This question comes from a Focused Compounding member. I wrote up a stock called U.S. Lime & Minerals (USLM) on the member site last week. In my write-up (which is behind a paywall), I mentioned that I believe lime producers in the U.S. have “market power” because lime is not shipped far (U.S. Lime’s customers are all within 400 miles), it isn’t kept in inventory, and it’s decently likely there will be fewer lime producing sites in 5, 10, or 15 years than there are today. This last point is key. In many industries, I can’t predict that customer choice will be lower in the future than it is now. Often: I’m afraid it will be higher.
Before we get to this question, I need to repeat my own definition of “market power” which is different from the definition used for anti-trust purposes and things like that. I define market power as:
"Market power is the ability to make demands on customers and suppliers free from the fear that those customers and suppliers can credibly threaten to end their relationship with you."
Obviously, no firm has perfect market power. And almost all firms have some power over some subsets of customer and suppliers. However, plenty of readers of this blog have noticed that the stocks I tend to purchase for myself (not just the ones I tend to write about) seem to fall in the high market power group. For example, they usually combine high customer retention rates with prices that don’t fall from year-to-year.
Now that that’s out of the way, let’s get to the question.
“I've been thinking a lot lately about market power after reading your Focused Compounding article on it.
While I have always considered market power as a factor in analyzing potential investments, it has not been the primary factor I look for in a business. I have tended to focus on staying power and durability, ideally coupled with strong economics (ROCs). To some extent, there is a large degree of overlap between these factors (one could argue these are semantic differences), but I would say that market power is a little more comprehensive in tying in durability of the economic model with ability to sustain favorable economics due to the relationship between a business and the other entities in the economic ecosystem.
Basically, this idea of the primacy of market power is really changing the way I think about investing and how to frame my research process. In effect, I can't figure out why I would ever invest in a business without strong market power. In the past, I have included companies on my research list like Dominos that have strong economics. My thought process has been that it makes a lot of sense to include "great" companies like Dominos so that I have a value figure predetermined in the event we see a price meltdown, so that I could quickly act to invest in it.
Now, however, I'm wondering why would I research a company like Dominos when I could focus on companies like US Lime that enjoy much stronger market power and thus a more reliable investment outcome. In a perfect world, I would research both, and all, companies. In practice, it takes a lot of time to really dig in to a company and I think it makes sense to target research on those companies who appear on the surface most aligned with the type you would invest in.
What is your thinking on the topic? Do you spend a lot of time analyzing companies that have excellent economics but that are in competitive industries that could erode those economics, or do you try to steer your focus more on businesses with huge market power? It's clear your current portfolio favors businesses with strong market power, but I am curious how you frame your research process, not necessary for your writings on GuruFocus or Focused Compounding, but for actual investment.
In summary, I'm trying to figure out if I should shift the way I use my research pipeline to only include companies with strong market power, or if it makes sense to include other types of companies, too. For reference, I am a focused investor and have been becoming more so over the past 15 months. I have 8 positions and the top 3 are 60% of my portfolio, so I am the type of investor who likes to invest heavily when I come across ideas I feel strongly about. And as I have been increasing concentration, it has become increasingly important for my ideas to be extremely high conviction, which is more attainable by focusing on businesses with strong market power.”
First, I need to go a little off-topic and discuss Domino's specifically.
One interesting point is that I actually researched Domino’s (DPZ) and talked it over with Andrew offline.
I think Domino’s is one of the best businesses I've ever seen.
And I think it has a lot of little systematic advantages that really add up to something impressive. What got me interested in researching Domino's was actually that I was noticing just how important digital orders (and carryout) was becoming for this business. So, there was a real change in habits in terms of making availability greater. If people don't know what to get for dinner now, they can just decide "what the heck" take out their phone and re-order their "favorite" order in the app and it's very affordable (if picked up instead of delivered). I do Starbucks (SBUX) digital orders when walking to my office and it was actually me thinking about that habit I'd developed that made me take another look at Domino's. And I was very, very impressed with what I saw.
