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Steven Chen
Steven Chen
Articles (177)  | Author's Website |

Urbem’s ‘Quality Strategy’ Series: Reputation-Based Moat

A valuable intangible asset in the mission-critical space

Durable competitive edges often come from intangible assets. A superior reputation is one type of them. A highly-reputed product or service is especially effective in guarding the business against competition when it comes to the mission-critical application with zero or little error tolerance.

Take a look at Intuitive Surgical Inc. (NASDAQ:ISRG), the pioneer and leader in robotic-assisted surgery. The company is well-known for successfully transforming its first-mover advantage into a last-mover power thanks to its reputation earned from over 6 million procedures already performed and more than 18,000 peer-reviewed scientific publications regarding its da Vinci system. Thus, the barrier for entry is quite high for newcomers, which have to persuade hospitals to rely on a much lesser-known product to perform critical procedures to patients. The more niche player, Atrion (NASDAQ:ATRI), is another example in the safety-conscious medical field. Both companies deliver consistently high returns on capital for their owners (see below).

As with the health care sector, some industrial businesses involve mission-critical operations. In this domain, we like niche-market service providers like Graco (NYSE:GGG) and Gaztransport et Technigaz (XPAR:GTT). To compete favorably, the former specializes in solutions with well-recognized reliability to help clients manage corrosive, viscous and hard-to-move materials, while the latter delivers LNG transportation technologies that are approved by international classification societies and recommended by major gas production companies worldwide. As a result, both businesses manage to demand super-normal margins, as indicated below.

Reputation-based moats can be found in some business service niches as well. Take Exponent (NASDAQ:EXPO) as an example. The international consulting company with a focus on failure analysis still accounts for approximately 60% of all projects as of today. These projects are “reactive” in nature, covering litigation support, product recalls, regulatory actions, insurance investigations and so forth. In this regard, Exponent possesses an unparalleled track record of putting its name behind many well-known investigations, including Oso Landslide (the single deadliest landslide in U.S. history), Superstorm Sandy, the PG&E Explosion, the 9/11 attack and the Kobe earthquake. With an established reputation for reliability, the company has the “unfair” advantage in terms of winning new businesses and even charging premium prices, as clients that are in crisis mode could be reluctant to hire an unproven company to do a mission-critical project for them.

Similarly, the reputation matters considerably for the “endorsement” type of business model at Collectors Universe (NASDAQ:CLCT). The small-cap company is a household name in the community of high-value, high-priced coin and trading card collectibles. Dealers and collectors depend on the company’s brand-bearing certification service to improve marketability and liquidity of their holdings and to even boost trading prices. They would generally not risk a significant monetary or non-monetary loss by having the items ungraded or graded by a less reputed brand.

As you can see below, both Exponent and Collectors Universe have consistently earned superior returns on assets for the last decade.

Disclosure: The mention of any security in this article does not constitute an investment recommendation. Investors should always conduct careful analysis themselves or consult with their investment advisors before acting in the stock market. We own shares of Intuitive Surgical.

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About the author:

Steven Chen
Steven CHEN is a quality-focused investor (with bottom-up opportunistic approaches), an ex-hedge fund analyst on Wall Street, a serial entrepreneur, computer scientist, and free-market capitalist.

Steven is the Managing Partner of Urbem Partnership, a value/quality-focused investment partnership fund (www.urbem.capital), and Urbem Capital, the research boutique that focuses on the highest-quality 0.1% of all public companies worldwide.

Steven can be reached at [email protected] or through LinkedIn.

Visit Steven Chen's Website


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