3 Stocks With Huge Competitive Advantages

If you can find companies with wide and durable moats, successful investing becomes much easier. Here are three great examples.

Daniel Miller
Daniel Miller, Rich Smith, and Sean Williams
Jun 19, 2017 at 12:48PM
Health Care

"The key to investing is not assessing how much an industry is going to affect society, or how much it will grow, but rather determining the competitive advantage of any given company and, above all, the durability of that advantage." -- Warren Buffett.

When one of the best investors on the planet speaks about successful investing, we'd all be wise to listen. Below, three of our analysts explain why they believe the durable and powerful competitive advantages of Cerner (NASDAQ:CERN), Intuitive Surgical (NASDAQ:ISRG), and Apple (NASDAQ:AAPL) could pay off for investors.

When switching costs matter

Daniel Miller (Cerner): For those of you unaware of Cerner, it's a leading healthcare information technology supplier (HCIT) that helps clients improve their operations and efficiency with a slew of software, hardware and other services. But the key factor supporting Cerner's top and bottom line performance is the high switching costs its customers face.

Consider that these complex information technology products have significant implementation times -- ask any IT professional, in any industry, how difficult it is to switch to a new product companywide. Some clients that move to Cerner choose to implement its products over periods as long as 18 to 24 months. But once that's done, switching to a competitor's product is an expensive and inefficient proposition.

Investors should also consider that the complexity of health record management systems, and the regulations around them, are only increasing. That bodes well for Cerner, which has a strong reputation within the industry. Clients are buying into its story: The company posted a win rate above 50% and added 360 acute facilities in the past two years. Further, in the first quarter, it posted 11% revenue growth and 7% bookings growth -- and 37% of bookings were from new footprints, as well.

Cerner isn't without its risks though, as competition is likely to increase right along with the favorable outlook for the HCIT sector. But as long as the company's products and services remain top-notch, it has competitive advantages that should make it a long-term winner.

A picture-perfect example of the razor-and-blades business model

Sean Williams (Intuitive Surgical): One company that practically has "catch us if you can" inscribed over its doors is robotic-assisted surgical system developer Intuitive Surgical.

What makes this company so great is its razor-and-blades business model. Those who have only a passing familiarity with the company probably assume that sales of its da Vinci surgical systems generate most of its revenue and profits -- but they'd be wrong. Though these machines cost around $1.5 million each, they're actually quite low margin for Intuitive Surgical.

da Vinci Xi robot surgery system.

da Vinci Xi with splayed arms.

Its real money is made by supplying the instrumentation and disposable supplies for each procedure, and in servicing the da Vinci hardware every so often. Since the training required to use the da Vinci system is complex, and the cost of its surgical systems so high, once a hospital buys one, it's unlikely to switch to competitor's platform. In other words, Intuitive Surgical is able to lock in its customers for the long term, and keep profiting by providing high-margin instruments and services long after the initial sale. Thus, the larger the company's installed base, presumably the higher its margins should head.

How far ahead is Intuitive Surgical? According to the company's first-quarter investor presentation, 3,919 da Vinci Surgical Systems were installed worldwide as of Dec. 31, 2016. You could add up all of its competitors' installed bases, and the total wouldn't even be close to that figure. It takes time and money to build the type of rapport with hospitals that Intuitive Surgical has developed, and that's not easily replicable.

The company is also constantly innovating. A little over two weeks ago, the Food and Drug Administration approved the next version of its da Vinci system, which isn't as pricey as its other systems and could have significant appeal in overseas markets.  Not to mention, Intuitive Surgical's marketing team is doing a great job in pushing physicians to use its robotic devices in more general soft-tissue surgeries.

Opportunities abound domestically and internationally for Intuitive Surgical, and it has its massive business advantages to thank for it.

This one will shock you (not)

Rich Smith: (Apple): With your indulgence, I'm going to go ahead and state the obvious: Apple has a huge business advantage when it comes to selling smartphones. And no, I don't mean the iPhone 8.

Fact is, analysts are starting to argue that iPhone 8 might actually not be the best thing that could happen to Apple stock -- not if the long-awaited 10th Anniversary edition of the iPhone gets introduced late in 2017, siphons sales out of 2018, and thus creates a sales-slowdown next year. (Too abrupt a slowdown could rapidly cool enthusiasm for the stock).

Rather, what I'm referring to here is the fact that while many companies (and lately, many Chinese companies) have proven they're able to sell smartphones and capture market share, Apple is far and away the best company at earning profits from selling smartphones.

According to market researcher Strategy Analytics, Apple captured 79% of all profits made from selling smartphones last year. Indeed, in one quarter -- Q3 -- Apple accounted for 104%  of smartphone profits earned worldwide. Put another way, if selling smartphones is a zero sum game, with Apple competing on one side versus everyone else on the other, then Apple earned all the profit that quarter, and everybody else lost money.

Fortune magazine explained the phenomenon last year: "The last several years, Apple and Samsung have nearly exclusively owned smartphone profits and have typically combined to secure more than 100%. Profit shares are able to exceed 100% as smaller handset makers post losses. Companies like Apple and Samsung gobble up everything else."

And here's the thing: Profits are what smartphone companies use to fund their R&D for new smartphones. Because Apple has most of those profits, its ability to innovate and develop the new technologies that will allow it to remain dominant is secure. Meanwhile, a lack of profits puts its competitors at a real disadvantage in developing their own next-gen devices.

Long story short: Investors may debate whether Apple is "too expensive" with its P/E ratio at 17 and its long-term projected growth rate at only 11%. But at least Apple has profits, and a P/E to debate about. Most of its competitors have neither on the smartphone front -- and that's a huge business advantage for Apple.