How we find great businesses
Our portfolios are stuffed with companies that possess durable advantages over those who would compete for their customers. We identify these businesses in two steps: 1) we filter for extraordinary profit margins and business returns, and 2) we study the history of the business and attempt to understand why they have achieved this enviable position relative to competitors.
Step 1 suggests that the business is worthy of our time to investigate, and step 2 should give us confidence that their competitive advantage is durable.
Step 1: Profit margins. So why is it that a small number of businesses are allowed to charge prices high enough to produce outsized profits? It is often assumed that businesses set the prices for their products or services, but in reality, the customer sets the price. In a highly competitive industry, customers know they can buy from a competitor at a similar price so they have the power to negotiate.
On the other hand, some businesses deliver products and services of such high value to customers that they are able to charge prices much higher than their costs. In both cases, the customer signals to the producer what they are willing to pay.
Step 2: How did the business get to the point described above? Sometimes, it’s luck—they pursue an idea that others ignore, and as technology advances, they benefit from their early start. But most often, it is because an individual at the business made a crucial and risky decision to invest massively in an unproven product or service. That investment was made long before it was an obvious opportunity to potential competitors.
These investments sometimes result in what Warren Buffett calls a “moat” – a barrier that is difficult or impossible for competitors to overcome. The guess-work involves determining the durability of that moat. That’s where we spend most of our time at Dock Street.
This is why trying to find “the next whatever” often produces sub-optimal results when compared to sticking with winning businesses with a track record.
Daniel A. Ogden