At the right price, I would definitely consider Domino's. I think it does have "market power" in some ways. But, this gets complicated, because the way I like to define market power is a little different from the textbook definition. Basically, I consider something like an ad agency, bank, maybe a cloud computing business, a distributor from which a business customer buys the bulk of its needs in a category, etc. to have market power when it's likely to retain customers and/or suppliers even if its offering starts to slip compared to a revival in terms of price or quality or something like that. As an example, if Grainger wants a supplier to provide it with a 2% lower price this year so it can pass a 2% price decrease on to its customers – Grainger would have market power (in this instance: over suppliers, not customers). The “suppliers” part of my definition often gets overlooked. On balance, a successful business needs to have more bargaining power over its customers than its suppliers have over it.
Once again, here’s my definition of market power:
"Market power is the ability to make demands on customers and suppliers free from the fear that those customers and suppliers can credibly threaten to end their relationship with you."
That's different than the usual definition of market power, and perhaps I should call it bargaining power. Of course, the greatest bargaining power of all is in situations where a customer or supplier doesn't make much of a conscious effort to bargain with you. This fact gets overlooked a lot when I talk with investors. With my Grainger example, investors immediately get the “bargaining power” idea. If one company buys twice as much from a manufacturer than its nearest rival does, the manufacturer may give them a lower price per unit than the second place player. That’s what we might call “hard” bargaining power. However, it’s very common for a company to have “soft” bargaining power in the sense that a customer simply defaults to using this source for a product/service etc. For example, when researching Breeze-Eastern (now part of Transdigm), Quan and I spoke with some customers who didn’t actually know Goodrich (now part of United Technologies) manufactured a part that could be made to work in place of the Breeze part they had been using. This is an “if a tree falls in the forest” question. If a customer doesn’t really know – or doesn’t really care – that there’s an alternative, does that alternative really exist?
If I have a Domino’s app with my payment information in it, my address, the store I get carryout from, my favorite order etc. already on my phone – does the latest coupon offer from Pizza Hut or Papa John’s matter? It still matters some. But, a pizza company that manages to get an app on your phone has a lot more “soft” bargaining power over you than they would in the same situation 10 years ago, where you were ordering by placing a call each time. I really do consider the “soft” bargaining power of an app on your phone and the “hard” bargaining power of a business-to-business purchasing advantage based on scale to both be sources of market power.
That’s a long tangent to go off on.
But, it’s important, because when I talk to investors they tend to focus on economies of scale in business purchasing decisions and to completely overlook habit, availability, etc. in consumer purchasing decisions. However, the evidence in terms of the predictable, persistent profitability from various industries suggests that either source of market power works. There’s a tendency to assume “rational” sources of market power are more durable than “irrational” sources of market power.
So, I think having a Domino's app, a favorite order, a nearby Domino's location for carryout, etc. really ups the availability of Domino's versus other pizzas and makes this into more of a habitual sort of business. What impressed me with Domino's was the way it has an advantaged system versus others. So, for example, Domino's has the best pipeline of franchisees compared to other pizza companies. It has far more people who came up through being a Domino's driver and then eventually operate a franchise. You also see things like how Papa John's (PZZA) has to offer incentives to new franchisees that Domino's doesn't. This reminds me of what I saw when I did a little digging into the terms that MoneyGram (MGI) gets versus the terms Western Union (WU) gets from agents. To grow its number of agents, MoneyGram has often had to offer both higher signing bonuses and higher commissions than Western Union. That's especially interesting, because the way a payment system like that works is that the economics for agents are basically flat and then the economics for the payment processor goes up with the number of agents (this is why payment systems are deflationary – the number of agent locations being processed through the same system causes cost per transaction declines for the payment processor). So, I was impressed with how Domino's has that kind of system. The economics for a franchisee are good enough (I was pretty focused on answering that question) and there are enough potential franchisees who know the Domino's system and then really the benefits of the system tend to go very much to the public company instead of the franchisees.
