What Is Value Investing And Why Invest In Value Funds

  1. Brand: A good way for a business to build its competitive advantage is by building a brand. A brand that has consumer recall. It would take years and lot of investment for another company to challenge the authority of a good brand. Take the example of Coca cola. It is one of the most well-known brands in the world. This brand gives it the pricing power. Despite the number of soft drink manufacturers who have been in existence, none have been able to dethrone Coke as a leading soft drink brand.
  2. Economies of scale: A good way to look at economies of scale is to think of a company that can increase its operations without increasing its costs at the same pace. Such companies tend to have a massive size of operations. They have already incurred huge fixed expenses. Additional costs that are more variable in nature are not very high. So as sales increases, these companies are able to expand their operating margins. The economies of scale help the company makes a moat because for any competitor to enter the market, it would need to make a huge investment. Something that is only possible if it has very deep pockets. And even if it is able to make such an investment, it would still take time for it to become a low-cost producer, something that economies of scale can help in. As a result, the dominant company could cut prices to retain its competitive advantage. A fine example would be Walmart. The company has been able to reach the size it is today simply due to the economies of scale.
  3. Switching costs: When you buy a laptop or a computer, more often than not it comes loaded with the Microsoft operating system. Have you even thought about changing the operating system? The answer would most probably be no. Why not? Because there is a cost involved. This is what called a switching cost. High switching costs make it costly for a customer to switch from one product to another, or from one company to another. If a company is able to create this moat, then it ends up having a customer following without the threat of competition. Switching costs create a barrier of entry in a way that it deters competition.
  4. Patents: A great way to build a moat is to simply patent the product. If competition wants to enter the market place, it has to wait till the patent expires. Or, it will have to buy the patent from the company. Typically, pharma companies have been able to build such moats.
  5. Monopoly: Being in a unique or niche business makes for a good way to create a safety moat. Being the only company in the area means that there is literally no competition. But, there is something important to note here. The company should not have monopoly in a business that has demand. Because this advantage is something that is harder to sustain. The higher returns that a monopoly earns can and does end up attracting competition. Therefore, the test for the company is whether it can defend its competitive advantage over long-term.
  1. The results of the company
  2. The treatment of the company’s shareholders
  3. How well it allocates capital
  1. Results: Past performance is highly indicative of how well the management has been able to steer the growth of the company. This is through both good times and bad. Indeed, a good management needs to be proactive and have the ability to respond to changes, competition, opportunities, and threats. Having said that, what must be noted is that, the management track record has to be evaluated in context of the sector dynamics in which companies operate.
  2. Treatment of shareholders: Shareholders obviously stand to benefit if the management has been able to provide healthy returns on capital and dividends consistently. Return on invested capital and dividend yield are some of the important parameters to be looked at while determining whether or not a shareholder is getting the most of what he has put into the company.
  3. Allocation of capital: How effectively the management is able to allocate capital is a very good indicator of its quality. For instance, one needs to evaluate whether this capital is being invested in projects or activities in line with the company’s overall growth strategy. Moreover, are these investments generating good returns? If the capital is not being invested in, the question of whether it is being distributed to the shareholders.

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