As Warren Buffett said, "It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price." Leaving valuations aside, this simply emphasizes the importance of investing in a "wonderful company".
The underlying business will still be the most important thing that an investor should consider, very much above all the other elements that may attract an investor. So what, actually, is a "Wonderful company"? The definition of this phrase differs from one investor to another. But, I would like to share, through this article, my definition of a wonderful company, by writing about four of the most important points that a business must have to qualify for a spot in my portfolio.
My portfolio aims, as stated in my profile, to contain "dividend stocks with established businesses, which are expected to pay reliable, predictable and consistently increasing dividends (and also) high-quality stocks that have strong fundamentals" (Refer to my profile here).
1. Products/Services Must Be Able To Capture Recurring Sales From Customers
First and foremost, I want a company to offer great, high quality products or services, that are well-liked by customers. As Warren Buffett said, "Your premium brand had better been delivering something special, or it's not going to get the business". This stresses again the importance of a high quality product that consumers like. Besides having a high quality product, I would also like the product to be one that customers continually need. This means having to purchase a good or utilize a service consistently again and again, which gives a certain company pricing power and long term sales growth.
For example, Procter & Gamble (PG)'s Gillette brand, which holds 70% of the global shavers market share, is well liked by customers (as shown by its enormous global market share) and are very much essential in the lives of its customers. As more products emerge under Gillette's world-famous brand, consumers will purchase these goods again, again and yet again.
Another example of such a product is Colgate-Palmolive (CL)'s Colgate toothpaste. I do not think I have to elaborate much here. Toothpaste is needed in our everyday life, and we will definitely have to buy more toothpaste after we have finished using a packet of it, ensuring that Colgate gets more and more sales over the years.
One final example of a service that customers need is Kinder Morgan (KMI)(KMP)'s midstream pipeline service. Energy companies need to deliver oil from one place to another constantly, and Kinder Morgan, with the largest networks of pipelines in North America, does just that. Customers, believing in the quality of its service, will definitely come back again.
This is what I mean by having fabulous products that will entice customers to keep buying it again. Thus, I am searching for such companies for my portfolio. But having one or a few fabulous products are not all a company needs to qualify as a great businesses. Something else that ensures customers' long term loyalty is needed.
2. Famous Brand Name
And that, unmistakably, is a brand. Although the value of a brand is intangible and cannot be measured in dollars, it is one of the most valuable assets a company can have. This is what differentiates a product from Coca-Cola (KO), Kraft Foods Group (KRFT), Nestle (NSRGY.PK) or McDonald's (MCD) from just another unknown manufacturer of these very much essential goods and services. In my eyes, brands are as good as a promise to consumers, which differentiates the product from the rest, and promises that the standard of that certain product will be much better than that of another manufacturer. Without this brand that people trust in and are loyal to, there will not be substantial profits and future growth for the company. Do you think Warren Buffett would have bought out Heinz (HNZ) without its world-famous brand name? Definitely not! It would be as good as just another ketchup brand left on the shelf.
Summing up this point, the brand name is what differentiates a company that will continue operating and prospering for many years to come, from just another passing fad, and is what will sustain a company's business over the next decades.
3. Competitive Edge Over Other Companies (A MOat)
Next, I look for the company's placing in the industry. I always like to ensure that a selection is the leader, or at least one of the leaders in the industry. This ensures that a company has a competitive edge over its competitors, no matter whether it has a comparative advantage (able to produce a good cheaper than its peers) or a differential advantage (the higher quality product of the lot, known for its brand).
For example, Digital Realty (DLR) is the undoubted leader in the data storage industry, with a market cap of $8.3B. Its other three competitors, DuPont Fabros (DFT), CoreSite Realty (COR) and CyrusOne (CONE), have market caps of $1.5B, $930M and $430M respectively. In addition, with the level of complexity involving Digital's business making it immensely difficult for companies to operate data centre facilities, the company is in a good position for future growth. The company also has a wide network of 595 tenants (significantly more than other competitors), including CenturyLink (CTL), AT&T and Morgan Stanley (MS). This further secures its long term business prospects and also its dominance over its competitors.
Another example of such a company is Textainer Group Holdings (TGH). Besides having a great container leasing service that is needed by shipping companies, like Digital Realty, it is the undisputed leader in its industry. Being the largest of its kind in the world, the company has a significant economies of scale benefit. This means that Textainer will get the lion's share of the profits, which is proven by the company's outsized profit margin of 42.10%.
Management personnel and their actions can also impact a company substantially, and in my opinion, with however good a company, a bad management would ruin all its future growth potential and its favorable prospects. Therefore, to make management analysis as quick and simple as possible, I simply look for just two quick points when it comes to analyzing a management team.
- Management Integrity
Management integrity is also a very important aspect in my opinion. I would like management to be as honest as possible to shareholders. You would not like a management who will mislead investors and analysts about its future prospects, which subsequently causes its stock price to crash after it misses expectations, would you?
Therefore, I would normally read conference calls to get an idea of how honest management is in informing shareholders about bad results and more pessimistic future projections. Warren Buffett is one great example of a good manager. In many of his annual reports, he has been incredibly candid in his reports to shareholders. It is obvious when you see words like:
I have made plenty of mistakes in acquisitions and will make more
I've run out of good news. Here are some developments that hurt us during 2011
These quotes were found in the 2012 and 2011 Berkshire Hathaway Annual Report respectively.
Besides this, I would also avoid companies which had previously fooled investors by using things such as "creative accounting" or "aggressive accounting" (Remember Enron); had been involved in a scandal which required it to restate past financials or go to court with shareholders (Remember the Diamond Foods (NASDAQ:DMND) scam); was unable to produce financial statements on time [One recent case being World Acceptance (WRLD)]; or was being investigated by the SEC. These are all some signs of management being dishonest, and I would rather avoid companies with such a history, unless there is a change in the company's management team.
Employees can also act as a good metric as to how effective current management is. I like using Glassdoor.com, which gives me an inside look of any company, showing what current or former employees think about the company and its management.
The above snapshot shows the Glassdoor page for Valmont Industries (VMI), a company that I was looking into previously. I like looking at various metrics shown on the page, with its overall rating and what employees think of the CEO bearing the most significance to me. Other metrics I would advocate taking a look at are: What percentage of employees would recommend the job to a friend; and also how optimistic the employee is about the company's future (not shown in picture).
After reviewing the summary, I would then look into employees' comments. For example, in Valmont's case, a number of employees thought that the management were "completely out of touch (with the employees)", and did not understand what employees feel. Therefore, looking into these sites can offer a further inside look at the company's management team.
In conclusion, these are the four key points that I look for when investigating about a certain company. I would require a company to fulfill all of these qualities to qualify for a spot in my portfolio. Here is a recap of my four points:
|#1||Products/Services Must Be Able To Capture Recurring Sales From Customers||Procter & Gamble, Colgate, Kinder Morgan|
|#2||Famous Brand Name||Coca-Cola, Kraft, McDonald's, Nestle|
|#3||Competitive Edge Over Other Companies||Textainer, Digital Realty|
Finally, I would also like to hear your opinions about how you evaluate stocks. These are purely my opinion, thus, I would appreciate it if you could leave your opinion as a comment in the comment box below.
Disclosure: I am long KO, MCD, TGH, DLR, KMR. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.