I will just say that the multiple I put on the cash flow from the U.S. franchised business of Domino's was very, very high. I'm sure that my appraisal of that business unit included the highest multiples I have ever awarded a business unit versus this year's EBITDA, EBIT, etc. Other parts of the business: international, owned stores, supply chain, etc. got lower multiples from me for the appraisal. But, you can see that I really do think Domino's U.S. franchised business is an incredible system.
And a lot of that was because I researched Papa John's before I researched Domino's. So, I could see Domino’s had the same system with better results.
And also, I just think digital is very, very good for something like Domino's. If you look at how they've remodeled their locations and how they use that app - everyone is looking at start-up food delivery companies and stuff thinking that something will come out of Silicon Valley to take advantage of digital orders for food. But, really, I think the company that captures the profits from something like that is Domino's.
Since I haven't written about Domino's and yet I consider it to be very, very high on my list of favorite businesses out there - I felt I had to go on a tangent and discuss it with you there.
But, I realize your question wasn't really about Domino's. You were asking a more theoretical question about "market power" versus just "business quality" in the sense of historically having a higher return on capital.
So, now the question of whether I would feel more comfortable with investing forever in Domino's or in U.S. Lime. Obviously, Domino's has the brighter future. Whatever market power Domino's has comes from having a bigger, better system than competitors. This is more of a "survival of the fattest" business. Growth investors should favor that kind of business. U.S. Lime is limited because its advantage is physical location based (not corporate system based).
I tend to be biased toward companies with very clear market power and away from companies with competition in their industry. I think that's potentially an error I make. I mean, if you look at the investments I did and didn't make - you could say the biggest mistakes I tend to make are: 1) Selling the stocks I like the most too soon and 2) Not buying into stocks with a big upside but some chance of a downside.
My approach is not the Mohnish Pabrai approach. He’s more of a heads I make 5 times my money, tails I lose all my money investor. And my approach is likely to have worse returns than his I think. There's something to be said for just betting that a Magic Formula type stock will do well even though you know competition is a big risk.
I really overweight market power compared to how other investors operate. You can see this with NACCO (NC). The Hamilton Beach Brands (HBB) business is obviously durable. Yet, the coal business (the new NACCO) obviously has more market power in the sense that Hamilton Beach is going to have an awfully hard time raising prices on its customers (Amazon, Wal-Mart, etc.) in line with inflation. Whereas I know that as long as the clients NACCO has continue to operate they will continue to use coal provided by NACCO and they'll do it at like a cost-plus type rate. So, NACCO has market power (and it had a low stock price on the day of the spin-off). But, it doesn't have durability. Meanwhile, HBB has durability but I don't think it has a lot of market power.
I went with the cheap stock with high market power and low durability. A lot of other investors would go with the somewhat more expensive stock with lower market power but higher durability.
You can see there I was more willing to take on the risk of obsolescence (coal power declining as a percent of U.S. electricity production) rather than taking on the risk of having to negotiate with Amazon. That gives you an idea of just how skewed my thinking is towards a focus on market power. I’m more willing to invest in a buggy whip business as long as I know the firm will get a good price for each buggy whip it sells than I am to buy into a business where I know the product will always be demanded but have no clue what price the maker will be able to charge for it.
I try to look for fairly simple situations. The way I summed it up recently was that I'm usually interested in one of two situations:
A. A stock that initially seems to be cheaper than 95% of the stocks out there
B. A business that initially seems to have more market power than 95% of the stocks out there
So, basically my idea is to read 20 annual reports and put 19 of them to one side because they aren't extraordinarily cheap or extraordinarily "wide moat" as Buffett would say.
My logic is that it's not that hard to know what price an "average" public company often fetches. So, if I feel sure that what I'm buying is much cheaper than an average business or has much more market power, I'm fine. Where I get into trouble is when a stock I buy is only a bit cheaper or only has a bit more market power than the average business out there. I’m not a skilled enough analyst to know whether a company should trade at 13 or 19 times earnings or whether one teen retailer has a bit better competitive position than another teen retailer. I know an ad agency is a good business. I know a net-net is cheap. So, I stick to obvious extremes of either business quality or valuation.
