With so much uncertainty and turmoil in the markets these days, investors need to choose stocks that combine safety with solid growth prospects. In choosing such low-risk, core holdings, one principle that has served us well over the years has been to focus on “franchises.”
In the investment world, “franchise” is a term most people associate with Warren Buffett. It refers to a company that has a secure and sizable share of its market. Even better is if the company has a secure place in a growing market.
It's easy to identify franchises in sectors like consumer products or fast-food. Just ask any 5th
grade class to name some companies they've heard of, and they will rattle off names such as Wal-Mart (NYSE:WMT
), Procter & Gamble (NYSE:PG
), Johnson & Johnson (NYSE:JNJ
), Coca Cola (NYSE:KO
However, there's one sector where it gets a little harder to spot the true franchises. Yet this sector has proven very rewarding in the past, and will continue to do so...
TECHNOLOGY FRANCHISES FOR A TURBULENT WORLD
No matter which nation leads the world in the future – China, the U.S., or some other – technology will remain an important sector. The question, when looking for safer bets, is whether there are any real franchises in the technology arena. After all, technology constantly evolves, making it hard for any company to hold onto dominant market share for the long term.
On top of that, technology hasn't been around nearly as long as other sectors. Companies like Coca Cola or Johnson & Johnson began over a century ago. Technology, as we normally think of it, incorporates digital electronics, which only got its start in the 1950s when the first silicon transistor was built. So the longest lived technology firms have only been around 60 years. That's not quite long enough to really be called a franchise, and may be one reason Buffett has seldom invested in tech stocks.
That said, we do have a few recommendations in the tech sector that come as close to franchises as you are likely to find. They may not be the fastest growing tech stocks, but they are well established with steady growth, and we believe they will be around for the long haul.
Pick #1: Intel (NASDAQ:INTC)
The first such company that comes to mind is Intel. The company's roots go back to one of the inventors of the transistor, a man named William Shockley. A rather authoritarian, egotistical, and paranoid man, Shockley had a hard time earning loyalty from co-workers and employees. At one point, eight of his researchers at Shockley Semiconductor (known as “The Traitorous Eight”) left his employ to found Fairchild Enterprises. Later on, two of the eight, Robert Noyce and Gordon Moore, created Intel.
Noyce has since passed away, but Moore remains Intel's largest shareholder and his proteges continue to run the company. (Moore is also famous for penning 'Moore's Law.')
In terms of age and lineage, Intel certainly resembles a franchise. Admittedly, the company has had its up and down periods. But today, it has a near monopoly as a manufacturer of microprocessors whose designs remain firmly based on the transistor.
Intel has also ventured into other types of chips. While it’s too soon to say whether these new product lines will succeed, we suspect they will. Even if they don't, microprocessors are an essential component of all computers and many other devices, and Intel's dominant position in them should guarantee the company's longevity.
Naturally, Intel's size and maturity makes it difficult for the company to grow as fast as it once did, but it should continue to grow well for many years. It has an exceptional balance sheet and extraordinarily high free cash flow. As much as any company can be assured a role in future technology, Intel is a number one choice.
Pick #2: Microsoft (NASDAQ:MSFT)
What other tech firms could qualify as franchises? Obviously, Microsoft comes to mind.
Like Intel, Microsoft has a long lineage, one that stretches back to the original operating system for the personal computer, DOS. Along with Apple (NASDAQ:AAPL
), Bill Gates's company was also the first to develop a graphic user interface (GUI) that greatly added to the PC's popularity. Though Gates has more or less retired from Microsoft, one of his colleagues and former Harvard classmates, Steve Ballmer, runs the company today.
Microsoft has been through fewer wars than Intel, and it may be losing some of its franchise. Open source software, including Linux is a real threat. However, the majority of servers and PCs today do run Microsoft operating systems. In the applications area, Excel is unchallenged as a spreadsheet.
