Characteristics of an Excellent company
High return on invested capital is the most important metric for the NBS Fund. Let's have a look at the characteristics of companies that can maintain strong returns on invested capital.
Barriers to entry
If a company is able to achieve above-average returns on equity for an extended period of time, word is going to get around. Newcomers will set up shop and start trying to emulate/replicate that successful company. The industry will become crowded, and returns will be diluted.
Typical barriers to entry include:
Geographical advantages: BHP, RIO, FMG own vast amounts of prime quality land, very difficult for a newcomer to establish a business that comes close to rivalling this.
Existing Infrastructure: The original monopolies, the railroads and electric companies. They were monopolies because they owned the infrastructure, and were able to charge customers whatever fees they liked, as there was no alternative. Current examples include Transurban. However we must be careful with this trait, as it's very easy for government intervention to spoil the shareholder party. Examples include Telstra (the NBN), Aurizon (QLD govt regulation).
Network Effect: Does the value of the network/platform increase when another user joins the network? For example, UBER and AirBnB become more valuable as more people join the network; as more customers join UBER, there is more demand for drivers, more drivers equals a better service, thus more customers joining. Some ASX examples include REA, Realestate.com, Afterpay & Seek.
Brand Power: is the company able to charge more for essentially the same product or service? If so, they have a strong brand name. The strongest brand names becomes an Anthimeria (a term used to describe using a word in a new grammatical form). For example, searching something on the internet- Google it. Take a good picture-Gram it.
Switching costs: Does the cost of switching to a competitor outweigh the benefit? The most common example is Banks, people rarely ever change banks as its far too much of a hassle. Others include telecommunication providers, accounting software, mobile phones, laptops.