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Most columnists will tell you to buy and hold "great" companies for the long term. Today I'm going to give you one crucial reason you should not blindly follow this advice.
Yes, really. I am a long-term investor, but I believe the great company concept has been oversimplified throughout the years, and I want to end that misguidance now.
What's a great company?
The word great is highly subjective, which means it can mean completely different things to different people. That's the first and most major flaw in the concept. What's great for me can be awful for you. This can be based on various tolerances for risk or differing investment timeframes.
In a minute, I will reveal two "great" companies I'm concerned about, one truly great company that I'm looking to buy, plus give you free access to four other outstanding companies that The Motley Fool itself owns.
Before we get to that, let's go review what I believe to be the No. 1 reason many investors and analysts mis-identify great companies.
In 2001, best-selling business author Jim Collins published his oft-quoted Good to Great. It was the result of five years of research by his 21-person team, narrowing down some 1,400 companies to an elite 11 that had transformed themselves into great companies.
Collins picked several winners, but also two notable failures: now-bankrupt Circuit City and government-seized Fannie Mae. My intention isn't to speak ill of Collins, since I have the luxury of hindsight, but to highlight that in less than a decade, two "great" companies, as confirmed by years of research by almost two dozen people, became utter disasters for shareholders.
Why the great fell
In both cases, Collins' research period was applied when the companies were flying high. In 1995, Circuit City was the largest U.S. brand-name consumer electronics and appliance retailer, and Fannie Mae was the monopolistic mortgage king. However, both companies suffered irrecoverable falls because they didn't have strong long-term advantages in their industries.
Fannie Mae likely signed its death warrant in 1999, with its decision to ease credit requirements to borrowers with "slightly impaired" credit. Although politics were definitely involved in this decision, it illustrates the lack of advantage that Fannie had over the rest of the industry, thus putting it on a course for disaster less than one decade later.
In my opinion, Circuit City failed to survive the recession because of a lack of differentiation between itself, other brick-and-mortar retailers, and various online disruptors. The decision to lay off 3,400 of its arguably best salespeople further sealed the once-great retailer's fate . While Circuit City focused on cutting costs, Amazon.com focused on delivering goods as conveniently as possible.
Great companies on My Watchlist
Using The Motley Fool's free stock tracker MyWatchlist.com, I've specifically got my eye on two companies that I think suffer from similar disadvantages to Circuit City and Fannie Mae. Neither of these stocks are going to zero, and I would never short them, but I'm concerned about their long-term growth prospects. Others deem them great, but I'm not so sure about them for my own investment dollars.
First up, Nintendo (OTC BB: NTDOY.PK), named the World's Best Company in BusinessWeek for 2009. The ingenious move to focus development dollars on the Wii's user interface gave the company a short-term advantage over rival Sony (NYSE: SNE ) , which concentrated heavily on raw processing power and graphics. But Nintendo will soon face competition from unfamiliar directions.
One decade from now, I believe Apple (Nasdaq: AAPL ) and Google (Nasdaq: GOOG ) will have directly led to or enabled Nintendo's fall from greatness. Apple led the way, showing consumers that they didn't need a dedicated gaming device when they could have an iPhone or iPad, and that a game didn't need to cost $50.
Meanwhile, Google's building an unbeatable (and free) platform in Android, which developers can extend and spread to every imaginable consumer electronic device. Why buy a dedicated Nintendo gaming device when you have a Google TV potentially running more than 100,000 apps?
The next company I'm watching is Coinstar (Nasdaq: CSTR ) , the coin-sorting leader, which now gets 80% of its revenue from its movie rental brand, Redbox.
Coinstar's stock is up 93% over the past 12 months, which indicates that retail and institutional investors alike are using their buying power to extol these shares' greatness.
But I don't buy it over the long term. Given that Coinstar's namesake business has single-digit growth rates, and that Redbox is offering a commoditized and highly competitive product of recently release movies, I simply don't see the long-term greatness, despite the company's rapidly growing DVD segment.
In this space, I'd much rather invest in Netflix (Nasdaq: NFLX ) , whose DVD rentals have primarily been "back catalog" or older movies. There are no other major players focused on older flicks, which allows the majority of the profits of old movies to flow Netflix's way, while Coinstar's Redbox dukes it out with massive companies like Amazon, Apple, and Google for new-release market share.
Don't get me wrong. I think Nintendo and Coinstar are great companies right now. I'm a consumer of both of their products, but the question is whether they can be sustainably great over the next decade or two. My bet is no. But we have a better choice ...
A truly great company for the long-term
I'm talking about Qualcomm (Nasdaq: QCOM ) , which was identified by technology guru Eric Bleeker as the one company positioned to rake in the profits from the mobile device boom. Two simple lines from Eric's report sealed the deal for me:
Qualcomm has patented the technology behind every 3G data network in the world.
If you want to use a phone that can connect to a modern data network, Qualcomm is profiting.
That's the kind of long-term advantage I look for in a truly great company. I believe in the long-term growth of mobile data usage, and Qualcomm will unquestionably take advantage of that growth. Notice the stark difference between Qualcomm's position in their industry compared to Nintendo and Coinstar. The latter companies have a high potential for disruption, while Qualcomm's bulletproof patent portfolio ensures its longevity as a truly great company in an electrifying industry.
More outstanding companies
Qualcomm is one of the five companies highlighted in a new free report called 5 Stocks The Motley Fool Owns -- And You Should Too. Inside, you'll find Eric's masterful 1000-word write-up on Qualcomm, including the risks, plus four other stocks The Motley Fool owns. I invite you to get instant access to this indispensable free report by clicking here now.