People often ask me this question and my answer is always the same...
The businesses that I like the most are the ones that are most profitable :)More specifically...
I like businesses with predictable profits in which profits grow linearly (or exponentially) with the growth in business (i.e.: Same or higher ROI/ROE on incremental/expanded business)... "Economies of Scale"
Whereas, I like to avoid businesses that either fetch lower ROI/ROE on incremental/expanded business... "Diseconomies of Scale" or those that require massive amounts of debt/capital investment to scale out/expand... without a clear visibility of profits...
Three kinds of businesses that I like:
Selling products at high margins
(This is achievable and sustainable through one or more of: high brand value/mindshare, (beyond compare / distinguishing) product quality/service/experience, secret formula/patents and sticky products)
- Apple: sells hardware at amazing margins
- Coke: sells soft drinks at amazing margins (Further, having globalized well, it can potentially sell "1 billion" bottles a day while maintaining high margins) (imagine!)
It may have taken Microsoft $7 billion to develop Windows 7.
A copy of windows retails anywhere between $49 and $399.
However do you know how much does an incremental sale of Windows 7 cost microsoft?
Yes, they burn the software on empty DVD's worth after $1 or $2
The profit margins increase with every additional unit sale.
Most product based software companies come in this category.
Some more example would be production houses(movies), writing books and enjoying royalties etc
Off course, such a business may make loses until it recovers the fixed cost (threshold unit sales), beyond which everything is but neat Profit.
Platforms and Services
(Businesses that don't require huge capital for "scaling out")
e.g.: Security brokerage, Services, Consultancy
Developing platforms for buyers and sellers to meet and trade is a wonderful business. (and so is providing platforms for people to develop and host)
The variations range from all Stock Exchanges, Brokerage houses, Ebay to the modern world Windows Azure, Facebook, .Net/Visual Studio and what not...
Just like the government, you get to collect brokerage/share on all transactions, whether or not the individual makes a profit. "More trades/transactions/volumes --> more brokerage and earnings"
Another good thing about these businesses is disposable earning. The profits need not be reinvested to sustain or grow the business and hence can be distributed as dividends or used in other businesses.
Looking at it, even Telecom, Broadband and DTH services come under the category but these specifically require huge sums of Capitals.
(Do NOT confuse this with physical retail which not only requires capital investments but also requires managing huge inventory)
Additionally, I like a special category of businesses that I like to call "Naturally Growing businesses"
These businesses are like my long term investment portfolio. Profits in these businesses in some sense are directly proportional to the book value (while the differentiation also comes through effective management etc) These grow incrementally/consistently year after year in their book value yielding some dividends and reinvesting the remainder of profits. Any equity dilutions at a price above book value is usually favorable for existing shareholders.
Barring few exceptions, most well managed banking and finance companies would come in this category.
No comments:
Post a Comment