Wednesday, 3 June 2015

What is a Good Stock to Own?

When we buy shares in a company, we are buying into a part of the business. If the business do well, the share price will follow because the company becomes more valuable due to its capacity to generate more revenue and earnings.

Question: How do we determine which company will do well in the future?

Answer: The company that has the most sustainable competitive advantage. 

What is competitive advantage? Basically, it refers to the company's ability to prevent competitors from entering the market and eating up its profit. Without much competition, the company is able to protect its excess profits and use them to generate extra returns for its shareholders.

MorningStar catergorised competitive advantage into 5 different sources: Intangible Assets (Brands, Patents), Cost Advantage (Low Cost Producers), Switching Costs (Softwares), Network Effect (Everyone is using it!) and Efficient Scale (Distribution).

Companies that have at least one or more of these sources of competitive advantage are usually a good bet for the long term as they have the ability to create value into the future.

Personally, I use this as my primary screen for stocks. I'll ask myself, is this company going to thrive 10 or 15 years from now? If so, which source(s) of competitive advantage does it display that will allow it to do so?

Please do comment below to let me know where I can improve on! :)

The Journey to Financial Freedom,
SGInvestingSuccess

5 comments:

  1. Hi SG Investing Success,

    Care to share your screening / selection methodology from start to end in a future post? I'm always interested to see the process of how others do it.

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  2. Hi GMGH,

    Thanks for your comment.

    Ill definitely share all readers in future as to how I screen for stocks :)

    However, I always feel that everyone will have a slightly different methodology in stock screening, mostly dependent on their personality.

    Would like to find out more about your screening methodology as well :)

    SGInvestingSuccess

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  3. Agree. It's better to pay a little expensive but more sustainable economic moats rather than vice versa.

    ReplyDelete
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