In the business world, success attracts competition. When a company is achieving vigorous growth and attractive profitability, chances are that rivals will try to steal market share away by offering similar products at competitively low prices. But brand value protects a business from competitive pressure, so companies with powerful brands tend to deliver above-average returns for investors over time.
Consulting firm BrandFinance tracks the estimated value of big brands around the world via a methodology which considers variables such as consumers' emotional connection to the brand, the company's financial performance, and brand sustainability, among others. According to its recently published research report, investing in companies with brands that are highly valuable relative to overall enterprise value would have delivered massive outperformance over the last several years.
The average company in the S&P 500 delivered a return of 49% from 2007 to 2014. However, investing in companies with a brand value to enterprise value ratio of greater than 30% would have generated returns of 94% over this period. Investing exclusively in the 10 companies with the highest BV/EV ratios would have resulted in a 96% return, according to BrandFinance.
How to find valuable brands
It's important to keep in mind that not every recognizable brand necessarily gives its owner solid competitive advantage, nor does a bigger revenue base necessarily mean a more valuable brand. For a brand to be a sustainable source of competitive advantage, it needs to be an important factor for consumers when they're making purchasing decisions.
For example, BrandFinance calculates that Wal-Mart (NYSE:WMT) has a brand value of $56.7 billion. That's similar to the $56.1 billion in brand value the consulting firm assigns to Amazon (NASDAQ:AMZN). However, Amazon made $107 billion in sales during 2015, while Wal-Mart is expected to produce a much larger $483 billion in sales during the fiscal year that ended on January 2016. So Amazon is only about 22% the size of Wal-Mart in terms of revenue, but brand strength is determined by variables that go well beyond revenue.
Amazon is well-known for its customer-centric business philosophy, and most of its customers have a strong connection with the brand. Amazon has been rated at the top of its industry in the American Customer Satisfaction Survey in each and every year since 2000, which says a lot about the kind of relationship the company has built with customers over time. Wal-Mart, on the other hand, is consistently rated below average in customer satisfaction, so the company needs to rely on other sources of competitive strength, such as scale advantages and geographic presence, to attract customers to its stores.
Apple (NASDAQ:AAPL) is considered the most valuable brand in the planet by BrandFinance, with a calculated value of $128.3 billion. Most smartphones in the world are powered by Android, however, a large fraction of customers are willing to pay a substantial premium for Apple products. While most manufacturers offering Android products are aggressively cutting prices to protect their market shares, Apple announced that the average selling price for iPhones was $691 last quarter, up from $687 per unit a year ago. Needless to say, superior pricing power allows Apple to produce profit margins well above those of the competition, and this is a major plus for investors in Apple.
Brand value is not just about sales volume or market share. Valuable brands are the ones that bring customers to the company even if the competition is offering similar products at similar prices. Also, when you can get away with higher prices than the competition for a similar product, then you have a strong and profitable brand.
Competitive strength is one of the most important aspects to consider when making investment decisions for the long term, and brands can be an amazingly powerful source of it. Next time you're considering an investment, don't forget to take deep look at the company's brands.
Andrés Cardenal owns shares of Amazon.com and Apple. The Motley Fool owns shares of and recommends Amazon.com and Apple. 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.