Less than a month ago, I sat down with the CEO of a $1 billion company. The company is well-known, and I can almost guarantee that you've heard of it. Here are some of the highlights of the conversation:
"We have to invest year after year to maintain our competitive advantage."
"There's little that we do that no one else can do."
Are you kidding?
"We continually have to adjust for some kind of 'vaporization' effect with respect to our write-offs."
If I told you the stock, I may well get fired. So don't count on it.
Dime a dozen
You might find the stock, though, if you looked hard enough -- actually, you could probably find dozens more in a similar predicament. The exec's honesty was noble, which is a big plus in my book. But the point here is universal: If the person I interviewed sounds anything even remotely like the CEO of a company in your portfolio, dump that stock. Now.
A lasting competitive advantage is a vital element of a great business. Without it, a company's brief edge in sales or technology will disintegrate like a finely built sandcastle on the beach.
Remember when IBM (NYSE: IBM ) was the only company mass-producing individual computers? It was making money hand over fist -- and yet it couldn't maintain that momentum. Eventually others started taking tastes, then nibbles, then gigantic bites. Only recently did IBM refocus and realign, but most companies aren't so lucky.
A deadly trap
No matter how good a product or a service is, if it can be replicated by others, it's not worth much. In time, competitors will squeeze margins, batter revenue growth, and produce a red ocean of competition. More and more each year will need to be invested, only to receive a smaller piece of the earnings pie in return.
That's precisely why Intuitive Surgical (Nasdaq: ISRG ) has delivered more than 260% gains in two years. No one is even close to replicating the company's technology or its products. Which explains why businesses like General Motors (NYSE: GM ) and Ford (NYSE: F ) have stagnated for years, while industrious and innovative Toyota (NYSE: TM ) has prospered.
Investing legends will tell you the same thing. Among others, Warren Buffett has made billions identifying companies that leverage products or brands whose edge was not in danger. American Express (NYSE: AXP ) and Johnson & Johnson (NYSE: JNJ ) come to mind specifically. Buffett's track record confirms that looking for these types of businesses is a fundamental characteristic of a successful long-term investment.
Back to the horror story
I knew going into the CEO interview that I didn't really like the company's position in the industry. So when I got a sense that he was willing to talk, I pushed harder. I asked him whether the company had any kind of ringer in the pipeline -- perhaps a blockbuster project in one important segment that investors could anticipate. His response?
"There's no killer application."
Man. Sell that sucker.
Foolish bottom line
If you own shares of a company that has no real barriers to hungry competition, and it doesn't have anything in the works for the future, then what do you have? Not that much, really.
Instead, focus on the companies that do. Every single one of the recommendations in Motley Fool Stock Advisor leverages some kind of competitive advantage -- it's a crucial aspect of our selection process. And the strategy has paid off: We're currently beating the market by 44 percentage points since inception in 2002. Want to take a look? Try the service free for 30 days.
Fool analyst Nick Kapur owns no shares of any company mentioned above and has no material interest in the company whose CEO he interviewed -- though he wishes he could tell you the name of it. Intuitive Surgical is a Motley Fool Rule Breakers recommendation. Johnson & Johnson is an Income Investor recommendation. The Fool has a disclosure policy.