Another Point, Key to Investment Success

Investment Perspective – November 2016

Peter Flannery CFP AFA

 

 

“Neither the investing method nor the fundamentals of the business are right or wrong because the mood of the market is favourable or unfavourable toward the “stock”. That is because when you really think about it, “stocks” (shares) are all about the financials and the trading price, the share price… the cash up value. What matters more is the economics of the business” 

Peter Flannery

 

Another important key to investment success is to invest in productive assets (good businesses that grow).

But what makes a good business anyway? Well, Warren Buffett (I reckon he knows something!) has long been a fan of what he calls the durable competitive advantage.

 

What is the formula / calculation?

This is something that is not widely available wherever you look. It is difficult to find, unusual. Perhaps what makes it more challenging is that a durable competitive advantage is not something that can be easily measured or broken down to a number. Profitability (not reported profit) is one indicator. Profitability measures how well a business uses shareholder funds.

Whilst mathematicians might well argue that everything right down to the meaning of life can be broken down to a number, in my experience, as important as proper financial analysis really is, value judgements around method, whilst perhaps a bit intangible, are also important for investment success.

There are many ways to invest, lots of methods. Investing in a sustainable competitive advantage helps reduce risk and make money work in a way that other investments are unable to replicate.

Property for example may well have a desirable location and great tenants but in the end is tied into economic conditions (e.g. the impact of rising or falling interest rates).

 

Pricing power

Great businesses with a sustainable competitive advantage on the other hand “can make their own music” so to speak, regardless of economic conditions.

Warren Buffett suggests that any business with a durable competitive advantage is likely to have a long history of profitability that is based on a narrow range of products or services, be resilient during tough times and be around for a long time.

Furthermore, a company that enjoys a strong competitive advantage is likely to offer a product that has a rising or stable pattern of demand.

In addition to very strong market positioning, indications of a sustainable competitive might also include strong profitability (e.g. Google, Apple). This may arise out of the ability of the business to increase prices whilst maintaining sales and profitability because of the demand for their product or service. These businesses offer products and services that are distinctive and high quality.

The trading price (the share price) of such a great business rising and falling is more a reflection of market sentiment and often has little to do with the sustainable competitive advantage.

A business such as Trilogy has no real sustainable competitive advantage. Companies like Xero have some competitive advantage in the markets in which they operate but they are by no means the largest, most profitable player globally and the durability or sustainability or their thin competitive advantage is questionable.

Google (Alphabet) on the other hand controls over 60% of search engine space in the world with the next largest competitor Baidu, controlling around 9%. Yes, technology can change; there are competitors and a number of risks. The strength of the durable competitive advantage of Alphabet the business is difficult to find elsewhere.

 

The point…

Just to press the point home, price movement usually has little to do with the fundamentals of the business such as a durable and sustainable competitive advantage.

That is why an over focus and over emphasis on price movement is somewhat futile, particularly in the short term.

The return on your portfolio over the last 12 months for example is the score card if you like, gauging the collective market sentiment for the businesses in your portfolio – not a measure of the sustainable competitive advantage of each business.

The point here is that it is usually better to base your investment decisions around the underlying business than the popularity or unpopularity of a business as measured by share price movement.

Make sense?

“Games are won by players who focus on the playing field – not by those whose eyes
are glued to the scoreboard.“

Warren Buffett 

©1987 – present WISEplanning. All Rights Reserved. The integral concepts are part of The Money M – A – T – R – I -X and Wise Asset Management and cannot be used without the written permission of WISEplanning. If you would like further information about The Money M – A – T – R – I -X programme other services and products, please telephone 03 375 7001, fax 03 386 0686 or email admin@wiseplanning.co.nz 

Attention: Any form of reproduction, or further dissemination of this content is strictly prohibited. The views and opinions expressed are those of the author, and are not necessarily those of WISEplanning, and are not intended to be a personalised service for an individual retail client. The views and opinions are general in nature, and may not be relevant to an individual’s circumstances. Before making any investment, insurance or other financial decisions, you should consult a professional financial adviser for personalised advice.

Any calculated projections or any predictions given by me to you are not guaranteed and are merely an expression of opinion and are intended for illustration purposes only.
Product performance can vary over time. The payment of a particular rate of return and the repayment of your capital is not guaranteed by myself, the company or any of its officers,  Historical information and performance may not necessarily be a good guide to future performance.

While every care has been taken to supply accurate information, errors and omissions may occur. Accordingly, WISEplanning accepts no responsibility for any loss caused as a result of any person relying on the information supplied.

Any mention of Warren Buffett or other successful investors is not intended to mislead anyone to think that WISEplanning or clients of WISEplanning will be as successful as Warren Buffett and other successful investors.

Click here to view our Disclosure