Tuesday, June 2, 2015

Competitive forces and competitive advantages...

From The Small-Cap Advantage: How Top Endowments and Foundations Turn Small Stocks into Big Returns:
If a company is earning far in excess of its cost of capital, it is likely to attract competition. Competitive forces chip away at economic margins in a capitalist system so that participants generally end up earning their cost of capital. The exceptions to this dynamic are companies with unique competitive positions. The competitively advantaged company can lever its position in the market and earn sustained economic profits.
... 
Most fundamental analysts understand and acknowledge that the goal of competitive analysis is to identify the qualitative characteristics that enable a company to earn sustained profitability in excess of its cost of capital. What many investors fail to realize is that this quest is premised on another assumption: As long as a manager does not overpay for a business, sustained above-average internal business compounding should lead to above-average total stock returns, given a long enough time horizon. This is because increases in stock price necessarily follow the growth in value of the underlying business. In the short term, a company’s stock price may be volatile and appear to reflect the highs and lows of market emotion; over longer time periods, it will tend toward an average appraisal or intrinsic value. This outing of value happens in many ways. It may occur through information dissemination and the aggregate actions of market participants. It may be the result of a tender offer for the company. The company itself may help to out intrinsic value through the repurchase of stock or payment of special dividends. In any case, the manager’s chain of logic should begin with the assumption that stock prices follow internal business compounding. And since managers are looking to experience above-average stock-price performance, they should be pursuing the competitive characteristics that allow for above-average business compounding.