As Warren Buffett (Trades, Portfolio) puts it, “protect the downside, the upside will take care of itself.” This is why we at Urbem prefer to invest in long cycles when it comes to product-driven businesses.
The connection between product lifecycle and investment risk is not difficult to understand. In cases of short cycles, companies have to keep rolling out new products on a frequent basis in order to stay competitive. Nonetheless, the success of those products is hard to predict and often requires contribution from some geniuses, causing uncertainties for shareholders over the long haul.
Take Denmark-based Pandora A/S (OCSE:PNDORA, Financial), the world’s largest jeweler by volume, as an example. We like the business's value proposition of “affordable luxury," which has proven to generate super-normal returns on capital underpinned by high margins and asset turnover when compared to competitors Tiffany & Co (TIF, Financial) and Richemont (XSWX:CRF, Financial). However, consumers tend to think of the brand as the fast fashion of jewelry as they buy Pandora’s products mainly for everyday wearing and to express themselves. According to the company’s own analysis, it is the design that drives the customers’ purchase decisions regarding its products the most, accounting for more than 50% of the volume. As a result, we think that Pandora has to continually refresh its product portfolio with designs that capture the trends. Things can easily go wrong when the jewelry starts to lose its luster. Think about the declining sales of Pandora’s once hugely-successful bracelet and charm segment.
Filled with short-cycle products, the technology sector is the perfect example that innovation can destroy value for business owners. Take a look at the rise and fall of Blackberry (BB, Financial). Back in the early days, the company’s namesake product started to gain significant traction in the mobile industry by concentrating on email, but later on quickly lost its dominant position in the battle with the Android and iOS platforms. Fast forward to today, and if you think the incumbent Smartphone leader, Apple (AAPL, Financial), can easily sustain its successes indefinitely, you may be in for an unpleasant surprise.
At Urbem, we believe that investors should focus on businesses that have been selling the same products for quite a long time. Think of Coca Cola’s (KO, Financial) flagship soft drink dominating the market with the same formula for over a century now, as well as its failure in launching the “New Coke” back in the 1980s. With respect to a business like this, shareholders may even hope for the corporate manager to simply sit back, do nothing and not mess things up.
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 do not own any security mentioned in the article.
Read more here:
- An Annual Review on the CORA Portfolio
- Paycom: A High-Quality, Fast-Growing Company
- Should We Waste This Crisis?
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