ARBOR WEALTH: Car washes, dark chocolate and The Rolling Stones
“Hey! You! Get off of my cloud …” from “Get Off My Cloud” by The Rolling Stones
When you buy a stock, you’re not just buying paper. You’re investing in a company. Ever wonder what makes one better than another?
Intelligent investors are searching for several factors, beginning with a durable competitive advantage. A company’s ability to defend its market share from price cutters and copy cats can mean the difference between a firm being a flash in the corporate pan and becoming a profitable, stable business.
Imagine you operate the only car wash in town and are monopolizing the local trade. If an enterprising challenger opens a similar business nearby, what measures you enact to maintain and expand your customer base will likely determine the company’s future success. Invent and patent a new type of car wash machine, and your innovation may allow your business to thrive and build what Warren Buffett terms an invisible moat protecting your profits.
Companies with low initial capital requirements often enjoy an inherent advantage. Businesses in this category, especially start ups, usually have little debt and can plow more of their profits into expansion and marketing because less of their revenue must be dedicated to retiring loans. Many Silicon Valley success stories begin in someone’s garage. Low overhead is a mantra for them.
The opposite can also be true in certain established industries. Some companies corner the market because it takes so much money and equipment to enter a particular business arena that very few firms can garner that kind of working capital. If a job is so big that only two or three companies in the world can tackle it, a lot of competition has been eliminated. For example, estimates are that it would cost over one hundred billion dollars to build a new transcontinental railroad system from scratch. The cost and scope of the project rules out many potential contract bids.
Additionally, if a company can produce a good or service at a price that is consistently lower than the competition’s price, odds are that company will be able to withstand economic booms and busts better than most. Companies are also smart to build in some room for potential pricing increases.
Brand loyalty, oddly enough, is seen as a durable competitive advantage of the highest order. We all maintain emotional connections to certain products, regardless of cost. How likely are you to change your favorite soda or snack food, or your preferred cleaning product, even in down times? Companies that produce such valued products often enjoy premier pricing power. If you love a particular brand of dark chocolate and the folks raise the price by 3 percent annually, you’re likely to pay up and stick with your favorite.
Margaret R. McDowell, ChFC, AIF, a syndicated economic columnist, is the founder of Arbor Wealth Management, LLC, (850-608-6121 — www.arborwealth.net), a “fee-only” registered investment advisory firm located near Sandestin. This column should not be considered personalized investment advice and provides no assurance that any specific strategy or investment will be suitable or profitable for an investor.