" The great personal fortunes on this country weren't built on a portfolio of fifty companies. They were built by someone who identified one wonderful business "
Companies must have a Durable Competitive Advantage if Warren Buffett is to be at all interested.
This is sometimes called a 'Sustainable Competitive Advantage'.
But what does that mouthful mean?
We like to break stuff down into their simplest components so in this case we'll look at each word in that expression and try to make our own definition of the phrase.
Durable - dictionary definition: lasting for a long time.
Competitive - wanting to achieve more than others.
Advantage - superior position.
And in an investing context the term "durable" means able to withstand recessions, political events, and anything bad that may come along.
So, a company that has a 'Durable Competitive Advantage', can be described as one that is ahead of all competition in its field, has some kind of monopoly and will remain ahead of any chasing pack, possibly even pulling further ahead - for the foreseeable future.
Companies that have a Durable Competitive Advantage are very difficult to copy and for others to even try to do so would be cost prohibitive.
But having just a unique product in itself is no guarantee that it will always be No.1.
This type of company must have at least some of the following:
Such companies are likely to have been around for a long, long time. And will still be around for a long, long time. Because that customer loyalty will keep them there.
Food and drink is a sector that comes to mind. Everybody's heard of Heinz and Starbucks. There are many more.
These kind of companies dominate their marketplace. Largely because they are high quality and their image allows them to increase their prices year on year . They don't have price battles with other companies.
Low research and development cost and little investment in new plant development allows them to free up cash that they might otherwise use.
Therefore companies are likely to have high amounts of free cash flow which can be passed on to shareholders (this being one of Warren Buffett's favourite reasons for liking these companies).
Products that are essential to peoples' daily lives typify what a company with Durable Competitive Advantage is all about.
Companies with superior products that customers will buy over and over again.
What is essential is the repeat need for their products.
Companies with a Sustainable Competitive Advantage exhibit common traits. You need to look for most of these characteristics if you're thinking about investing in them.
Remember, these type of companies will be your CORE holdings. Your: 'buy them and forget them' investments.
Sidebar: You can buy and forget these type of shares, sure, but a much better strategy would be to sell them when they are oversold and buy them back when they are cheap. Even the best shares become overbought and oversold from time to time. Buy and hold forever if you like, but trading them can be better.
So what common characteristics do these companies posses?
Companies that you invest in should satisfy most of the above criteria, as over time, these companies will grow. It will be impossible for them not to, as money is re-invested back into them.
Warren Buffett's company, Berkshire Hathaway, has never paid a dividend. Never, not once. He likes to re-invest that money back into the company. So the type of companies he looks to invest in, do something similar.
A company with a strong competitive advantage means that it will make good profits year in, year out. Because no matter how bad the economy performs there will always be a demand for its products and services .
Do not think that finding such companies is as easy as looking for 'Price/Book Ratio' or 'Price/Earnings Ratio'. It's not as easy as that. You would need to fully understand what the company is and how it operates.
Chances are, we, as amateur investors will never be able to find new companies that fit the bill. Fortunately, we don't have to. But an understanding of them is essential.
Stick to the tried and proven companies.
Beware of companies with innovative products. Sure, their share prices may go wild but they are not what we are looking for. They do not satisfy the criteria that we are looking for. They could be one-trick ponies.
The whole theme of this website is to invest for the long term. If you make a quick turn on a share that's great too, but it's not what Common Sense Retirement Investing is about.
So back to 'our type of companies.'
In addition to the characteristics already mentioned above, look for signs that put companies into the "Premier League."
Here are some pointers to take note of:
#1: High Margins. For us lay-people, this is the amount of money a company keeps after it sells its products. And just to be clear, look at NET margins.
#2: Lots of Cash. Look for cash on the company's balance sheet.
#3: Low Debt or No Debt. Debt could be non-existent for our type of company since, by definition, they generate a lot of cash. You would therefore question why it has any debt at all.
#4: Consistent Profits. Peruse at least the last 10 years of profit. A rise in every year is a (very) good sign.
