We are looking for a durable competitive advantage, not just a temporal one. This is because we want a business that can continue to employ such an advantage over and over again for many years.
Did you get the 5 questions?”
Sean was furiously noting down the 5 questions, the reasons and explanations. He had trained himself well since Business School days to be able to copy notes. When he completed, he looked at the messy handwriting on the notes and made sure he could understand what he was writing. After all that scribbling, that page on the journal looked like graffiti instead of business notes. But he was satisfied as he read through once and found himself being
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able to interpret the mess. He looked up and saw that the old man was waiting for him to continue. The old man took that as an indicator to move on.
“Now sonny, let’s try these 5 questions with the list you have and we will mark out those businesses which we suspect, have durable competitive advantage. For those which you are not sure, I would suggest you either leave them aside, or probe further by finding out more about them.
Sean looked at the first business on the list; it was ‘Digital Printing’, a photo development shop with printing services. He began running it through the 5 questions:
1. What is the value (products/ services) this business is providing?
Ans: Developing Photos and printing services.
2. Is this value provided by anyone else?
Ans: Yes. In fact, there were other similar shops around.
3. Will I choose to get this value from elsewhere instead of this business?
Ans: It does not matter.
At this juncture, Sean looked up and asked the old man. “If it does not matter where I choose to get this value from, does it mean in that entire industry, there isn’t a business with competitive advantage?”
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“Very good thinking, sonny. This may mean a few things. If it doesn't matter to you where you get this value from, it is either you do not understand the business enough or it may mean that it is in a Price Competitive Industry. Either way, you should avoid this business. Just to share a little more about Price Competitive businesses. There are some industries where it is difficult for businesses to build up a competitive advantage. In these businesses, ‘Price’ may be the only factor customers look at when making their buying decision. We want to avoid these industries. But sometimes, there are businesses that can consistently offer a lower price to their customers because they have some durable competitive advantage. These businesses surface well when you go through the 5 questions. The key point is to use these 5 questions to find out businesses you strongly suspect the existence of a durable competitive advantage.”
“I see. I should only invest in businesses which I strongly believe that there is a durable competitive advantage. I will continue with the rest on the list and see how it goes. ” Sean replied and continued this mini exercise. The next business was KFC or Kentucky Fried Chicken.
1. What is the value (products/ services) this business is providing?
86 2. Is this value provided by anyone else?
Ans: Of course. There is plenty of fast food restaurants around and there are many shops selling fried chicken.
3. Will I choose to get this value from elsewhere instead of this business?
Ans: Hmm. That depends. There are times when I really do crave for the Finger Licking Good chicken. So if it is fast food, I can get from other places, but if it is fried chicken, I will want a KFC.
4. Why would we rather get this value from this business instead from anywhere else?
Ans: Because it has a secret recipe that made the chicken taste great. It has a unique aroma.
5. Is the reason(s) we identified in question 4, sustainable in the long run.
Ans: Since it is a secret recipe and KFC is an established brand, it should be sustainable.
Sean looked up at the old man. He still wasn't sure if KFC had a durable competitive advantage. The old man looked back and asked, “Will you want to own a business like KFC? Do you suspect that it has a durable competitive advantage in business?”
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“Well, it seems so. But I am not sure.” Sean replied.
“That's good. What we want at this stage is to find business we suspect may have a durable competitive advantage. We will confirm it later by looking at its track records. But why I want you to do this even before we look at the numbers is to make sure you only invest in businesses you can understand. This will help a lot especially in changing times like this. Some people dive in to look at numbers and become so absorbed in the statistics. They ended up buying businesses which they cannot explain what the natures of those businesses are or if the businesses have any durable competitive advantage. You want to be able to explain to yourself why you want to buy this business. And you want to be able to understand the business so that you know if it is still relevant in the long run. In this case, if you suspect KFC to have a durable competitive advantage, we will shortlist it and find out for ourselves using the numbers.” The old man explained.
“Oh, I see your point. I do suspect that KFC has a durable competitive advantage since it has a secret chicken recipe, or rather; they have their customers thinking that their chicken is special. Looking at it this way, I would consider buying KFC as a business since I think it should be able to make money in both the short and long run.” Sean remarked.
Sean was beginning to connect the dots: the idea of looking at stocks as businesses and the way to sift out winners from the rest. For the first time in his life, he began to look at 'shopping' in a different light. He is becoming a Value Investor, shopping for stocks in Main Street instead of Wall Street.
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