Table of Content

• What constitutes a good business.
  • Entry Barriers
  • Brands
  • Franchise Led Growth
  • High Gross Margins
  • Change the Metric of Measurement:
  • Government Lease
  • Patents
  • Low cost of production and economies of scale
  • Large upfront capital Expenditure
  • Network Effect and Switching Costs
  • Product penetration and distribution Network:
  • Low Priced Items
  • Possibility of Postponement
  • Invest in the Sector Leaders

I made these notes from Basant Maheshwari’s Book : A Thoughtful Investor . I would recommend budding and experienced investors alike to read this book.

What constitutes a good business.

• A good business is one that purchases on credit and sells on cash.
• It will generate a high return on Equity without employing too much debt and follow an asset light model where investments in fixed assets like machinery and plant is relatively low even while the working capital remains negative.

Entry Barriers

A business can have an economic moat also defined as an entry barrier through various sources. Strong barrier to entry helps company maintain a high pricing power.

Brands

Most important entry barrier to business. A product becomes a brand after creating years of consistent customer delight. Mere customer satisfaction is not enough.

• Mind Share capture is superior to market share capture and indicates high product recall.
• A product that has captured mind share sells more on words of mouth and less less of advertising.
• Market Share is quantifiable and can be deciphered by numbers.
• Mind Share is a subjective exercise with unquantifiable arguments.
• A company captures market share by pushing it product toward its customer either by lucrative pricing or distribution or advertising.
• A Mind share is more of a pull strategy where the customer himself comes looking for the product because he perceives the product to be of superior quality with a more than sufficient utility.

Franchise Led Growth

• Most companies with strong brand appoint franchises for selling their products to the last mile customer.
• If the business is strong, shareholders of the company will make more money than the franchise owners. However, management needs to run the business in the interest of minority share holder.
• Franchises make just enough enough to be incentively to be in the business.

High Gross Margins

• Gross Margins range from 50 to 60% .

Change the Metric of Measurement:

• A company buys in weight, sells in pieces. E.g Pharmacy
• Companies that change the metric of measurement are known to have a very strong pricing power.

Government Lease

• It carries an entry barrier which prohibits competition from getting into its business.

Patents

• Companies having brand and patent have the best return on capital as it can charge more for its products irrespective of input price movement.

Low cost of production and economies of scale

• Low cost of production is also an entry barrier for competition.
• More relevant for company selling commodity product.
• Costs cannot be cut to 100%. . Choose a company that can raise price rather than stay with one that can only cut costs.

Large upfront capital Expenditure

• E.g. Indian Railway : The sheer scale of capital involved in these kind of companies ensures that the return on capital employed remains low and unattractive for any competitor to breakthrough.

Network Effect and Switching Costs

• Network effect is created by the customers of the business.
• The switching cost of a customer arises from the inconveniences that the customer face. E.g. Mobile Phone number change.
• The concept of ‘Winner takes all’ . In Bollywood, the top 50 participants in the form of actors, directors etc take 80% of the revenues.

Product penetration and distribution Network:

• Unless the Market is not under penetrated, focus on stocks that sells items of repeated use.
• If the replacement cycle is high, the penetration level has to to be low (cookers)
• If the penetration is high, the replacement cycle has to be low (cigarettes).

Low Priced Items

• Companies which sell low ticket price items that are small % of overall consumer disposable income find it easier to raise prices than companies selling items which form a larger part of customer’s disposable income. E.g. News paper vs Car

Possibility of Postponement

• Products whose buying can be postponed by a buyer isn’t as good as business as whose buying needs immediate action by the buyer. E.g. Postponement of Car vs Postponing purchase of medicine

Invest in the Sector Leaders

Leading stock of each sector will either have :

• Strong brand, patent
• Low Cost producer
• High Network effect etc.