Investing in growth companies is not only about selecting businesses with rapidly increasing sales or earnings. Competitive strengths are crucial when it comes to sustaining financial performance over time. Amazon (AMZN 0.37%), Netflix (NFLX -1.74%), and Priceline (BKNG 0.79%) are becoming stronger as they grow in size, and that bodes remarkably well for investors in the long term.
How Amazon is dominating retail
Amazon's success over recent years is nothing short of spectacular: The company has increased sales at a compounded annual growth rate of more than 30% per year through the last 10 years while at the same time building a rock-solid competitive position in the retail industry. Importantly, Amazon's competitive advantages are only getting stronger as the company grows in size.
Amazon has a natural cost advantage versus brick-and-mortar retailers due to its lower-cost structure and efficient business model. These advantages are becoming bigger over time as Amazon gains market share in different retail categories and growing volume allows the company to spread its fixed costs more efficiently. All else being equal, more sales with the same fixed costs means falling fixed costs per unit.
On the other hand, Amazon is actively investing in areas like technology, expanding its distribution network and digital content, among other things. This requires heavy capital investments, and it erodes the company's cost advantages in the short term.
In the long term, however, the company continues to be focused on providing a high-quality service and conveniently low prices for its customers, even at the expense of profit margins, and that's probably the simplest and most effective way to sustain a competitive advantage over the years.
Amazon announced that it gained more than 1 million new Amazon Prime members during the third week of December 2013 alone, and it now has "tens of millions" Prime members around the world. This is great news for Amazon investors, as Prime membership generally has a positive impact on customer loyalty and spending per customer.
Netflix: An offer you can't refuse
Investors will get more up-to-date information when the company reports earnings on Wednesday, but as of the end of the third quarter of 2013, Netflix had surpassed the whopping amount of 40 million global subscribers, a big increase of more than 10 million subscribers versus the same quarter in the previous year.
This means growing cash flows for the company to invest in content and increase its value proposition by providing more tittles for the same price. In addition, as Netflix becomes bigger, it also becomes a more attractive platform for content producers from a commercial point of view, so Netflix gains negotiating power over time.
Just as important, Netflix leverages the enormous amounts of data it collects from users to make better decisions when it comes to creating or buying new content. The company analyzes data like ratings, recommendations, viewing habits, and social media interaction in order to efficiently select the most valuable content to add to its library.
Content is king, and Netflix is able to provide more and better content as it gains more subscribers. A growing user base means better service and a stronger competitive position for Netflix, and that will be a powerful growth driver for the company in years to come.
Priceline: Clear skies ahead
Priceline is a textbook example of a company benefiting from the network effect, meaning that the value of a service increases as more people use that service over time. The online travel agency becomes more useful to customers when they can find more and better offers through its platform, and companies like hotel operators, airlines, and car rental businesses choose to partner with the online travel companies that can provide access to a wider client base.
In the online travel business, supply attracts demand and vice versa. Priceline has consolidated its leadership position in the industry by building a gigantic online travel platform, which produced almost $10.8 billion in gross travel bookings during the third quarter of 2013.
In addition, the business model is vastly profitable: Priceline has an operating margin above 35% of sales. As the company continues to attract more customers and travel service operators to its platform while benefiting from growing scale advantages, investors have good reasons to expect growing sales and high profit margins from Priceline over the coming years.
Bottom line
Growing sales and earnings are a nice thing to have, but financial performance is of limited value if it can't be sustained through the years. Amazon, Netflix, and Priceline, on the other hand, combine both growing businesses and increased competitive strengths over time. Investors looking for high-quality growth companies for the long term may want to give some consideration to these names.
