Strong brand names have an exceptional amount of power in the marketplace. It normally takes a long time and large investments by companies to make their brands powerful, but at that point we as investors can harness the companies' brand power for our own benefit in our portfolios.
Coca-Cola (NYSE:KO), Nike (NYSE:NKE), and McDonald's (NYSE:MCD) have three of the most visible and powerful brands in the world, and this has led to the prosperous growth of all three of these companies even in highly competitive markets.
Coca-Cola faces competition from other name brands and store brands that undercut it on price by large amounts. Nike also faces stiff competition from other strong name brands and off-brand shoes that sell at heavy discounts to Nike's own sneakers. McDonald's too faces a huge amount of competition from numerous other fast-food restaurant chains out there as well as sit-down restaurants. More uniquely, it also faces competition from a section of consumers' own houses: the kitchen.
In the face of so much competition, these companies' brand names have helped them flourish in marketplaces often dominated by price. With consumer loyalty and recognition comes pricing power, which in turn leads to higher margins and higher return ratios.
Coca-Cola is able to sell its products for nearly double what some store brands charge for their products even if the differences between the actual products are negligible. Coca-Cola has built a loyal customer base that wouldn't go near another brand of soda. It is not just the actual Coca-Cola brand where this is noticeable though; Coca-Cola also sells bottled water under the Dasani brand name. As impossible as it is to find differences between bottled water products, some consumers will still pay more for Dasani over store-brand water.
Similarly, Nike can sell a pair of sneakers for a couple of hundred dollars, which is almost ridiculous considering that you can buy a decent pair of shoes that will get the job done for under $40. However, like that of Coca-Cola, the consumer perception of Nike is highly valuable. By recruiting top athletes and entertainment stars to market its products Nike has shown consumers that having a large "Swoosh" on their shoes will produce superior athletic results and make them the most-stylish person in the group. Whether either of these claims are factual or not doesn't matter, as long as consumers continue to believe that they're true.
McDonald's is in a slightly different boat. Consumers would typically not tell you that a $0.99 cheeseburger from McDonald's is the greatest thing they have ever eaten. However, they would probably tell you that it is convenient, has very little variability, and is a cheap fix. McDonald's has built a reputation on being pretty tasty, reliable, and cheap, all of which consumers love. McDonald's has done so well in instilling this into consumers' minds and placing a McDonald's restaurant within a stone's throw of almost anywhere in the world that it wouldn't matter if a competitor came out with similar products priced a few cents lower.
Value in pricing power
The first and most easily recognized benefit of having pricing power over competitors is the ability of each company to preserve its margins. Coca-Cola, Nike, and McDonalds have averaged net profit margins of 21.4%, 9.2%, and 17.1% over the last ten years, respectively.
Secondly, an important measure in which these three companies thrive is their returns on equity. Return on equity is very important in evaluating a business because it shows you whether or not management can reinvest earnings back into the company in a highly profitable manner. Coca-Cola, Nike, and McDonald's sported return on equity measurements of 26%, 23.1%, and 35.2% last fiscal year, respectively. Strong brands help companies' reinvestments become more profitable ventures.
Just because you like a particular brand does not mean that it brings the respective company a lasting competitive advantage. You need to dig deep into companies and numbers typically don't lie. If a company has high margins and is very profitable in comparison to its invested capital or assets it is likely that this company's brand name may give it a competitive advantage and it could be a candidate for investment.
Coca-Cola, Nike, and McDonald's all pass this test.
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Jacob Meredith has no position in any stocks mentioned. The Motley Fool recommends Coca-Cola, McDonald's, and Nike. The Motley Fool owns shares of Nike and has the following options: long January 2016 $37 calls on Coca-Cola and short January 2016 $37 puts on Coca-Cola. Try any of our Foolish newsletter services free for 30 days. 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.