Competitive Advantage

This definition from Investopedia is probably as good as any;

"An advantage that a firm has over its competitors, allowing it to generate greater sales or margins and/or retain more customers than its competition. There can be many types of competitive advantages including the firm's cost structure, product offerings, distribution network and customer support.

Investopedia explains 'Competitive Advantage'
Competitive advantages give a company an edge over its rivals and an ability to generate greater value for the firm and its shareholders. The more sustainable the competitive advantage, the more difficult it is for competitors to neutralize the advantage.

There are two main types of competitive advantages: comparative advantage and differential advantage. Comparative advantage, or cost advantage, is a firm's ability to produce a good or service at a lower cost than its competitors, which gives the firm the ability sell its goods or services at a lower price than its competition or to generate a larger margin on sales. A differential advantage is created when a firm's products or services differ from its competitors and are seen as better than a competitor's products by customers."

As a long term investor I have been giving this more and more thought lately, if a business can be found with these qualities and the price is reasonable, holding for the long term should work out OK for shareholders.

So with this in mind I thought to create a watch list of ASX listed companies that may have these qualities of particular interest to me would be any small or micro caps. Any contributions and arguments would be greatly appreciated.

The problem being, these companies are almost always trading at a premium.

Often at P/Es of over 20.

The large end of town is probably the easiest to spot in my opinion;

The big four banks maybe with the exception of NAB so;
CBA
ANZ
WBC

BHP is a difficult one, while they are price takers they have the assets, scale and diversity to have some sort of advantage through the economic cycle.

CSL, Cochlear (COH), Resmed (RMD) and Sirtex (SRX) probably deserve a place in the health care sector. These need to be watched for major changes in technology however.

Looking to the online space Realestate.com (REA) Carsales (CRZ) both have that network effect happening. Another company I would throw in is Iproperty Group (IPP) this business is still building their network.

Navitas (NVT) seem to have not much competition and nice margins.

IMF seems to have some sort of advantage, they have backed so many winning cases lawyers come to them with strong cases.

So there is a start, many won't agree with all of them but hopefully we can add to this list.

chops_a_must said:

The problem being, these companies are almost always trading at a premium.

Often at P/Es of over 20.

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Very true but that does not mean they will not trade at a more reasonable multiple in the future. Many will find this exercise a waste of time but with patience there may be some opportunity to be found.

I bang on about it a bit, but IVC is another one.

It is pretty pricey now though.

TOX is another, off the top of my head.

robusta said:

Very true but that does not mean they will not trade at a more reasonable multiple in the future. Many will find this exercise a waste of time but with patience there may be some opportunity to be found.

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For what its worth, i have most of the shares you mentioned on my watch list.

I quite like the Morningstar approach of assessing the 'moat' a company has, basically same as competitive advantage.

I guess Woolies/Westfarmers at least have some CA or narrow moat.

The low hanging fruit will be where you can find companies with a CA that havent yet grown to the size to get noticed. Small to mid caps in niche markets with CA and potential growth - i guess thats the holy grail.

Great idea for discussion anyway, Robusta.

Cabcharge (CAB) is a business that has not made my list (to the detriment of my returns). They have the network and the infrastructure but I could never convince myself some other epayment system would not steal their business away.

CTD and AEU are some others.

galumay said:

For what its worth, i have most of the shares you mentioned on my watch list.

I quite like the Morningstar approach of assessing the 'moat' a company has, basically same as competitive advantage.

I guess Woolies/Westfarmers at least have some CA or narrow moat.

The low hanging fruit will be where you can find companies with a CA that havent yet grown to the size to get noticed. Small to mid caps in niche markets with CA and potential growth - i guess thats the holy grail.

Great idea for discussion anyway, Robusta.

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Cheers you are right it would take a lot of cash to dislodge the market share of WOW and WES I reckon they deserve a spot on the list.

You are also correct it would be life changing to invest in a REA, RMD, CRZ or CSL soon after listing and hold for the long term.

chops_a_must said:

CTD and AEU are some others.

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Thank you I have not had a meaningful look at either of these, I will offer up a opinion once I have researched these guys a bit.

chops_a_must said:

CTD and AEU are some others.

