While there are many ways to measure quality, high-quality businesses share one defining characteristic: a durable competitive advantage which generates persistent excess returns over time. The key to this advantage is durability, without which a business’ excess profits will whittle away by the simple economics of competition. There are many businesses that are able to earn extraordinary profits for a short period of time, but as competitors move in to take a piece of the prize, few are able to maintain their edge. These businesses reward their owners over time through consistent growth without the risks inherent to weaker business models. While each instance of a durable competitive advantage is different, there are some common themes.
Strong Brands
A brand is a promise. To the customer, a brand represents a promise to consistently deliver a quality product, experience, or level of service. Further, a brand can promise a certain image which the customer finds desirable on a personal level. Examples include Coca-Cola, Starbucks, and Apple, which have durable competitive advantages attributable to their iconic brands.
Low-Cost Provider
Cost matters. In the ruthlessly competitive markets that most businesses find themselves, the ability to operate at the lowest cost is an extremely valuable competitive advantage. This advantage can come from scale, operating efficiency, or superior sourcing ability. Examples include Texas Instruments, which has low-cost manufacturing; Costco due to its sourcing and supply chain capabilities; and McDonald’s for its scale.
Regional Monopoly
Being the only game in town has its benefits. Some businesses have durable competitive advantages based on the exclusive ability to operate in a particular region. Consider American Tower Corporation, which operates cell phone towers that the wireless carriers utilize to provide their customers with cell phone coverage and expand their reach. As data usage rises, carriers have greater need for local tower capacity. Yet, it is very difficult to obtain zoning to build new towers. These challenges increase the value of American Tower’s fully developed tower network and increases the carriers’ dependence on them.
It is important to remember that a stock is not just a piece of paper or an ever-changing number displayed on a screen, but a fractional ownership interest in a business. With this in mind, it is easy to see the importance of owning high-quality businesses with durable competitive advantages that can produce excess returns for their owners over time. At Haverford, we have successfully implemented this approach for over four decades as the foundation of our Quality Investing approach.
This material is provided for informational purposes only. The implications and risks of a transaction may be different for each client based upon unique financial circumstances and risk tolerances.