The issue with market power - or "moats" - is that they tend to be limited and easily outgrown. That's why I mentioned Domino's as having an unusual amount of upside. It still works well at scale.
Booking Holdings (formerly Priceline) is potentially a much better business than say Omnicom (OMC). Advertising as a percent of GDP isn’t going to go up over time. And then traditional advertising – done through something like Omnicom rather than certain forms of online advertising that don’t go through the kind of businesses Omnicom owns – isn’t going to grow as a percent of total advertising. So, Omnicom’s got market power. But, it can’t grow very fast. Booking Holdings can. Hotel spending can grow nicely worldwide. And then you could probably still double the share of hotel rooms sold through something like Booking.com rather than more traditional ways. The business isn’t all online yet – but one day, it should be 100% online.
So, if I could be sure of Booking’s market power 5, 10, or 15 years out with the same degree of certainty as I am of Omnicom’s – I’d be better off investing in Booking. That’s true even with Booking’s much higher stock price than Omnicom. It’s not a value stock. But, it’ll still outperform – even if bought at today’s price – if market power holds up. Booking is an idea that can work at tremendous scale. The source of Booking’s market power scales well.
The source of U.S. Lime’s market power doesn’t scale at all. It’s location based. I wrote about Watlington Waterworks (a tiny stock traded on the Bermuda Stock Exchange). It's done fine over the seven years since I wrote about it (stock price up 9% a year plus the dividend yield and yet it still trades a bit below book value). But, it can't expand at all. The economics of a water company somewhere other than Bermuda aren't good. If Watlington was sold to a 100% owner who harvested the business for its dividends and re-invested those dividends elsewhere – it could make that guy pretty rich. For public shareholders, it’s a bit trickier. A company like that tends to either pile up cash or it starts to outgrow its market power. It begins expanding into other stuff that doesn’t have the special advantages the original business did. For shareholders, this means that the market power of the “business” – defined as the original business unit – holds up perfectly forever, but the return on capital of the corporation declines over time. Simply put: the company expands beyond its moat.
I run into this problem constantly. I can find companies with market power and I can even find companies with market power at decent prices. But I can't find companies with market power at decent prices that have good growth prospects.
So, then, it becomes all about capital allocation. In large part, I like Omnicom because I think it'll mostly buy back stock and pay a dividend. I like BWX Technologies because I think it will stick to nuclear technologies unrelated to new-build for civilian power. I like NACCO, because I think it won't buy an underground, consolidated coal mine. If I'm wrong about those things, my investment results could really start to deteriorate, because I'm buying something I know has market power but then the company is taking the free cash flow and allocating all of it to something without market power. And that's how you end up with "reversion to the mean" and all that.
Remember: all the data we have on profitability and stock returns is at the corporate level. Academics often treat this as if we know that the profitability of businesses are “reverting to the mean”. We don’t know that. These corporations aren’t paying out 100% of earnings in dividends. The original business they were in might be holding up quite well in terms of return on capital – but the corporation’s return on capital will decline if it tries to grow faster than the business unit with high market power.
When Buffett buys a company outright for Berkshire, he doesn't have to worry anywhere near as much about growth. If he's really, really right about both market power and price - he's fine. That's because he allocates the capital. So, Berkshire could easily buy Watlington Waterworks, or U.S. Lime, or Omnicom and it would work out great for Berkshire because he will just re-allocate the free cash flow they can't use inside the business.
Where I really run into problems is with companies like Cars.com (CARS) and Booking Holdings and things like that. I know they have some advantages (Booking especially). But, the intensity of competition is high. Rivals spend a lot on ads, they can - right now - get private equity, public investors, etc. to fund them even if they are losing money at first. It's seen as a very fast growth, winner takes all sort of mad scramble. And, that's tough for me to evaluate. But, those are the stocks that often work out well.
