Investing in the stock market is about many things, but the one concept that stands out above all others is this: ‘buy low, sell high’. It seems obvious, and it is a stock market truism – it is the way to make money and it has been that way since the inception of the modern stock market in the 1920’s.
If this is the case, then how come so many people still don’t make money when they invest in the stock market?
Well, from my vantage point of having read dozens of investment books over a 15 year time period and having been an investor for most of that time, it seems that most investors don’t really think for themselves. Most investors follow the crowd and don’t act independently. Following the crowd is not a profitable way to invest – and that is where the problem lies for individual investors.
If you look at the superstars of investing – Warren Buffett’s, Charlie Munger’s, John Neff’s, T. Rowe Price’s, Bill Miller’s, Charles Brandes’, David Dreman’s, Ronald Muhlenkamp’s, Peter Lynch’s, Joel Greenblatt’s, Martin Whitman’s, Kenneth Fisher’s, and Seth Klarman’s of the world – it seems that they all have one thing in common. It isn’t the style of investing since some of aforementioned investors are value investors, others are contrarian investors, and still others are growth at any price investors.
No, the one thing they all have in common is that they have information – in one way or shape or form or another – that you, as an individual investor don’t have. This doesn’t necessarily mean that you can’t find it – but if you take one concept away from todays’ column, take this one away: successful investors know something that other investors don’t know. That is, they have a competitive advantage that the rest of us don’t possess. So, what I am saying is that any information that can put you in a competitive or advantageous position relative to other investors is what individual investors should strive for –that is the goal.
Now, finding that information, and applying it is the subject of a whole different article – but I’ll give some brief examples of what I mean.
Digging deeper into this concept means that investors who have specific and useful pieces of information have a leg up on other individual investors. Information like this can take many different forms and wise investors would do well to learn about these various competitive advantages that companies could possess.
All of the following characteristics that I’ll be discussing have the concept of moat as a main idea. Traditionally when a person thinks of a moat, he/she thinks about medieval castles and water and the traditional bridge that is let down when someone wants to enter the castle.
In investing parlance, a moat is one of the great things for a company to possess. It means that the company has something that effectively differentiates the business from competitors. Typically the company is able to monetize (that is, the company can charge extra because of this moat) the moat and become more profitable than its competition and grow faster.
Various types of moats and a brief description follows:
Patents
The March 3, 2006 issue of Manufacturing and Technology news stated that the top United States company in 2005 with respect to generating patents was IBM. The rest of the list is as follows:
1. IBM, 2941 (3,248 in 2004)
2. Canon, 1,828 (1,805 in 2004)
3. Hewlett-Packard, 1,797 (1,775 in 2004)
4. Matsushita, 1,688 (1,934 in 2004)
5. Samsung, 1,641 (1,604 in 2004)
6. Micron Technology, 1,561 (1,601 in 2004)
7. Intel, 1,549 (1,513 in 2004)
8. Hitachi, 1,271 (1,893 in 2004)
9. Toshiba, 1,258 (1,311 in 2004)
10. Fujitsu, 1,154 (1,296 in 2004)
Businesses that receive patents from the U.S Patent and Trademark Office (the US government organization that issues patents) have a competitive advantage over their competitors since they are dedicating time and money in the form of Research & Development. In this way the business is using R&D to generate new products for the company’s future – which can presumably (and hopefully) be translated into sales and profits for the organization.
Research
A pharmaceutical company like Pfizer or Merck has definite advantages over a small pharmaceutical start up like Albany Molecular Research or Amlyn Pharmaceuticals since Pfizer spends billions of dollars trying to find new drugs to bring to market and sell. At any one time Pfizer can have dozens of clinical trials and various drug candidates in the pipeline, whereas smaller companies might only have 1 or 2 drugs in the R&D pipeline: Rationale: more drugs that are being tested for efficacy means that eventually sales (and profits) will increase in the future.
Size
The size of a business is another important indicator of a company’s competitive advantage. Examples of companies that use size to their advantage include Wal-Mart, Boeing, Citigroup and others.
Wal-Mart and Boeing (two companies that have many, many small vendors with whom they have contracts with to purchase goods or materials), for example, has recently decided to start make their top 100 vendors use RFID chips for inventory control (which will help Wal-Mart save money due to the chips’ inventory control) . Very few other company’s can force such changes. And why can Wal-Mart do this? Because it is a retailing behemoth that can literally put smaller businesses out of business by not purchasing their products.
Product(s)
Companies that produce something ‘unique’ or offer a service that is not offered by other businesses are at a distinct advantage over other ‘generic’ type products or services. For example, a company like Alcoa – which in, large part, manufactures Aluminum – competes with many other smaller companies that do the same thing. Essentially though, Aluminum is a commodity, which means that it is fungible. One company’s Aluminum is basically the same as another company’s (of course a company can manufacture a ‘new and improved’ type of Aluminum to give it a leg up on the competition) – which means that sellers of Aluminum basically compete on price. Just competing on price alone means that industry giants will tend to put the smaller company’s out of business since larger companies have the financial wherewithal to keep prices low and make less of a profit. Smaller company’s might only be manufacturing one type of Aluminum (or Steel or iron or whatever other commodity is being manufactured) whereas Alcoa has many different product lines that it is selling.
