Click heOften, a good investment is made when the underlying company has special characteristics that will allow above-average profitability not just the next year or two, but for decades into the future, and the shares can be obtained for a reasonable price. But, how do you figure out degree of competition advantage?
Philip Fisher, the leader of the growth investing school, recommends, as a starting point, using Scuttlebutt (asking around) in seeking companies which have a consistent history of performing better than their competitors.
How to retain a competitive advantage
There are a number of ways in which a company can maintain its competitive edge, and the best way is to promote efficiency in all aspects of the company’s activities, whether it be selling, buying, manufacturing, management or any of the other elements that contribute to the running of a company.
Companies which make high profits invariably attract the attention of other companies who would like a share of their market. The best way to deal with this type of competition is to be so efficient that competitors cannot compete without committing themselves to considerable expenditure, or getting involved in a damaging price war which is likely to cause indignation in their shareholders, and thereby a loss of confidence in the company with a resulting loss in value.
Economies of scale can be a potential source of competitive advantage. But any operating cost benefit gained is too often lost in the extra cost of the additional layers of management needed.
Companies that run perfectly well at a certain size can lose their efficiency as they grow larger, and their executives can be increasingly isolated from the company’s activities; Scuttlebutt is useful in this situation and can give clues to company performance.
The biggest advantage for the largest company is usually not on the manufacturing but on the marketing side. If the largest company develops a new product, the average customer is likely to buy it because the large company has already established ‘an atmosphere’ (Philip Fisher) in which new customers are more likely to buy from the industry leader.
This is because the leader has an established reputation for performance and/or sound value. Thus the manager responsible for buying is unlikely to be criticised for making this particular decision.
A company which is the leading company in its field seldom loses its position as long as its management remains competent.
As an example of a large company, Philip Fisher liked to use Campbell, the soup producer. A household name and market leader, it had achieved cost reduction through scale and backward integration (buying up suppliers); it had the most prominent position in retail outlets with the largest display area and the cost of its marketing was spread over billions of cans of soup.
Sometimes high returns are not caused by a company being excellent at the core business. Rather it is able to maintain its competitive edge by the efficiency with which it handles what appear to be subsidiary matter such as its leases, insurance policies, or real estate.
The three factors
For Fisher, three factors combine to give a company dominance in some industries:
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