Coca-Cola is one of a select group of businesses chosen by Warren Buffett for long-term investment. What are the principles for discovering the next generation of inevitables?
Warren Buffett (pictured), the ultimate value investor, described businesses that produced solid returns on invested capital over the long term as ‘the inevitables’. ‘Inevitables’ make products that are indispensable for everyday living and/or are indisputable market leaders.
In 1999, he explained his investment approach to Businessweek, citing Wrigley’s as an example of the type of company he liked: “Our approach is very much profiting from lack of change rather than from change… I don’t think it [Wrigley’s chewing gum] is going to be hurt by the internet. That’s the kind of business I like.”
But nearly 15 years have passed since then. Consumers may still chew gum and drink Coke, but more shopping is online, high-tech products are seen as essentials rather than luxuries and, with the rise of the emerging markets, there are new consumers as well.
What are the new inevitables?
“The question for investors is: what are the staples of tomorrow, ie, something which once invented is very unlikely to be replaced?” says Russell Napier, Global Macro Strategist at CLSA Asia Pacific Markets. He points to technology as a possible source. “The internet is very unlikely to be replaced, but there is a question around who has staked out a place on it that cannot be replaced. Amazon and perhaps eBay are examples in modern life of businesses that have become a staple, like Marks & Spencer.”
Nick Haddock, CEO of Atomic Intelligence, an investment intelligence company, says: “What is inevitable is that the way things are done in the future will be different.” He uses Wrigley’s gum as an example. “Amazon’s Add-On service, where a small item can be added to an order for no extra postage, is an example of how traditional modes of distribution are being disrupted.
“Before, it wouldn’t have made sense to order a small item online, but now consumers will even buy Wrigley’s gum online.”
Haddock believes Google and Amazon, although traditionally seen as higher risk stocks, will remain dominant in their markets. “Amazon has established new infrastructure for the distribution of physical goods, while Google has reinvented how information is accessed.”
Maike Currie, the author of The Search for Income, suggests that investors seek out quality companies that benefit from brand recognition, which will, in turn, lead to greater returns on capital.
“As the wealth of emerging market nations grow, so too does their consumption of goods, whether luxuries or essentials,” says Currie. “A good example is Heinz, of which Berkshire Hathaway acquired a large chunk. The company represents the kind of quality franchises with dominant market positions on which Buffett built his empire.
“Such companies boast strong earnings potential in the form of cash flows, profits, strong margins and returns to shareholders. Other inevitable candidates that play to the emerging market consumer include the likes of Nestlé, SABMiller and Burberry.”
An inevitable or an imposter?
But could some inevitables prove to be imposters in the long term? Philip Morrish, the founder of Intellisys, an equity research company, sounds a warning. Companies such as General Motors and Sears seemed good bets at one time “but turned out to be ‘imposters’ when their competitive positions worsened or the stocks became overvalued. There will undoubtedly be some inevitables in the BRIC countries, as well as many imposters. But one should not confuse size or transient success as an identifier of an inevitable.”
What about technology? One of the iconic brands of the past few years is Apple. “In the rapidly changing environment of technology it is difficult, or nigh-on impossible, to determine the long-term future of a company,” says Currie. “No one can say if, for example, Apple does lose its ‘coolness’ advantage that it will struggle to continue selling products at a premium price, which will impact its sale volumes and, in turn, balance sheets. [You are] better betting on companies such as Microsoft, IBM and Cisco, with proven franchises and promising growth revenues.”
It seems that finding a true ‘inevitable’ is not easy. As Philip Morrish reminds us: “Buffett is often quoted as saying that he could identify only a few inevitables even after a lifetime of looking for them.”
Six rules for investment
Instinct may be telling you to look for Warren Buffet’s ‘inevitables’ as good long-term investments but reason should be equally applied when making investment decisions.
Neil Messenger, Head of Financial Planning at Grant Thornton, has put together six rules for those thinking of investing in the new inevitables.
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