Would it make sense to swing for the fences on business with market power that can scale up rather than niches like U.S. Lime where I feel more sure the market power will not be diminished over 5, 10, or 15 years?
I feel more comfortable betting on stocks where I’m more sure of future market power. But, I suspect that having a few really big winners – that is, growing companies with market power – would outperform my own approach.
With lime, it seems especially easy to consider researching a company in the industry because you figure in 5 years, 10 years, 15 years there will be fewer sites producing lime. Generally, if that's true in an industry, your results are going to be pretty good as an investor. I don’t know that there are going to be fewer websites competing with Booking.com in 5, 10, or 15 years.
If you're a long-term holder, I've found "market power" to be an incredibly helpful tool. It's difficult to quantify. But, it is the most constant feature of the business. The industry structure, the relative position of the company in the industry, etc. is all stuff that gets decided fairly early on in a business’s history and then tends to stay the same much more than things like growth rates, P/E ratios, etc.
Market power tends to be the most useful thing about a business to understand because it tends to be the most constant thing about a business. Big shifts in market power tend to happen more decade by decade than quarter by quarter.
And then the other advantage is you can just buy a stock with market power whenever you think it gets cheap, hold it till it is expensive looking again, sell it and then you keep buying the same companies more than once. Researching a company with market power tends to have the potential for longer-lasting insights that will help you as an investor. Like, I read about U.S. Lime a long time ago. I owned Omnicom 9 years ago. Companies with market power tend to make good “files” for your archives.
For research purposes, I find stocks with market power have the highest pay-off relative to the time you put in studying them.
However, very cheap stocks are also useful things to research. I’m talking net-nets. I’m talking Nintendo when its market cap got down to about the same level as its net cash. Very cheap stocks are a good use of your research time. Spin-offs are a good use of your research time. A retailer at 13 times earnings is often a bad use of your research time, because it’s unlikely to have absurdly high market power (due to the industry it’s in) and it’s unlikely to be absurdly cheap (13 times earnings is a pretty ho-hum price that most stocks hit at some point in their history as a public company). If you have limited research time, I’d spend it on stocks that seem like they might have extraordinary market power and stocks that seem extraordinarily cheap.
Often, a really cheap stock gives some very obvious quantitative sign of its cheapness right off the bat. Like, right now, Vertu Motors (a U.K. stock) looks cheap to me. The P/E says 6. The price-to-book is less than 1, the price-to-tangible-book is awfully close to 1. Even if you don’t know what car dealerships normally trade at – you know that looks like a cheap stock.
FirstGroup (another U.K. stock) doesn’t have a P/E or P/B that would knock your socks off (P/E is 7 or 9 depending on whether you’re “adjusting” EPS or not, book value’s negative) but it has an EV/EBITDA that would grab your attention (it’s 3). I can’t sit here and tell you to focus only on stocks that seem likely to have strong market power when you have car dealerships trading around book value and bus companies trading around 3 times EBITDA. You probably want to put stocks that cheap in your research pile too.
The tricky thing is learning enough about a company to know it might have market power. When I read what most investors have to say about a company - it could be Domino's, it could be U.S. Lime, etc. - they have too quick, too knee-jerk a reaction to the business. So, they say "lime's a commodity" I don't buy commodity stocks. Or, you know Domino's is just some restaurant stock with a ton of competition. But, using Domino's as an example, profit persistence in restaurants is actually really high. People will convince themselves that patents are a moat for some tech company, but they often don't have as consistently good returns on capital as a restaurant. Obviously, restaurants are just the same local, microeconomic "box" replicated thousands of times across the country. So, it's obvious why things like restaurants or supermarkets should have pretty similar economics for a long time. It's the same concept repeated over and over again. If it's a bad concept at the individual location level it'll be a bad company long-term, but if it's a good concept at the individual location level it'll be a good company.