Service
Company’s that offer unique services might include consulting firms like EDS or IMS Health. Essentially these type of company’s offer advice for company’s in a specific industry. Service type company’s generally have very low capital expenditures since they don’t have to build a manufacturing plant or have hundreds of stores in which they sell their products. Service type companies generally have salaries of employees as being one of their largest expenses. As a result their profit margins are higher than company’s in other industries.
Business Process/Organization/Idea
By process I don’t mean how a particular product is made. I am talking about a certain procedure or how a business is structured – and how that business can translate this process into profits. One example of this is Illinois Tool Works. Essentially, Illinois uses the 80/20 rule in making business decisions. The 80/20 rule simply says that 80% of a company’s sales generally come from 20% of its customers. Why not focus on the 20% of customers and try to wring more profits from them? This is a clever business model and can be applied to many different parts of a business (inventory, employee retention, analysis of new sectors and industries and more)
All of the aforementioned business characteristics have one thing in common: they give the company that applies these strategies a competitive advantage over other companies in its industry. When company’s have this advantage they can grow and not whither away like so many other company’s that don’t evolve
Moats are a great way for company’s to differentiate themselves from their competitors and can lead to investors finding profitable investments.
Specifically, investors might want to look at either the Net Profit Margin or the Return on Equity to find out whether or not a company possesses a moat.
Investors who look at the various margin lines on a company’s income statement might find a potential investment which others have discarded. In particular, looking at a company’s Net Profit Margin and comparing it to the average for the company’s industry and for the S&P500 is helpful. In addition, a company’s Return on Equity is also indicative of a profitable, efficient company. Again, compare the ROE to the S&P500 and the average ROE of other company’s in the industry.
Investors would be wise to find company’s that possess these characteristics – it will help you get a leg up on other investors and see potential investments that the rest of the investing world doesn’t see – or can’t see.
Companies mentioned in this article:
Berkshire Hathaway (BRK-A), IBM (IBM, Financial), Canon (CAJ, Financial), Hewlett-Packard (HP, Financial), Matsushita (MC, Financial), Samsung ( SSNNF.PK) , Micron Technology (MU), Intel (INTC, Financial), Hitachi (HIT), Toshiba, Fujitsu, Merck (MRK, Financial), Albany Molecular Research, Amlyn Pharmaceuticals, Wal-Mart (WMT, Financial), Boeing (BA, Financial), Citigroup (C, Financial), Alcoa (AA-P), EDS (EDS, Financial), IMS Health (RX, Financial), Illinois Tool Works (ITW).
If this is the case, then how come so many people still don’t make money when they invest in the stock market?
Well, from my vantage point of having read dozens of investment books over a 15 year time period and having been an investor for most of that time, it seems that most investors don’t really think for themselves. Most investors follow the crowd and don’t act independently. Following the crowd is not a profitable way to invest – and that is where the problem lies for individual investors.
If you look at the superstars of investing – Warren Buffett’s, Charlie Munger’s, John Neff’s, T. Rowe Price’s, Bill Miller’s, Charles Brandes’, David Dreman’s, Ronald Muhlenkamp’s, Peter Lynch’s, Joel Greenblatt’s, Martin Whitman’s, Kenneth Fisher’s, and Seth Klarman’s of the world – it seems that they all have one thing in common. It isn’t the style of investing since some of aforementioned investors are value investors, others are contrarian investors, and still others are growth at any price investors.
No, the one thing they all have in common is that they have information – in one way or shape or form or another – that you, as an individual investor don’t have. This doesn’t necessarily mean that you can’t find it – but if you take one concept away from todays’ column, take this one away: successful investors know something that other investors don’t know. That is, they have a competitive advantage that the rest of us don’t possess. So, what I am saying is that any information that can put you in a competitive or advantageous position relative to other investors is what individual investors should strive for –that is the goal.
Now, finding that information, and applying it is the subject of a whole different article – but I’ll give some brief examples of what I mean.
Digging deeper into this concept means that investors who have specific and useful pieces of information have a leg up on other individual investors. Information like this can take many different forms and wise investors would do well to learn about these various competitive advantages that companies could possess.
All of the following characteristics that I’ll be discussing have the concept of moat as a main idea. Traditionally when a person thinks of a moat, he/she thinks about medieval castles and water and the traditional bridge that is let down when someone wants to enter the castle.
In investing parlance, a moat is one of the great things for a company to possess. It means that the company has something that effectively differentiates the business from competitors. Typically the company is able to monetize (that is, the company can charge extra because of this moat) the moat and become more profitable than its competition and grow faster.
