The most incredible returns I have seen in investing have come from businesses with formidable competitive advantages.
These are businesses that customers return to time and time again and which sensibly reinvest to compound their above average returns over time. Just take a look at how CSL Limited (ASX: CSL) could have turned $1,000 into over $200,000 in 22 years.
This, my friends, is the only investing secret you need to know.
Formidable competitive advantages
The ASX has a slew of companies with formidable competitive advantages for us to choose from. Without doubt the majority of them, especially the big blue-chips like Sydney Airport Holdings Pty Ltd (ASX: SYD), Domino’s Pizza Enterprises Ltd. (ASX: DMP) and hearing device manufacturer Cochlear Limited (ASX: COH), come at premium valuations right now.
The market is willing to pay more for each dollar of earnings from these companies because it expects the competitive advantages will mean above average earnings growth down the track. Even if you can’t get your head around the share price, they are worth adding to your watch-list in case things change.
And it can be worth looking outside the obvious names too. SKYCITY Entertainment Group Limited-Ord (ASX: SKC) has a killer competitive advantage by the fact it is the only gaming company in New Zealand with a casino licence.
The company’s not a fast grower and is bound by regulation, but has respectable returns on equity and strong cash flows which it uses to fund an attractive dividend.
Trade Me Group Ltd (ASX: TME) is another mature New Zealand company with a significant competitive advantage. It is the dominant online sales platform for second hand goods, cars and real estate in the country.
By taking a cut of the sales of its users the business has the potential to create high margin, incremental revenue; a great form of ‘synthetic equity’.
Find you a company that can do both
A killer competitive advantage doesn’t guarantee success. A business can still be horribly mismanaged when it should have all the tools to excel.
Uber, for example with its incredible first mover advantage and user adoption, but incessant poor leadership.
The secret is to find a company that can do both.
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Motley Fool contributor Regan Pearson owns shares of Sky City Entertainment Group Ltd. You can follow him on Twitter @Regan_Invests. The Motley Fool Australia owns shares of Sydney Airport Holdings Limited. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.