Of course, GuruFocus can show you things about "predictability" as a screen. I think those are fine. But, that's not really how I get ideas. For example, I own BWX Technologies, Frost, and NACCO. GuruFocus rates those either "Not Rated" or 1-star on predictability. So, I am going totally against a statistical measure of a predictable business. Likewise, U.S. Lime is rated 1-star.
So, here I am saying I like predictable businesses – and yet I own only stocks GuruFocus says are not predictable. Obviously, there’s a “market power” analysis going on there. I read about the companies and liked something I read enough to feel I could disagree with an automated assessment of their past record’s predictability.
If we’re just talking about assessing market power by reading the 10-K, something like U.S. Lime would be at the top of my research list.
So, let’s look at the issues you can still face investing in a business that seems – from reading the 10-K – to have market power.
Growth is really low at U.S. Lime and they are piling up cash. So, the longer you own it the more potentially you could have real capital allocation problems. It's better if you can find a business with market power like U.S. Lime and then buy it when there's a change in capital allocation. Buffett does that a lot. Like, he bought into Coca-Cola when it changed its capital allocation policies, he encouraged Washington Post to change its capital allocations policies while he owned it, and then he bought General Dynamics when it changed its capital allocation policies. He does this even with failures like his investment in IBM. He liked that they were reducing share count.
I think companies with market power are great. But, you always have to connect it with the idea of capital allocation.
Remember two things:
1) It doesn't matter what a company is worth when you buy it - it matters what it's worth when you sell it
2) It doesn't matter what the return on capital put into the business before you bought it was - it matters what the return on capital put back into the business while you own it is
So, honestly, if U.S. Lime said "We're going to target a Net Debt/EBITDA level of 2 at all times and we're going to use all free cash flow beyond keeping leverage at that level to just buy back stock" - I'd feel totally differently about the stock. If they put out that statement, U.S. Lime would suddenly vault to the top of my investment candidates list.
There are only two reasons why something like U.S. Lime got as low an interest level as 50% from me in that write-up I did (meaning I see only a 50/50 chance I’ll analyze the stock further). One, the stock is reasonably priced - but it's not especially cheap for an "average" business. I think the business is more predictable, durable, better, etc. than an average business. But, it's always nice to buy an above average business at a below average multiple. That's not the case with USLM. It's a normal price for a hopefully better than normal business. And then two - and this is the huge one - what's capital allocation going to be?
I mean, say they buy another lime site. Okay. That's fine, I like the industry. But, what is the seller going to get? A lot. The seller of a lime deposit gets a lot of the value. So, the return on investment (the acquisition) isn't going to be great. If instead, U.S. Lime said it would use a safe amount of leverage (or just never hold excess cash) and then buy back its shares constantly - I'd be very interested in the stock. My interest level would soar from like 50% to 90%.
In the stock market, you often run into this problem. There are businesses that - if I could buy 100% of them for the then stock price - I could make a lot of money on, but I can't be a control buyer. This issue often becomes more important when looking at stocks with market power. The biggest issue a business with market power faces is usually how to allocate capital. There are times when a business with market power presents problems because it doesn't have great growth prospects and it isn't allocating capital in a way that'll keep the value compounding fast enough.
The advantage that growth stocks have is that there's someplace obvious to put all the cash flow. Basically, you know what capital allocation is at a growth stock - it's funding the growth.
So, there's always some doubt in my mind about whether I am getting the best returns by focusing so much on market power. Rolling the dice a little more in terms of accepting the idea I'm investing in something that is facing a lot of competition might work well over a diversified portfolio.
But, investing in stocks with a lot of market power and with market power you think is getting better not worse is a pretty forgiving way to invest. If you pick the right stock in terms of being right about market power, you can stay in it pretty much indefinitely and get an okay outcome. It can run into financial problems, operational problems, etc. and someone will still want to buy it, turn it around, etc. There will be stuff of real, lasting value there. It's durable. And it's unlikely to earn a below average return on capital for too long. Even the "failures" in stocks like these are often situations where you make 10% a year over a long holding period. You’ll underperform in a bull market doing that. But, if you buy at an acceptable price and you’re right about the durability of market power – you’ll get an acceptable outcome in these kind of investments.
