Becoming a successful investor in the stock market is a matter of doing your research, finding great companies and investing for long-term.
In previous articles I've discussed the importance of setting financial goals, adopting an investment strategy and identifying great companies. In this article, I'm going to continue the conversation about identifying great companies.
The previous article talked about using the tools of fundamental analysis to identify companies with a history of profits and the prospects for future profits.
One of the most important ways a company continues to be profitable is to build a strong economic advantage over its competitors. This economic advantage is often referred to as an economic moat.
This advantage or moat helps prevent competitors from easily taking market share away from the company. It is important to say up front that because the company has a strong economic moat today does not mean it will have one tomorrow.
Thanks to changes in technology, markets, consumer preferences and a host of other factors economic modes can and do disappear over time. In the previous article I discussed the importance of following a company's financial health.
Great companies protect their economic moat and make it more difficult and more costly for competitors to capture market share and dilute the company's profit. In many cases, great companies will also be large companies with the financial resources to defend their moat.
In some cases, defending the moat may mean building a new one in response to market or consumer demands. For example, Apple Computer, while profitable with a base of avid users, never grabbed more than 10% or so of the personal computer market.
The company introduced the iPod and quickly captured a huge percentage of the mp3 music market. While the company rolled out new models of the iPod it also built a huge online library of music, videos and other electronic entertainment that could be downloaded.
The iPods were followed by the hugely successful iPhone line, which defined the smart phone market.
As new models of the iPhone were rolled out, Apple introduced the iPad, which also captured and defined the tablet market. In a matter of a few years this combination of equipment software and entertainment completely changed the financial fundamentals of Apple.
For those who follow tech stocks, the Apple story is remarkable by any standards. Apple built superior products that were combined with content such as music, apps, video and other sources.
While Apple had a moat of sorts around his personal computer product line, the moat around its "i" products became very wide and very deep. As the moat was being expanded, Apple stock rose dramatically.
I am not suggesting you buy Apple stock. That is a decision you must make for yourself but I use the story to illustrate how a company can build and protect its moat. During this time, Apple was hugely profitable, but there is no guarantee that the company will be able to sustain this level indefinitely.
You may not be able to find many other companies that have been this successful in building and maintaining an economic moat as Apple did. However, there are companies with economic motes that provide them the opportunity to grow consistent earnings.
Don't believe that only tech companies like Apple can build and defend their economic moats. The reality is that tech companies can be the most vulnerable to new technology that can make their economic advantage disappear or be severely weakened.
Often you can find great companies in economic sectors that are not on the front page of financial news everyday. These companies may not be growing as fast as tech companies often do, but they have a history of consistently reporting earnings growth.
In future articles, I will talk about how you can protect yourself when investing in a company that you believe will continue to provide consistent earnings growth.
