Stock Analysis: Long-term Prospects – Good Signs
In the previous article, we looked at some of the bad signs that one should look for while evaluating the long-term prospects of a business. Let’s now turn our attention to the positive signs that strength an analyst’s belief in the long-term value of the business.
The company has wide competitive advantage
The first thing that an analyst looks for is if the company has some competitive advantage, also known as moat, over others. The competitive advantage can come in many forms:
- Can’t be swayed by competition: The company just doesn’t get affected by any of the competitor’s moves. In fact, some forces can make it stronger.
- A strong brand identity: For example, Harley Davidson, that almost has a cult figure and fans even get its logo tattooed on their body.
- A monopoly: If the company has a complete or near-monopoly in the market.
- Economies of scale: The company enjoys economies of scale and can supply huge amounts of goods and services that others can’t match (for example, Gillette)
- A unique intangible asset: For example, Coca-Cola has long enjoyed the secret formula for its aerated drinks, even though the formula has no physical value.
- A resistance to substitution: For example, it’s not possible to substitute electricity, so it’s always good for utility companies!
The company is a marathoner not a sprinter
By looking at the income statements of the company over the past few years, you can analyse whether the growth has been smooth and consistent. Many researches have shown that the companies that try to grow much faster end up overheating and burning-out. For example, a growth rate of 6-7% is considered sustainable. However, growing at 15% or so may not be healthy. The point is that businesses are about marathons, and you can’t run a marathon as if it’s a 100-meter sprint.
The company sows and reaps
Even if a company has great products or services, it is important that it spends some amount of money in innovation and developing new markets. The money spent on research and development may not yield immediate growth, however it sets the foundation for a healthy future and makes the company ready for tomorrow’s markets. Depending on the size of the businesses, their R&D budget may vary, however, having some R&D investment as a % of total sales is important. We are looking at moderate spending on R&D. Spending nothing or spending too much are both not desirable.