One of the most challenging areas that investors deal with when performing an analysis of a company is not with understanding the individual corporation but the competitive landscape in which it operates. Every company has competition and competition comes in a variety of forms. The importance for identifying competitors, industry trends and customer behaviour is the difference between becoming a reactive investor versus a proactive investor. If you are able to identify a trend before the market takes notice you can stand to better benefit from your investment decisions.
Today I’ll share some more insights into how I conduct a competitive analysis in my own stock analysis process.
From Taking Stock in IGM, Part I:
Whether big or small you want to take the time to see what the competition is doing and how that directly impacts the ability of the company you’re examining to operate and grow.
Frequently in this section of my analysis I’ll find a company or set of companies that are competitors to the stock I’m researching and any significant competitor immediately receives their own situational analysis. This is because any prospective competitor could either be a better investment prospect (after completing all the research) or a potential acquirer of the specific business I’m analyzing.
By creating a new SA on a competing company this helps to give me a broader perspective on the industry both domestically and globally. There have been numerous occasions where I thought one company was a market leader and attractive investment only to find out that a competitor traded at a cheaper valuation or had better long-term fundamentals. My own analysis of PepsiCo (PEP) prior to investing in Coca-Cola (KO) is one example of this situation where PEP’s product diversification actually hurts their profitability because it lowers their margins (both gross and profit).
A Competitive Analysis is an important tool for a number of reasons:
- It assess the strengths and weaknesses of current or potential competitors
- Allows an investor to put offensive and defensive strategies into context to assess opportunities and threats
- Identifies competitive advantages/disadvantages within in industry/sector
- Helps an investor understand the specific competitive advantages/disadvantages within an industry
- Generates an understanding of where the industry has been, where it is presently situated and where the industry is going in the future.
Before you start a competitive analysis you want to make sure you have an adequate set of criteria for comparing companies in your selective categories. If you decided to compare management between two of more companies make sure you set an appropriate number of criteria that evaluates each corporations top leadership based on collective competencies, investors’ return on equity, years of previous/relevant work experience, education, percentage of ownership, accuracy with forecasting results and other important standards.
There’s a lot an investor can learn by focusing on the goals, mission statement and corporate culture of a business. If management is saying one thing and employees are saying another then an investor needs to scrutinize whether management has their fingers on the pulse of the business, are actively involved in the daily operations of the company and have shareholders best interests at heart. Simply stating a commitment to corporate culture or a mission of teamwork doesn’t cut it and actions always speak louder than words.
Assessing for a competitive gap is one of the more difficult or advanced items to a competitive analysis and not every investor will want to take the time to conduct this. Assessing for a competitive gap is looking at a company’s current or future products/services and determining whether demand from their intended target market (or another) will gain momentum after adoption in the product life cycle. Often new products and services don’t gain traction because they don’t adequately fill an underserved segment of consumer or business demand and rarely, in the case of Apple’s iPod product, there is a dramatic adoption by a market that grows into expanding global demand. Identifying these competitive gaps where a product/service exists for a company in the face of laggard competitiors takes a certain amount of skill and will also give you a much broader view of the industry and other prospective companies to invest in. If you choose to concentrate on a competitive gap you want to make sure that a product or service is scalable, distinctly unique, protected or is an experience or product that is easily replicated by its end consumer.
Some tips that I would suggest an investor use would be:
- View each company in the competitive analysis as if you were a customer of the business: describe what you like, what other customers like, explain your experience(s), what you would improve/discard, etc.
- Check the public filings: investigate public filings of the corporation and press releases by their media relations department to find out what they’re up to and currently pursuing.
- Always assess for potential new competition: is there a company that offers a competing product/service cheaper, more effectively, faster or is there a competitive gap that is already served or underserved?
Remember that competition is fierce, unrelenting and sustainable for a company. A competitive advantage is rarely sustainable and a company may need to go to great financial lengths to protect their moat. Gaining a sense of exposure to competition is a vital component to a competitive analysis. An investor will also want to scrutinize:
- Rivals within the industry
- Product substitutes
- Threat of new entrants