Using the analysis laid out in Michael Porter's book Competitive Advantage, Motley Fool contributor John Maxfield and analyst Gaby Lapera dig into ways of identifying standout stocks. Often, it isn't enough to simply gain an edge over the competition; a company has to hold on to it in order to succeed. Here's a look at how several prominent stock market names have managed to do that.
Listen to the entire podcast by clicking here. A full transcript follows the video.
John Maxfield: The second piece of Porter's analysis looks at the companies themselves. Once you've assessed an industry for its competitive dynamics, then you want to get in there and assess whether or not the specific companies in that industry have a durable competitive advantage. He talks about two different ways that a company can acquire that. The first is through cost; low cost.
Think about Geico. They say: "Spend 15 minutes to save 15% on your car insurance." Well, the reason Geico Insurance is so much cheaper -- for the record, Geico is a subsidiary of Berkshire Hathaway (NYSE: BRK-A) (NYSE: BRK-B) and there's not a coincidence there that it has a strong competitive advantage, and that Berkshire Hathaway bought it.
The reason Geico is able to operate and sell their insurance products for less than their competitors is because they don't have offices all around the country like State Farm. They operate much less expensively and can therefore sell their products less expensively. That's a competitive advantage on the cost side.
Wells Fargo (NYSE: WFC) is the same, exact thing in the banking sector. This company has earned outstanding returns for decades now, and it's been able to make it through a lot of these crises that have otherwise hobbled its competitors. Why has it been able to do all these things? It's my analysis of Wells Fargo that the reason it's been able to outperform its competitors is because it has a pricing advantage. Keeping costs low is in Wells Fargo's DNA.
That comes through loud and clear in their shareholder returns over time. You have that cost piece of the competitive advantage on the company level; that's the first element. The second element in the company's specific level is differentiating your product. Making your product uniquely appealing in some way, shape, or form that differentiates it from the competitors and allows you to generate wider margins from it.
Gaby Lapera: I think this is a lot more intuitive for people to grasp because pricing structures can be hidden and people don't think about them as much. For example: if you're in a CVS (NYSE: CVS), will you reach for Band-Aid, or CVS Adhesive Wound Stopper? You're going to reach for the Johnson & Johnson (NYSE: JNJ) product, which is Band-Aid. Everyone knows about Band-Aid, or Coca-Cola (NYSE: KO). Are you going to buy Coca-Cola, or are you going to buy supermarket soda?
It's fine; supermarket soda is pretty much the same thing as Coca-Cola, but brands have managed to create this trust among consumers where they are able to charge consumers more because without thinking about it, people will reach for their products before other people's.
Maxfield: Yeah. When I think about differentiating a product, when you say "Coke", that's the textbook example. My wife is ridiculously frugal. We do not use a full roll of paper towels for a year and a half. Possibly longer. I could go through a number of examples to give you. She's all about buying generics and all that, but we had a gathering at our house a couple weeks ago and her whole family came over.
She sent me out to do the shopping, which is always an enormous mistake, but I go out and I'm looking on the soda aisle and I'm thinking "What would I do if I was Jamilla?" I'd think "I definitely have to go with the generic."
If I sat down and did a blind taste test, I guarantee you and everyone else along with me would not be able to tell the difference between generic cola and Coca-Cola, or Pepsi (NYSE: PEP). I get the generic, I bring it home...
Lapera: I can totally tell the difference between Pepsi and Coke.
Maxfield: I think statistics are against me on that. I bring home the generic and even my wife -- who otherwise would think generics are the way to go -- she was not happy with that because she was thinking "How is this going to reflect on us with all my family? You bought the generic as opposed to the Coca-Cola." It's basically twice the amount, just for the brand. That is what a competitive advantage gives you. You're making the same thing, but you're selling it for 50% more.
Gaby Lapera has no position in any stocks mentioned. John Maxfield has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Berkshire Hathaway, PepsiCo, and Wells Fargo. The Motley Fool has the following options: long January 2016 $37 calls on Coca-Cola, short January 2016 $43 calls on Coca-Cola, short January 2016 $37 puts on Coca-Cola, and short January 2016 $52 puts on Wells Fargo. The Motley Fool recommends Coca-Cola, CVS Health, and Johnson & Johnson. 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.