Identifying themes and qualities that have helped companies succeed in the past can be an excellent guide for identifying future winners. There's no one set template investors can use to identify potential winners, but by seeking out businesses with similar traits, we can increase our chances of finding a good company to own.
Some of the greatest investments of the past 100 years have exhibited similar qualities. This was something Nick Sleep highlighted in his 2011 annual letter to partners of the Nomad Investment Partnership.
Nomad returned over 18% per annum net of fees between 2001 and 2013. By all accounts, it achieved this performance by finding a handful of highly successful companies and sitting on them, watching them grow and evolve.
In his 2011 letter, Sleep noted that the "economics of incremental products" and advertising activity were the two of the most essential qualities "the long-term investor really needed to embrace." The fund manager gave the example of Colgate-Palmolive (CL) shares:
"For example, what investors needed to understand, and attribute sufficient weight to, in order to hold Colgate-Palmolive shares for the last thirty years, and so enjoy the fifty-fold uplift in share price, was the economics of incremental products (often referred to as "line extensions", from the first "Winterfresh" blue minty gel in 1981 to "Total Advanced Whitening" today) and the psychology of advertising."
Other factors were important too, the manager noted, but without investing in growth and spending to get its products in front of customers, Colgate would have struggled to grow. He went on to highlight some other examples:
"A similar story can be told at Nike (NKE, Financial) and Coca-Cola (KO, Financial) (manufacturing savings funnelled into dominant advertising) or Wal-Mart (WMT, Financial) and Costco (COST, Financial)(scale savings shared with the customer). Recognizing and correctly weighing this information in-spite of the latest news flow is a matter of discipline, and it is that discipline that is so richly rewarded in the end."
Nomad sought these qualities in its investments. Sleep continued to explain that a "virtuous spiral" is established when a firm keeps costs low and shares its "growing scale with its customers." He added that this would be more important in the long run in determining a company's end destination than "the distractions of the day."
This was something Amazon (AMZN, Financial) founder Jeff Bezos realized early on and explained in an interview with Wired Magazine around 2011:
"There are two ways to build a successful company. One is to work very, very hard to convince customers to pay high margins [the Colgate, Nike, Coca-Cola model alluded to above]. The other is to work very, very hard to be able to offer customers low margins [the Wal-Mart, Costco, AirAsia, Amazon, Asos model]. They both work. We're firmly in the second camp. It's difficult – you have to eliminate defects and be very efficient. But it's also a point of view. We'd rather have a very large customer base and low margins than a small customer base and higher margins."
Since this letter was published, shares in Amazon have risen nearly 1,700%. This is just one example.
However, the other stocks highlighted by Sleep in his letter have also performed exceptionally well. Nike is up nearly 500%, Colgate has more than doubled and Costco has gained nearly 400% excluding dividends.
This cannot be all coincidence. It is clear that there is a factor that links the success of these companies. Their rigorous focus on customer service, keeping costs low and investing for the future seems to be the primary reasons behind these performances over the past decade.
Disclosure: The author owns no share mentioned.
Read more here:
- Nomad Investment Partnership: Inactivity as a Source of Value Added
- Buy What You Know: A Strategy for Any Market
- Warren Buffett: Why IPOs Can Be Painful for Investors
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