Various types of moats and a brief description follows:
Patents
The March 3, 2006 issue of Manufacturing and Technology news stated that the top United States company in 2005 with respect to generating patents was IBM. The rest of the list is as follows:
1. IBM, 2941 (3,248 in 2004)
2. Canon, 1,828 (1,805 in 2004)
3. Hewlett-Packard, 1,797 (1,775 in 2004)
4. Matsushita, 1,688 (1,934 in 2004)
5. Samsung, 1,641 (1,604 in 2004)
6. Micron Technology, 1,561 (1,601 in 2004)
7. Intel, 1,549 (1,513 in 2004)
8. Hitachi, 1,271 (1,893 in 2004)
9. Toshiba, 1,258 (1,311 in 2004)
10. Fujitsu, 1,154 (1,296 in 2004)
Businesses that receive patents from the U.S Patent and Trademark Office (the US government organization that issues patents) have a competitive advantage over their competitors since they are dedicating time and money in the form of Research & Development. In this way the business is using R&D to generate new products for the company’s future – which can presumably (and hopefully) be translated into sales and profits for the organization.
Research
A pharmaceutical company like Pfizer or Merck has definite advantages over a small pharmaceutical start up like Albany Molecular Research or Amlyn Pharmaceuticals since Pfizer spends billions of dollars trying to find new drugs to bring to market and sell. At any one time Pfizer can have dozens of clinical trials and various drug candidates in the pipeline, whereas smaller companies might only have 1 or 2 drugs in the R&D pipeline: Rationale: more drugs that are being tested for efficacy means that eventually sales (and profits) will increase in the future.
Size
The size of a business is another important indicator of a company’s competitive advantage. Examples of companies that use size to their advantage include Wal-Mart, Boeing, Citigroup and others.
Wal-Mart and Boeing (two companies that have many, many small vendors with whom they have contracts with to purchase goods or materials), for example, has recently decided to start make their top 100 vendors use RFID chips for inventory control (which will help Wal-Mart save money due to the chips’ inventory control) . Very few other company’s can force such changes. And why can Wal-Mart do this? Because it is a retailing behemoth that can literally put smaller businesses out of business by not purchasing their products.
Product(s)
Companies that produce something ‘unique’ or offer a service that is not offered by other businesses are at a distinct advantage over other ‘generic’ type products or services. For example, a company like Alcoa – which in, large part, manufactures Aluminum – competes with many other smaller companies that do the same thing. Essentially though, Aluminum is a commodity, which means that it is fungible. One company’s Aluminum is basically the same as another company’s (of course a company can manufacture a ‘new and improved’ type of Aluminum to give it a leg up on the competition) – which means that sellers of Aluminum basically compete on price. Just competing on price alone means that industry giants will tend to put the smaller company’s out of business since larger companies have the financial wherewithal to keep prices low and make less of a profit. Smaller company’s might only be manufacturing one type of Aluminum (or Steel or iron or whatever other commodity is being manufactured) whereas Alcoa has many different product lines that it is selling.
Service
Company’s that offer unique services might include consulting firms like EDS or IMS Health. Essentially these type of company’s offer advice for company’s in a specific industry. Service type company’s generally have very low capital expenditures since they don’t have to build a manufacturing plant or have hundreds of stores in which they sell their products. Service type companies generally have salaries of employees as being one of their largest expenses. As a result their profit margins are higher than company’s in other industries.
Business Process/Organization/Idea
By process I don’t mean how a particular product is made. I am talking about a certain procedure or how a business is structured – and how that business can translate this process into profits. One example of this is Illinois Tool Works. Essentially, Illinois uses the 80/20 rule in making business decisions. The 80/20 rule simply says that 80% of a company’s sales generally come from 20% of its customers. Why not focus on the 20% of customers and try to wring more profits from them? This is a clever business model and can be applied to many different parts of a business (inventory, employee retention, analysis of new sectors and industries and more)
All of the aforementioned business characteristics have one thing in common: they give the company that applies these strategies a competitive advantage over other companies in its industry. When company’s have this advantage they can grow and not whither away like so many other company’s that don’t evolve
Moats are a great way for company’s to differentiate themselves from their competitors and can lead to investors finding profitable investments.
Specifically, investors might want to look at either the Net Profit Margin or the Return on Equity to find out whether or not a company possesses a moat.
Investors who look at the various margin lines on a company’s income statement might find a potential investment which others have discarded. In particular, looking at a company’s Net Profit Margin and comparing it to the average for the company’s industry and for the S&P500 is helpful. In addition, a company’s Return on Equity is also indicative of a profitable, efficient company. Again, compare the ROE to the S&P500 and the average ROE of other company’s in the industry.
Investors would be wise to find company’s that possess these characteristics – it will help you get a leg up on other investors and see potential investments that the rest of the investing world doesn’t see – or can’t see.
Companies mentioned in this article:
Berkshire Hathaway (BRK-A), IBM (IBM, Financial), Canon (CAJ, Financial), Hewlett-Packard (HP, Financial), Matsushita (MC, Financial), Samsung ( SSNNF.PK) , Micron Technology (MU), Intel (INTC, Financial), Hitachi (HIT), Toshiba, Fujitsu, Merck (MRK, Financial), Albany Molecular Research, Amlyn Pharmaceuticals, Wal-Mart (WMT, Financial), Boeing (BA, Financial), Citigroup (C, Financial), Alcoa (AA-P), EDS (EDS, Financial), IMS Health (RX, Financial), Illinois Tool Works (ITW).
