Investors who are interested in following the Warren Buffett investment strategy will do well to avoid investing in businesses that strive to have the lowest prices in their industry. While low prices initially seem like a great selling point, price competitive businesses often make poor investments. Let’s look at some of the reasons smart investors avoid staking their future gains on businesses that compete on price alone.
Price Competitive Businesses and Short-Term Growth
All too frequently, businesses that compete on price are dependent on short-term growth. For their business model to be sustainable, they have to constantly bring in new business at a low price, and they have to constantly increase their number of customers.
This may mean that they have high advertising costs, that they produce their products extremely quickly and in mass, or that they use less expensive materials so that they can keep their prices low. Their focus is on growing their bottom line in the short-term, but they may not have much of a long-term outlook.
Investors looking to grow their portfolio may instead want to follow Warren Buffett’s example and seek out businesses that are concentrating on building a long-term growth strategy, and will likely be around in fifteen to twenty years with a higher stock price, thanks to years of servicing happy customers.
Buffet’s goal is to identify a remarkable business at a reasonable price, not an average company at a low price. His advice for those who choose to build their own stock portfolio, instead of placing their shares in an index fund, is to follow their good judgment and educate themselves. According to the sage of Omaha, to be successful, you don’t need to be an expert in the latest business and finance theories. All you need is to learn ‘’how to value a business’’ and ‘’how to think about market prices.’’
What Is the Ideal Business Warren Buffet Would Be Interested in?
When deciding to invest in a company, Buffet recommends the would-be investor to investigate four key aspects. The business:
1) Must belong to an industry you are familiar with and understand.
2) Should have a substantial intrinsic value, and the potential to grow on a long term.
3) Should be run by competent and trustworthy managers.
4) Have an attractive stock price.
Price Competitive Businesses and the Media
Businesses that compete on price are often dependent on how the media portrays them. They must have a steady flow of new customers while avoiding losing their current customers in order to maintain their business. According to the Warren Buffet investment strategy, price competitive businesses don’t make good investments. This type of business is highly dependent on how the media portrays them — negative press can send their stocks reeling, and they may never recover. When a price competitive business is criticized in the press, their customers may go elsewhere.
Price Competitive Businesses and Their Competition
The main selling point of the business is pricing — not their innovative products, not their unique selling proposition — only the fact that their prices are lower than those of the competition. For this reason, once they receive negative press, it’s very easy for another business to step into their place in the market. Competing on price requires constant vigilance, and one small change in the overall market can seriously damage a business’s stock.
Examples of price-competitive businesses that Warren Buffet prefers to stay away from, include internet service providers, airlines, raw food producers, companies supplying gas or oil, as well as car manufacturers. All these companies face a fierce competition and their only competitive advantage is price. Price competitive companies have low profit margins, which makes them an unfortunate investment. Let’s see an example: in 2000, United Airlines long-term debt was about $5 billion, while its total net income in the last decade was $4 billion. If price is the sole distinctive feature of a business, the commodity manufacturer that offers the lowest price will always win.
If you’re attempting to grow your investment income, you’ll do well to stay away from businesses that compete on price. Instead, choose companies that have a unique product, that are innovative in their market, and that have a strong customer following.
New investors who want to learn about the basics of making money from the stock market may want to take the time to learn about the Warren Buffett investment strategy. The techniques that Buffett employed to grow a billion dollar empire can be learned, and will allow you as well, to earn an income from the stock market. Contact us today to learn more about our unique video course, where you can learn important investment techniques.