<THE DRIP PORTFOLIO>
Simplifying the Business
...and a decision to Drip
by Brian Graney (TMFPanic)
ALEXANDRIA, VA (April 8, 1999) -- Continuing yesterday's theme about the importance of keeping investing as simple as possible, I'll try to keep today's column, which describes what can be a difficult business concept, simple and to the point.
As a matter of preference, Jeff and I tend to like simple things. Jeff's diet consists mostly of bread and water and he often wears the same outfit to work day after day. In fact, his clothes cause tourists visiting Alexandria to commonly mistake him for part of the local Amish community, pestering him with questions about where he stores his horse and buggy.
I, too, am drawn to the idea of simplicity. Since childhood, I have been personally fascinated by the efficiency, non-complexity, and purposeful nature of tools, especially everyday hand tools. A hammer, for instance, is a great example of an invention so simple in design and function that we often take what it can do for granted. It works through basic physics, coupling mass with momentum to supply a force that can be used to quickly and easily nail pieces of wood together. No pneumatics, hydraulics, electricity, or special chemical-based glue is needed. And by combining its inherent mass with leverage, the hammer's claw also provides an efficient means of separating those two pieces of wood once attached. To my simple mind, that's out-and-out brilliant.
What does this have to do with investing? Well, I tend to approach investing with the same simplistic point of view. High-tech trading software and complicated derivative transactions are not necessary when regular, methodical investments in the Drips of industry-leading companies can provide a more efficient, less time-consuming, and ultimately more reliable way of achieving market-beating returns.
On a different level, I am also attracted to companies whose businesses are fairly simple to understand, especially based on what Jeff and I like to call the economics of the business. While many folks find the general academic subject of economics anything but simple at times (myself included), business economics are usually pretty straightforward. Strong business economics can be represented by such things as high margins, low production costs, high cash-flow generation, and a strong competitive position and market share. There are other factors that determine a company's economics as well, but these are some of the main elements.
In other words, "strong business economics" refers to general advantages (competitive, financial, operational, or otherwise) that a company may have over its rivals. In some cases, the economic environment of a company's industry itself provides a huge advantage over companies in other industries. These fundamental advantages provide investors with the opportunity to earn a relatively higher rate of return from a company with strong business economics versus a company with weaker economics.
So what kinds of companies have the best business economics?
Academics will tell you that the most efficient economic environment for business is a monopoly, and they can produce the graphs and charts and theories to back up their claims. Unfortunately, investing in monopolies has been hard to do in the U.S. ever since the advent of antitrust law at the turn of the century. Outside of a monopoly, two competitors vying for the same market is most efficient, according to economic theory. This situation, sometimes called duopoly, is also relatively efficient since it comes the closest to mimicking the economic simplicity of a monopoly.
This is particularly true when one of the companies in a duopoly has superior business economics over its sole rival. This scenario can signal a great investment opportunity. While the duopoly status of the dominant player's competitive environment acts as a shield to ward off the return-destroying effects of antitrust regulation, the inefficiencies of a weaker rival open up the possibility of achieving monopoly-like returns. This situation, simply, is a very desirable thing for investors.
If this strong versus weak duopoly scenario sounds familiar, give yourself a gold star. It is a fairly accurate, if simplified, description of today's CPU marketplace, with portfolio holding Intel Corp. (Nasdaq: INTC) playing the dominant role to the economic detriment of rival Advanced Micro Devices (NYSE: AMD).
Although they did not express it within this framework, Jeff and Randy Befumo latched on to this simple concept of looking for companies with little competition and strong business economics when selecting Intel as the very first investment for this portfolio. With my belief in keeping things simple, then, it should come as no surprise that I have also chosen Intel as my first Drip investment, based in large part on the desirable nature of the company's business environment and its dominant business economics.
Of course, there is more to this story and many other reasons why I want to become a business owner in Intel for the next 20 or 30 years. As with any stock, there are also accompanying risks that must be weighed. I'll have more to say about Intel's business next week when the company's first quarter results are, coincidentally, set to be released.
See, we're already simplifying things. Ain't efficiency great?
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