There is often a correlation between competitive advantages and share price. A long-term investor wants to invest in companies with a superior edge in their business model.
Companies with strong advantages tend to have higher earnings potential and a greater ability to grow their revenue and market share over time. This often leads to a more attractive risk-return profile for investors, which can drive up the company’s share price.
However, often a company’s strategic advantages can be difficult to identify. In this article, we will share a few ideas and examples of businesses with competitive advantages.
Typical sources of competitive advantages
A company can have many sources of advantages, but it’s important that they lead to tangible benefits such as better customer experience, higher revenue or greater efficiency. The key is to have a combination of advantages that reinforce each other and result in a strong competitive position.
Seven examples of sources of competitive advantage
- Cost: The ability to produce and sell goods or services at a lower cost than competitors. Often the same as economies of scale.
- Differentiation: Offering unique and superior products or services that provide value to customers.
- Network effect: The value of a product/service increases for the user and for a company, as more people use it.
- Intellectual property: Having patents, trademarks, copyrights, or other forms of legal protection for products or processes.
- Learning curve: Over the years, the company has developed know-how that is difficult to quickly copy.
- Brand: Strong brand recognition and reputation among customers.
- Location: A favorable geographical location that provides access to resources, customers, or markets.
Sometimes an excellent management team or company culture can be seen as a source of competitive advantage, but it is much more difficult to evaluate.
How to recognize a company with competitive advantages?
Competitive advantage is often a blurry word on company websites and is often misused among investors. For example, a customer focus or strong brand can be a competitive advantage – or not.
A true edge must have an impact on the bottom line, otherwise it’s just a nice slogan.
Few metrics on how to recognize a quality company with competitive advantages
Financial performance: Higher profitability, revenue growth, and market share compared to their peers.
Market dominance: Often a dominant market position or it’s the fastest growing challenger taking a market position from the dominant player.
Customer loyalty: A loyal customer base (e.g.high retention rate), products or services are critical, or their customer experience is superior.
Pricing power: Ability to charge a premium for their products or services. This can be seen in higher margins and profits.
Strong brand: A well-established brand, with high levels of brand recognition and reputation.
Product differentiation: Unique or superior products or services compared to their competitors.
Example of Costco’s competitive advantages
The Costco business model includes internal and external advantages: Internal ones ensure the company can operate efficiently. External advantages create compelling value propositions for the customers (members). The combination is an accelerating flywheel to generating yearly growing hefty profits.
Cost advantage: Costco is known for its bulk purchasing and efficient supply chain operations, which allow it to offer its products at lower prices compared to its competitors.
Economies of scale: As one of the largest retailers in the world, Costco benefits from economies of scale in its purchasing and distribution operations.
Brand reputation: Costco has a strong brand reputation for offering high-quality products and a positive shopping experience.
Membership model: Costco’s membership model, which requires customers to pay an annual fee, creates a loyal customer base and provides a recurring source of revenue. Costco’s members’ retention rate is over 90% and growing steadily.
Costco’s strong competitive advantages have also been reflected in the stock price, which has risen over 1600 percent in the past 20 years (1.1.2003-2023) due to growing earnings. In the same period, the S&P 500 index generated about 370% in US dollars.
Competitive advantages create security for an investor
Often a long-term investor values security over overly risky strategies. It doesn’t make too big a difference if a riskier investment strategy could provide a better return of a few percent over a year.
The biggest risk for an any investor is to lose the initial capital.
Companies with competitive advantages are often better positioned to weather economic downturns and industry disruptions, which can help to reduce volatility in their share price and provide stability for investors.
Sifter Fund’s customer promise
Sifter is an equity fund that invests in carefully selected and high-quality companies with strong competitive advantages.
Over its 20-year history, the Sifter fund has provided its investors with an average annual return of 9.0%.
Our customer promise is to search, analyze and invest in high-quality companies around the world. During Sifter’s history, the disciplined strategy and investment process has been further refined and managed to bring good investment returns as well.
To deepen your understanding of our investment strategy, be sure to check out our guide on Long-Term Quality Investing for an in-depth look at our approach to quality investing.
Santeri Korpinen
CEO, Sifter Capital