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Mmmm...I had a brief look and neither appeared to have significant competitive advantage, but i probably missed the detail.

chops_a_must said:

I bang on about it a bit, but IVC is another one.

It is pretty pricey now though.

TOX is another, off the top of my head.

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Sorry missed this post IVC is a definite, I guess TOX does not have much competition I will have to look at their business model a little closer however.

So before I go to bed we have;
CBA
ANZ
WBC
BHP
CSL
COH
RMD
SRX
REA
CRZ
NVT
IMF
IVC
WOW
WES
With no argument yet.

And in the maybe camp;
TOX
IPP
CTD
AEU
CAB

i suppose TLS should be on the list. They have the money to bash their way through the market.

I'd add RFG and DMP. They're both on the pricey side but have show a long term ability to grow EPS and have good scale. DMP has taken to the internet quite well - from memory up to 50% of sales is now done online.

Prob add CPU in there. Not a great performer lately, but they do have global scale and reach and once the global economy starts growing strongly again they will be very leveraged to it.

CDA would be another company. They have the tech that puts them in the front globally. Read an article from a year or 2 ago where they out competed some Chinese company that was selling fake product, but CDA was so good at their manufacturing that eventually the Chinese company signed a distribution deal with them.

SEK prob needs to be on the list too. They have a stranglehold on the online job market in Australia and are moving internationally now too.

On a Global basis you can try the IOO ETF that invests in the top 100 global companies or the IXI ETF that invests in the top global consumer staples companies. Pretty much every company in those ETFs has small to large CA. In some ways I'd say you nearly have to go global to get into the best companies.

When I think about competitive advantages I usually have a few groups.

The first group contains the obvious ones (most of which have been mentioned).

Another group is companies that I feel are in the midst of building their competitive advantage. How do I identitfy these companies? Looking at their history of margins and returns - is there a story building? Is their a consistentcy/upward trend in excess earnings? Are they pulling further away from the competition?

Another group is companies which may have had a substantial CA in the past, but are slowly having this eaten away as competition figures out how to take a bigger bite of the pie...

Another source of competitive advantage can be in the pipeline for a long time, and then once a certain agreement is in force - the moat is in place. (think JUMBO acquiring an exclusive lottery license or a biotech acquiring a patent for a successful drug/product)

Then there is companies that can have CA built into their business model. I think McMillian Shakespeare is one of these. They have one half of the business that acts like a cash cow - which allows the other half of the business to load up on debt and leverage excess returns.

I think the best CA's are when their is multiple sources of the advantage. JBH is a bit like this. It had the low cost advantage, but as it lost this advantage due to online retailers being able to easily match and even beat prices by substantial amounts ---the business still survived, and is thus far still somewhat thriving. I think that this is because JBH had more than just a "lowest cost" CA. They marketed themselves well, ensuring that the brand effect was well integrated and has now become another source of competitive advantage.

Some other candidates (other than what I've mentioned) are FLT (scale, brand), CCV (scale, brand, networking), ARP (quality).

I try to ensure that my main watchlist has a large % of companies with competitive advantages to ensure that these are the types of companies I am constantly researching and keeping up to date with. However as has been said, they are often expensive and as such, i find it useful to keep track of other companies in order to try and identify some of those stocks which might just be building new moats

If I find such stock I load up over several months - year as cash come in and wouldn't tell anyone -

ROE said:

If I find such stock I load up over several months - year as cash come in and wouldn't tell anyone -

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At least not until your fully loaded

Competitive Advantages enablers

Intangible Assets
o Brands (if they allow pricing power)
o Regulations (lots of small regulations less susceptible to change)
o Patents etc.

Customer Captivity
o Switching costs
o Network effect
o Habits
o Search Costs

Cost Advantage
o Unique resource, location (Economic rent)
o Size (relative to niche)

chops_a_must said:

The problem being, these companies are almost always trading at a premium.

Often at P/Es of over 20.

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Hi Chops,

These companies should be used to create a watchlist for shorting candidates - they will all fail in the long run.

Cheers

ROE said:

If I find such stock I load up over several months - year as cash come in and wouldn't tell anyone -

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You have made a boring day very funny .

Maintain your own competitive advantage.

Cheers