Like me, you've probably seen plenty of 'Most valuable brand' surveys or reports.
Like me, you've probably figured that it's more about marketing the research firm than actually producing something of substance.
And, like me, you've probably had curiosity get the better of you, and read the report, anyway.
Partly, I think it's about having our own views validated. Partly it's the voyeurism of which brands and companies are rising and falling, and which remain in the global branding pantheon.
And partly, it's the investor in us, trying to answer the age-old question: "Just how important are brands, anyway?"
Many of us learned at the knee of the greats. Certainly, looking at the portfolios of Warren Buffett and Peter Lynch, among others, would have given you a sense that brands matter. And Buffett and Munger have gone a long way further, regularly citing Coca-Cola's brand strength as something they think sets the company apart. Indeed, while not a one-trick, brand-only pony, Buffett once said of the soft drink maker:
"If you gave me $100 billion and said take away the market leadership of Coca-Cola in the world, I'd give it back to you and say it can't be done"
He owns very large chunks of Apple, American Express and US bank Wells Fargo, too. Again, not just because of their brands, but of the few things these businesses have in common, brand is at the forefront. And the archetypal Buffett business, See's Candies, is more brand than anything else.
Indeed, try imagining those businesses being anywhere near as profitable, sans their hugely impactful brands. Imagine Grapefruit Computer, Credit Cards R Us, No Name Banking Corporation and Everyday Candies, instead.
Again, brand isn't everything for Buffett's companies, but take away their trust marks and they aren't worth a pinch of salt, relative to their current profit levels and market value.
In short, brands matter, and few other than ideologues would debate the point. Don't believe me? How much do you reckon an acquirer would pay, just for Coca-Cola's bottling operations, truck fleet, and staff, but none of the company's iconic brands? 10% of the current market cap? 25%, maybe?
So, I'm going to proceed on the basis that we all agree brands matter.
The far more interesting question, then, is just how much they matter.
And this is a tough nut to crack for investors.
Here's why: arguably, the value of the brand, say for Coca-Cola, is already represented in the current level of profitability. Coke makes more money than Pepsi (the brand) and more than Fool Cola, specifically because it can charge a premium price.
Under that line of reasoning, if all else was equal, you shouldn't pay a higher price (represented by the company's price/earnings ratio, for simplicity) for Coca-Cola than you would for Pepsi… otherwise, you're essentially paying twice for the same benefit: once based on the company's current profit and again for the brand premium that delivered that very profit.
Let's put that another way: you're not going to pay a higher P/E because a company has staff. Or buildings. Or machinery. They're the things that are already part of the profit you're buying. So why are you paying more for the brand?
Okay, that's not an entirely rhetorical question. There can be very good reasons to pay up — that is, paying a higher P/E — for a brand, but they have everything to do with the future. Or, they should, at least.
To pay more for a branded company, you have to believe that the brand (all else being equal) will contribute more in future, too. Maybe it makes a company more resilient in an economic downturn. Or makes customers more loyal. Or, of course, perhaps it'll contribute to future profit growth that exceeds that of its competitors and/or the general market.
These are very sound reasons to pay a relatively higher P/E.
But those assumptions have to be very carefully tested. It's too easy to say 'yeah, all of that', then blindly pay up for a company, just because it has a brand.
Frankly, I've made that mistake myself, and in a recommendation for Motley Fool Share Advisor. I have recommended — and own — shares of Coca-Cola Amatil Ltd (ASX: CCL). At the time, my assumption was that the brand gave the company a heap of competitive advantages. That was a good assumption.
What I got wrong was the degree to which those advantages would deliver profit growth that justified the then-prevailing price.
Alas, no dice.
I have absolutely no doubt that the company's brands make it more profitable than it would be without them. And that those brands support a distribution network that is better than any other in the market, in almost any category.
But up against a mature market — seriously, how many retailers don't sell Coke, and which Australian adult has never at least tried the product –, there just wasn't enough new opportunity left in Australia. And overseas markets, though growing, were never going to be significant enough, quickly enough, to make up the difference between reality and market expectations.
The result, as you can imagine, is red ink for members and my own portfolio.
Take away the brand, and Coca-Cola Amatil makes a truckload less money. And it's likely a much, much more resilient company with 'Brand Coke' than without it. But paying too much, in a growth-constrained market, was an outright mistake.
At significantly lower prices, it's currently still a Buy — the value proposition has shifted meaningfully thanks to a lower share price. That might still be a mistake — the shares aren't exactly cheap, and CCA isn't particularly impressing with its growth. We continue to keep a watching brief.
My recommendation (and purchase) of Coca-Cola Amatil is an example of a good concept executed badly.
For the record, I remain a huge fan of brands. Including Coke's. I'm just more mindful now of how much I pay for an investment 'brand premium', and how best to think about it in the context of market opportunity and — frankly — price.
I'd still much, much rather own a company with a known, recognised and in-demand brand than one without. Coke's challenges are also challenges for every no-name cola in the market, but the latter group has much less pricing power and likely lower margins as a result.
Well-known brands with pricing power make a company more profitable. If that's going to lead to superior growth, great. You're on a winner. But if it just explains the current level of profit, and the outlook is questionable, be careful of how much you pay.
A great business isn't always a great investment, and brands play a different role in each of those concepts, but in a different way and to a different extent.
I'm keen on the brand value of Kogan.com Ltd (ASX: KGN) (despite a struggling share price) and the brand promise (and repeat business) of Webjet Limited (ASX: WEB), as just two examples. And Wesfarmers Ltd's (ASX: WES) Bunnings is probably one of the strongest, yet least appreciated, brands in the country.
Now, if you'll excuse me, I'm going to do my bit for CCA (and our members) and crack a Coke No Sugar. There's no way I'm switching brands!
Fool on!
Scott Phillips
Chief Investment Officer
Motley Fool Australia
