In his book Common Sense Investing, legendary money manager Peter Lynch advises people to apply common sense in buying stocks, looking at the stocks of companies they like to spend their money, restaurant chains, pharmacies, retailers, etc.
In applying this strategy to my own family, I identified five companies on which we like and spend a great deal of our budget:
1. Costco (COST). My wife loves the variety, quality and price of the store chain. And any time we visit a store, we end up buying more than we planned; that’s certainly good for Costco’s bottom line, as is the annual membership we pay.
2. Panera Bread (PNRA). This is my daughter’s favorite, as she loves the menu, and we all love the environment and the convenient location of Panera restaurants.
3. Chipotle (CMG). This is my son’s favorite restaurant, as he finds the food healthy and affordable.
4. Apple Computer (AAPL). This is my son’s favorite company and mine, as we both love the MacBook, and I love the iPhone.
5. Ralph Lauren (RL). This is the whole family’s store, especially when we visit a mall outlet.
As it turned out, all these five companies have been stellar performers, and we could have done at least as well as investors as we have done as customers. This doesn’t mean, however, that every business people love as consumers is a good investment. I loved Borders, and I spent a great of time and money for coffee and books, but it is history, as it could not compete against Amazon.com (AMZN). I did also like Kmart, spending time there, too, but it is also history, as it couldn’t compete against Wal-Mart (and is now owned by Sears (SHLD). What makes the difference?
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Sustainable competitive advantage and sound management make the difference. All five companies have sustainable competitive advantage and barriers to entry that keep competitors away from their top line, and a sound management that keeps an eye on the bottom line. Costco's sustainable advantage, for instance, is based on economies of scale and economies of scope; Panera’s and Chipotle’s is based on franchising; Apple Computers and Ralph Lauren’s innovation and branding.
Bottom line: What makes these five stocks good investments isn’t just the popularity among consumers, but their ability to raise barriers to protect their top line, and to keep a close eye on the bottom line.
Disclosure: I am long AAPL, PNRA, COST, RL.