Hey yo, I hope things have been working out for y’all. As value investors we are always looking for companies that can generate consistently strong profits over the long-term. As the big man Warren Buffett said “If you aren't willing to own a stock for ten years, don't even think about owning it for ten minutes. Put together a portfolio of companies whose aggregate earnings march upward over the years, and so also will the portfolio's market value.” In this article, we’ll be looking at some of the clues that point to long-term profitability for a company.
A strong brand is definitely up there as a competitive advantage that can help a company maintain its profitability. The Apple brand makes the company’s products appear special and allows Apple to still make YUGE profits even as the smartphone market is entering the maturity phase (Tim Cook, who probably leans left, is gonna be pissed at me for using Apple and a word associated with Trump in the same sentence). On the other hand, the HTC’s of the world has seen their profitability fall off as competition intensified and smartphones become more commoditized.
A low cost structure helps protect the profitability of companies selling undifferentiated products. For instance, oil companies with high cost structures got fucking curb stomped when oil prices collapsed. However, there were oil companies that were able to operate within cash flow or even generate free cash flow due to their low cost structures. These companies’ low cost structures could be a result of acreage with good geology, ample pipeline capacity to transport their oil, proximity to distribution hubs, a low level of debt and/or a culture that prioritizes innovation and cost cutting.
One good predictor of consistent profitability is if the company has little to no competition. This could be a result of the company owning assets that are difficult to replicate aka trophy assets. For instance, it is very difficult to build a major oil or natural gas pipeline in the US due to all the regulations and the democrats pandering to hashtag campaigns from those damn environmentalists (things are starting to get better now that the republicans are in charge with the Dakota Access Pipeline receiving final approval). This turns certain pipelines already in the ground into not just cash cows, but big fat Kobe cash cows. A company could also dominate its market by creating such a great product that most consumers just choose to use its product. Examples of such companies are Google & Facebook. The government can also grant monopoly power to companies by giving them exclusive licenses to conduct certain types of businesses in the country. Great intellectual assets can prove to be quite the money maker. Disney will probably continue to make pirate shiploads in royalties from the sale of Elsa dolls, backpacks and clothes for many years to come. After all, Elsa is a pretty awesome gal.
There are also industry-specific stuff that investors need to take into account when analyzing the ability of companies to increase profitability over the long-term. A property developer’s ability to sustain its profitability depends on its current land bank and its ability to acquire new land at reasonable prices. For an oil company to grow its volume, it would need an ample inventory of drilling locations that are economically feasible at current oil prices. Pharmaceutical companies can make a lot of money from drugs under patent protection. So, it would behoove them to have a robust R&D pipeline of promising drugs to replace their existing patents when they eventually expire.
We’ve all read about how Netflix ate Blockbuster’s lunch, or how the camera industry has shrunk dramatically as Asians could just use their phones to take photos of their food (we truly are living in a brave new world). Obsolescence is a threat that investors should always be on the look out for. While it’s kind of a stretch to say that brick-and-mortar stores are obsolete, the impact of online shopping is very real for many retailers. Quite a number of retailers have seen their profits and stock prices plunge as they lose sales to online stores. To be competitive, traditional retailers need to develop and execute an effective omnichannel marketing strategy.
One of the best ways to make that “fuck you” money is to invest in shares of companies with superior and growing profits, at reasonable prices, and hold them forever. That is why it’s important to learn about the competitive advantages that lead to long-term profitability, and the threats to a company’s profits. Thank you for reading. Take care and stay rational.