#5: Steady Accumulation of Cash. Any company has to generate cash. A slow, steady accumulation of cash is a clue that the business is solid. Look on the Financial Statements for cash flow.
#6: Retained Earnings. When a company has money left over, it can do several things with that money: it can pay shareholders a dividend; it can buy back its stock; or it can re-invest money back into the business. Money re-invested back into the business shows up as retained earnings on the Balance Sheet.
Sidebar: If a company is growing its earnings then its net worth is expanding. Over time, Compounding Interest starts to take effect. The earnings begin to grow faster and faster. This means that the company's net worth grows faster and faster. (Think of a snowball rolling down a hill).
Note: This is exactly what Warren Buffett looks for in a company.
#7: Low Current Ratio.
#8: Low R&D to Sales Ratio. Too much money spent on R&D is a sign that a company is in an evolving, highly competitive industry. You want a company that is a market leader and stays a market leader for the foreseeable future. Only big companies can afford massive R&D spends. e.g. GSK, Pfizer, and they are protected with patents (for a period).
Do understand that the above is intended as a guide for your understanding. No way, except by chance, can we amateurs come up with a Durable Competitive Advantage company on our own. There are professionals poring over figures all day, every day.
No, we just jump on the coat-tails of those that have already identified our type of company.
All the above, is intended to be a simple guide for your understanding of the subject. In no way are we recommending any share or company.
The last part of this article reveals what you probably want to see. Which companies actually do fit the criteria.
Here are a few companies that you can safely invest in. Again, it's just a list. There is no recommendation for you to buy any of these.
However, as was detailed in this article, these type of companies are as close as you will get to a sure thing.
And if you want to invest in the ultimate "sure thing" then take a look at Warren Buffett's Berkshire Hathaway company. Although you may have to shell out a few hundred thousand just for ONE share. (The 'B' shares can be had for a more modest amount).
Try to see why the below mentioned companies have a Durable Competitive Advantage.
Here's a few of them:
And in the UK:
Glaxo Smith Kline (GSK) - pharmaceuticals
British American Tobacco (BATS) - tobaccos
Unilever (ULVR) - consumer goods
Diageo (DGE) - drinks ad beverages
We'll continue to add to these lists as time goes by. We're keeping them small for now.
Companies with a Durable Competitive Advantage can make big gains with very little risk. All you need to do is buy at the right time and wait.
You may think they are boring but it's a system that has worked like gangbusters for decades. And who would argue with Warren Buffett?
Warren Buffett and the Interpretation of Financial Statements by Mary Buffett and David Clark
The sub-title for this book is: The Search for the Company with a Durable Competitive Advantage.
And the authors do a grand job of explaining, with worked examples, how Warren Buffett digs deep and ferrets out the information that will convince him he has found another gem.
This resource is a terrific primer for private investors in the understanding of finncial accounts and the interpretation of them.
Get your copy by clicking on the link below:
The Little Book That Builds Wealth by Pat Dorsey
How do you find companies that are really performing today and will still be performing years from now?
The author identifies, step by step why Durable Competitive Advantaged companies are such a good long-term investment. And, having explained well what they are goes on to explain how you can identify those that may be in decline.
Get a copy of this 200 page resource by clicking on the link below:
Warren Buffett has made fortunes in the Stock Market. At the laast count: $90 Billion and counting.
He has achieved this, not just by being in the right place at the right time, but through his meticulous study of companies and their accounts.
His philosophy is to only invest for the long term and to invest in companies that are sound. Not just today, but have been sound over a long period.
O.K. That rules out an awful lot of companies.
He is continually on the look-out for what we call: the Holy Grail.
Except he calls these companies when he finds them: companies with Durable Competitive Advantage.
He has gone on record as saying that over a lifetime you may only be involved with 20 to 30 shares. That's a sure indication that his stock picking skills are well and truly honed.
He doesn't like companies that pay dividends, he prefers earnings to be ploughed back into the company. Who can possibly argue with him?
Take a look also at our webpages: The Balance Sheet, The Income Statement, and The Cash Flow Statement for more ideas about companies that have a Durable Competitive Advantage.