A bit over a year ago, I sat down with the CEO of what used to be a $1 billion company. The company is well-known, and I can almost guarantee that you've heard of it. Here are some of the highlights of the conversation:
"We have to invest year after year to maintain our competitive advantage."
"There's little that we do that no one else can do."
Are you kidding?
"We continually have to adjust for some kind of 'vaporization' effect with respect to our write-offs."
Agghhhh! %$)(@! No!
Out of journalistic considerations, I can't tell you the name of the stock. But the simple truth is that since the interview, shares have dropped more than 60% anyway -- so people are definitely getting the picture.
You might even be able to find the stock if you looked hard enough -- actually, you could probably find dozens more in a similar predicament. While I thought the exec honorable for his candid truthfulness -- and that's a big plus in my book -- companies like these are not good enough for any investment of mine. 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 sand castle on the beach.
Remember when 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 like Dell
A deadly trap
No matter how good a product or a service is, once 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 has delivered more than 600% gains in the past five years: No one is even close to replicating the company's technology or its products. On the reverse side, this explains why Boeing
Clearly, the whole mystery of large-scale flight isn't stumping too many engineers -- so the secret to success these days includes juicing margins as much as possible and seizing lucrative contracts. As an alternative, examine a business like eBay
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. Wal-Mart
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 look forward to. 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 nearly 29 percentage points since inception in 2002. Want to take a look? Click here to try the service free for 30 days.
This article was originally published on Oct. 15, 2007. It has been updated.
Fool analyst Nick Kapur owns no shares of any company mentioned above and has zero material interest in the company whose CEO he interviewed. Intuitive Surgical is a Motley Fool Rule Breakers recommendation. Dell is an Inside Value selection. Apple, Amazon, and eBay are Stock Advisor recommendations. The Fool has a disclosure policy.