Questions for Find a Durable Competitive Advantage

• Does the company allocate capital only to businesses within its realm of expertise? 

  • • When the company invests in other businesses, are they within their skill set? 

    • Companies that diversity too much often struggle to operate efficiently.

      • • Vertical Integration - Expanding business into areas that are at different points on the same production path.

        • Horizontal Integration - Acquisition of additional business activities that are at the same level of the current business offerings.

        • Random Integration - It's random. Just do not buy it.

• Do you understand how the company runs?

• Do you Understand How the Product/Service Works?

  • • Take the time to truly understand how the product/service works. Your ability to explain this portion during the presentation is critical. 

      • • Things to consider (unlikely to be the same):`

          • • Current Revenue Generation 

            • Future Revenue Generation

• Debt/Equity Ratio

• If the company is growing, are they generating revenue through operations and financing their own operations?

• Look at the annual Interest Expenses being paid by the company. Does this represent a significant portion of your revenue?

• Look at the Net Earnings over a 3-year period

• Are the earnings rising, staying flat, or the ever dreaded downward turn? 

• Is money generated from operating activities?

• Are they buying back shares?

• What is the dollar amount to by applied to the share repurchase/sales program?

• Is debt being repurchased?

• How many shares have they/will they be able to purchase based upon the current per share value?

• Does the number of shares to be repurchased represent a consequential amount when compared to total outstanding shares?

• Companies making net earnings do two things with the money: retained earnings and dividends.

  • • Dividends are cash payments to share holders as a sort of thank you for investing in the company. 

    • Retained earnings is the cash saved by the company to run it the following fiscal year.

• Per share earnings increases are only valuable in correlation to retained earnings. Are they both gradually increasing at a consitent rate? 

• Return on Equity = Net Earnings / Total Shareholders Equity

  • • Use MSN to find your ROE - Go to Fundamentals, Key Ratios and then Investor Returns to find the ROE

    • http://financials.morningstar.com/ratios

• Return on Assets = Net Earnings / Total Assets

  • • http://financials.morningstar.com/ratios

• Find the industry averages @: http://biz.yahoo.com/ic/, then select your industry.

• Return on Invested Capital = Net Earnings - Dividends / Total Capital

  • • Find the industry averages @: http://biz.yahoo.com/ic/, then select your industry.

    • Use MSN to find your ROC - Go to Fundamentals, Key Ratios and then Investor Returns to find the ROC

This is different from having a large amount of money in plant and equipment. For instance, McDonalds has a lot of money allocated for plant and equipment but this is not a bad thing as they own the property of their franchises. Microsoft too has a lot of money in plant and equipment but this is due to the constant need to update their production of goods. 

• Management, Monopoly, Brand Name, Etc

• Make sure you check the news to see what your company is doing.

Vocabulary

• • Durable Competitive Advantage

Additional Reading

• • Economic Moats: A Successful Company's Best Defense by Chris Gallant on Investopedia

Student Activity

Complete the questions to find a DCA for your selected company.