How to find companies for investing?

The first law of capitalism says that competition is inevitable. In a capitalistic environment, if a company is earning huge amount of money in a certain industry, then it is indirectly giving a welcome invitation to its competitors.  In the current information era, technology has made a level playing field for all the companies ranging from small start-ups to big cooperations to compete with each other.

Threats for investors

Competition is not only threats for companies, it’s a scary nightmare for investors also. Investors should be very careful in investing in companies which have got high competitions. If the company is not developing its business to withstand the competition and strive for more than 10-15 years, then the doomsday for the company is not far away.

Breaking the law of capitalism

Dealing with competition is not a show of puppet. It requires great strategy and dedication of everyone in the company. There are some companies who have thrashed out their competitors from the industry itself.

When the company is enjoying making large profits, their competitor’s will not simply sit and cheer for your success.  This also indicates that, in a relatively new industry, when there is no certainty of its products in future, there will be no competition. But once, when a company start making profits in that new industry, competition will come from every angle.   

There are some companies who have not only maintained their leadership position for 2-3 decades but also created huge wealth for its shareholder’s also. Those companies are rare but they are there.

How did those companies do it?

What separates men from boys is the ability to withstand in every worst situation possible. Likewise, these companies withstood even in the worst atmosphere so that they were able to shine in good years.

They were able to withstand the worst years because these companies have built a strong “moat” around them.

Moat

Moats are generally the competitive advantage the company have in their industry. It’s not only the competitive advantage but also the sustainability of those advantages the company have. Great company which have survived for decades have developed a sustainable completive advantage. E.g.: Havells India Ltd, Asian Paints Ltd, Pidilite Industries etc.

Source of building competitive advantage

Companies develop sustainable advantage mainly using these two sources,

  1. Low-cost production

  2. Powerful brand(s)

In a low-cost environment, the company can sell their products at very low prices and they can knock out the competition from the scene.

What would happen if the competitor prices their products even below the low-cost producer’s price?

This is where brands come into play.

There is a false assumption that companies develop their brands but they are not. The brand is only developed through customer loyalty. Loyalty is built through trust. Trust is the most important factor in the brand equation. Customer’s trust is the most powerful ingredient for the company to have because it cannot to cultivated by the company but rather it can only be earned. Earning the trust means developing a great intangible asset around your company known as – “brand”. Companies having powerful brands don’t fight for market share with their competition but rather they fight for share for the mind of a customer.

A perfect combination of low-cost producer and powerful brands is like, getting sugarcane juice without putting sugarcane. Those companies are cash machines. They generate cash not only for themselves but also for its shareholders also. These companies are rare to find and even rarer to buy at a bargain price.

But nothing can go on forever. In the current turbulence time, powerful brands can go bust if the company is not innovating and changing its strategies as the environment changes. E.g. think of Nokia.

Investor’s job is to find and buy these companies and regularly do check up whether the company is on right track or not.

There is another way of looking in investing. Investors can bet on industry or companies which don’t change a lot. E.g. cement industry, steel industry etc (they produce same cement and same steel that they produced 10 years ago. There might be some upgradation in quality or method of production but the end product remains the same). They generally belong to commodities. The trick here is also, to buy the commodity company having low-cost production and powerful brand.

Investors can bet on human behaviour.

Consider the tobacco industry, the tobacco industry has high customer loyalty.

Human Behaviour – the tobacco industry

When someone starts smoking for the first time, there is a high possibility that he will smoke for next time also. The main thing is that he would not change the brand when he smokes for the second time. This creates an intangible asset for the company. These companies have pricing power, if they raise the prices for the products, a customer would still love to buy it and smoke because customers have no other choice. It is not very easy to change from one brand to other suddenly. If you don’t believe me, just try it.

The liquor industry is also a great industry where investors can bet on human behaviour.

Human behaviour – liquor industry

People drink liquor when they feel happy, when they feel sad, when they go out with friends, even when they don’t have a reason, they find some reason to drink liquor. They are literally addicted to it. People drink quality liquor and have brand loyalty. Liquor industry also has a high barrier to entry.

In both the tobacco and liquor industry, we are betting on human behaviour because human behaviour doesn’t change easily. But all the company in the industries don’t make money, only few who have developed their share of mind in the customer’s mind will make money. Competition is limited because if any new entrant comes and even if, he gives better liquor or tobacco, people would not be willing to change suddenly at once.

To Summarize

Investors should be very clear in which category one is selecting the business, whether one is selecting the business with a large moat or betting on the industry which is not prone to any changes or betting on the industry based on human behaviour. We have to be very clear that investing in a good company doesn’t mean we have made a good investment. Our investments are great only when we can find them at an attractive price.

Collective effort

It would be great if everyone can share their ideas about the companies that come into your mind or which may be in your watchlist and specify exactly in which category it belongs to. It can become a collective effort if everyone can contribute to it. We can also move a step further and discuss the valuations in which these companies are being traded. We can also share our insights with others and grow together.