It may be a little soon to declare Microsoft a real franchise, but the company has been around since the advent of personal computers. It's grown rapidly into a mature but solid company. In the wake of the recent financial crisis, it's one of the few companies in the world to still hold a AAA rating.
Pick #3: Qualcomm (NASDAQ:QCOM)
Our third top pick is Qualcomm, which has patents centered on the CDMA platform used in the majority of the world's cellphones. The patent portfolio alone is a strong argument for calling this company a franchise. In addition, the head of Qualcomm today is the son of the company's founder.
Qualcomm has been through its share of battles in the past, both legal and technological, yet its product still dominates its market.
Recently, Qualcomm's stock suffered a huge drop in price on news that earnings may be less than expected. However, it is the nature of franchises that even when earnings dip they can still retain market share and bounce back. If you believe that mobile telephony and web browsing will continue to spread throughout the world and that the company's long-term earnings growth remains certain (which we do), then you will see Qualcomm as a strong buy today.
Our fourth pick, Visa, you may see as more of a consumer franchise – and a questionable recommendation given the economic climate. However, the company, while public only since March 2008, is certainly a tech franchise, owning the world’s largest payment network.
The company leverages its worldwide network by collecting fees for its use from credit card issuers, while steering clear of the consumer default risk. Other card companies, like American Express, have their own data networks too, but they also take on some of the default risk.
The brand was created in the 1970s, and has only gained steam with the proliferation of plastic payment. The company’s stake in credit cards is impressive, but debit cards have been a larger part of growth in recent quarters as credit card issuers have cut credit lines and increased fees. The company maintains a 75 percent market share in debit cards. Both its universally recognizable (and trusted) brand name, and extensive data network create a moat around the company’s business, and we see this franchise as a buy.
And now for a runner-up, which is also worth acquiring...
A Close Runner-up: Apple (AAPL)
Despite calling it a runner-up, we also rate Apple as a buy. Apple was the first real PC line and the main inventor of the graphic user interface.
Apple lost the race early on to Microsoft because it ran its company a little differently and it was harder to create applications for Apple computers. But more recently, under the influence of one of its founders, Steve Jobs, Apple has become one of the most remarkable tech stories of the past decade. The company has established its brand on many products and has a strong balance sheet. And the shares are not overpriced.
Is Apple really a franchise? We think it's too soon to say. If Jobs's grandson were running the company, we might concede the point. However, we think Apple is run too much like a small entrepreneurial enterprise with one creative guy at the top who calls all the shots. It remains to be seen whether the baton of leadership can be successfully passed on to someone else without the company faltering.
In the meantime, and assuming Jobs stays healthy, Apple should remain a very dynamic and profitable company.
You may be wondering why we haven't included companies like IBM or Hewlett-Packard in our list of top lower-risk tech picks. Well, those are great brand names, but they are stamped on very different product lines than what they started with. For instance, IBM originally made mainframe computers; today it's mostly a service company. In other words, it has not established a long-term major position in one market.
A FEW WORDS ABOUT CHINA
We noted two main things about last week's conference in Davos, Switzerland. First, there was no discussion of China's conflict with Google (NASDAQ:GOOG
), as apparently the Chinese can not only censor the internet, but they can also prevent the topic from being addressed in an international forum.
The other important item was that China, though it fully expects to meet its growth target this year, is worried about rising commodity prices. The reason they're worried must naturally be that they will be buying a lot of commodities. Considering that China also expects slow growth in the developed world, the implication is that China's commodity consumption must be climbing very rapidly.
So we continue to like China as a place to invest, and we view commodities as a growth arena. However, feel free to balance out your portfolio with the four lower-risk tech companies we mention above. They are a great balance between franchise and dynamism.
Disclosure: Leeb Group, its officers, directors, shareholders, employees and affiliated entities and/or clients of such affiliated entities may currently maintain direct or indirect ownership positions in financial instruments (i.e., stocks, bonds, options, warrants, etc.) of companies or entities whose underlying exposure is in the companies mentioned in this article.