Personally, it's my belief that the greatest risk investors face is competitive risk. It's the risk that the business they invest in will generate lower returns on capital, will have its existence imperiled, etc. simply because of the day-to-day risks of a capitalist system. It's just microeconomic business risk that investors take on in the long-run. This is especially true because you can mostly eliminate price risk by timing (unless you buy a lot of stocks in 1999, 2007, etc. you will dollar cost average into a decent enough stock price) and most macroeconomic risks dissipate over a long enough time horizon. So, the big mistake you can make is being wrong about the future competitive position of the business you invest in.
One way to avoid that is to diversify. If you own 15 stocks instead of 5 stocks, you reduce business risk. The other way to avoid this risk is by being selective in what companies you pick, what industries you invest in, etc. Basically, you can only focus on businesses with "market power".
How well will that work?
I think it can work really well over a really long time horizon for an individual investor who isn't trying to make a career out of this. If your goal in life is to be 100% invested in stocks that return 10% or better while you own them - I think focusing on just researching stocks with market power and then trying to buy them when they get to a reasonable price is a good strategy.
Do I think it'll work in a bull market? I don't know that you'll beat the S&P 500 in bull markets focusing exclusively on stocks with market power. You just won't end up with a lot of high growth stocks this way and high growth stocks tend to get popular at some stage in a bull market.
And then: for professional money managers - is a market power first approach best?
I have my doubts about that. Extremely cheap, somewhat troubled businesses might be a better bet. You'll have more complete losses, but you have more upside than you would sticking to high market power stocks. There are always some micro cap stocks, special situations, and distressed or “deep value” situations out there that are probably going to offer better returns. Professionals might be better off fishing in those ponds than the high market power pond.
Obviously, the real money is always made by finding things that are really one way and yet the market thinks it's another. So, it's about finding a stock with market power that most investors believe doesn't have market power.
There's no money to be made betting on Coke's moat today. You want to find things that are small, obscure, in weird industries, etc. and yet have a moat.
Finally, I've found that holding stocks with market power has the nice advantage that things in your portfolio get acquired. They get taken private. Everyone is always focused on when the market will recognize some company they believe in. But, if you buy something with market power it'll get taken private if it stays too cheap for too long. As an example, I owned IMS Health and it went private, combined with other companies, etc. and is now a public, very expensive stock again. I've found that businesses with real market power attract a lot of interest from competitors, control buyers, etc. who are willing to look beyond the stock as a piece of paper and commit to holding it for several years.
There are other approaches to investing that work too long-term. Like, if you invest in a great "jockey" in an industry you know is really good - even if the company isn't that impressive, that can work too. So far: I haven’t been smart enough to pull that one off.
Picking the right industry is important though.
Honestly, I'd say it's maybe 50/50 at most between the company's position in the industry and just the industry. Value investors tend to think in terms of "competitive advantage". So, they are looking for an advantaged company instead of an advantaged industry. It might be smarter to first look for an advantaged industry. I don't really like the term “competitive advantage”. I mean, I'm sure if you pick the exact right competitively advantaged steel maker and track its stock price along with the exact wrong ad agency, the ad agency will underperform. Airlines have been a bad business. Southwest (LUV) has been a good stock. There's a lot of stories like that.
But, I feel more comfortable fishing in ponds like: ad agencies, MRO distributors, and U.S. banks. I think knowing to focus on those industries instead of semiconductors, insurance, and steelmaking gets you more than half of the way to making a good investment.
So, I guess that's a big part of what I mean when I say "market power". That connects with what you said about the "economic ecosystem". I think probably more than 50% of my task as an investor is just picking the right industries, the right niches, etc. even before I pick a specific company in that niche.
You can reach Geoff by emailing him: email@example.com, following him on Twitter: @GeoffGannon, or listening to his podcast. His stock specific write-ups appear on a subscriber supported website: Focused Compounding.