in Canada, the majority of residents hold their money in either one of the “big five” banks, which is clearly the banks’ competitive advantage. Indeed, the Canadian banking system is essentially an oligopoly, an excellent reality for shareholders of a Canadian bank, not so excellent a reality for customers. Intelligently, the successful investor hedges the impact of high Canadian bank fees by becoming a shareholder in one of the “big five”.

Advertisements

3 thoughts on “Competitive Advantage: How to Find Stocks With Competitive Advantage

  1. Hello Robin,
    I just found out your site and was interested in your articles…and curious about the eBook!
    Do you use any particular metrics to evaluate if a company has a competitive advantage? For example in “Buffetology” the authors mention earnings predictability and ROE/ROIC as starting points to evaluate the existence of a moat.
    Thank you
    Ben

Leave a Reply

Please log in using one of these methods to post your comment:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s