Countless books have been written about what it takes to do well in the stock market. Each investor has his or her own investment style, and aspects like personality, targets, and risk tolerance are important particularities to consider when it comes to developing a successful investment strategy. However, at the end of the day, the most important drivers of long-term investment returns can be summed up in three simple ideas
1. Look for competitive advantages
“The key to investing is not assessing how much an industry is going to affect society, or how much it will grow, but rather determining the competitive advantage of any given company and, above all, the durability of that advantage”.
Warren Buffett
Competitive advantages are the tools that a company possesses to keep its competitors at bay and continue delivering value for shareholders in the long-term. There are different sources of competitive advantages: brands, technological superiority, cost advantages, or patents to name a few examples. Investing in companies with strong and sustainable competitive advantages can be the single most important factor for long-term success, at least according to Buffett.
Think about The Walt Disney Company (NYSE:DIS) for example, the company benefits from its tremendously valuable intellectual property which sets it apart from the competition. Disney owns brands like ABC, ESPN, and Pixar among others, and it has the rights to profit from an amazing portfolio of fiction characters, from Mickey Mouse and Tinker Bell to Spiderman and Darth Vader.
These may not be tangible assets, but they are real economic value: The Walt Disney Company (NYSE:DIS) monetizes its intellectual property through different venues like movies, shows, amusement parks, cruises, and merchandising among others. No competitor can replicate these assets, and that´s a big differentiating factor which allows the company to generate above average profitability for its shareholders through the ups and downs of the economic cycle.
When a company has strong competitive advantages, it can generate growing sales and earnings over time, and that means that the shares become more valuable with the passage of time. Investing in companies with sustainable competitive advantages means that time is on the side of the investor, and it can be a crucial aspect when it comes to avoiding the most expensive mistakes.
2. Valuation matters
Valuation can be tricky; there is no objective way to tell when a stock is undervalued or overvalued. But as a general rule, we can use valuation ratios to grasp an idea about how cheap or expensive a stock is at current prices, buying high quality for bargain prices can be a powerful tool for superior returns.
Caterpillar Inc. (NYSE:CAT) is a nice example to consider, the company has a rock solid competitive position in the machinery industry due to its brand presence, nationwide dealer network, and reputation for quality. This means that the firm is in a privileged situation to benefit from the long-term recovery in construction spending, which is showing clear signs of a post crisis turnaround, but still has plenty of upside room on the way towards historical averages.
