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Diamond in the Rough – Part I

Explaining a Competitive Advantage:

I often hear investors and other business types referring to the buzzword competitive advantage and how they associate it with a perceived opportunity for investment. It’s important to first realize that although lots of people use the term – they may not understand the complexities, unique situations or context in which these specific assets exist. In actuality, a true “sustainable competitive advantage” is a rarity, extremely valuable to a company and guarded aggressively against all forms of competition. It can largely define the success of the business in all aspects of operations because of the integration the advantage provides.

One of the most common & well-known descriptions of a competitive advantage is by Warren Buffett when he describes companies he likes to invest in with “wide moats”. Buffett routinely uses the description of a castle (the company) being surrounded by an impenetrable moat or barrier that keeps outside threats to the exterior of the company’s vulnerable walls. What you don’t want is your competition easily replicating your success in the market or with customers without having to put considerable financial resources to work. A competitor can go broke trying to compete on price (see my earlier post) in an attempt to gain market share; but a company holding a competitive advantage has the security of operating at a higher profit margin because of that advantage.

With this in mind – it’s first important to put the asset into the proper context. Very rarely does a competitive advantage exist in an intangible format. The quality, characteristics and environment in which one potentially exists should be examined fully in order to place some significance of value on it. That’s the difficulty with assessing a C.A. You first have to recognize, discriminate & evaluate one and then at some point place a certain value on what that C.A. is worth to a company or against an industry. Even more rare are companies unknown to investors which you can buy at a discount before the advantage is recognized by the market. Often a premium is paid once this advantage is recognized because of the competitive edge it gives a business over its competition through which the premium is based upon. Even in the instance where a private corporation holds the advantage – the incentive for a larger competitor to acquire that advantage is usually seductive and most often the sole reason for a merger or takeover. There have been a few times when researching a company in my experience that I’ve found a C.A. only to have another suitor acquire the company at a premium before I ever initiated a position.

As I said above – although many people use the term competitive advantage, very few know how to explain, identify, evaluate or determine when one exists. In actuality they are rare, precious and fiercely protected by their owners. It can mean the difference between life & death of a product line, business services division or profitability for a company.

Part II will go into greater detail of my personal assessment & examination of what a C.A. is in my own analysis of a business – but

What does a competitive advantage mean to you?
Where do you believe one exists today or has in the past?
Why do you think one might be important for an investor to consider when examining a stock?
When do you know you’ve found one when few in the market haven’t realized yet?

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