Begin With the Value Proposition in Mind

Summary:

• The second segment in the serialization of my next investing book explores how to define a business’s value proposition or durable competitive advantages.
• Due diligence resources explored in this segment include SEC filings, investor relations webpages, company and stock profiling, economic moats, and performance history vs. sector and market.
• How to use the value proposition research to write an elevator pitch of why, or why not, the enterprise and its common shares are worthy of a slice of ownership.

Welcome to the second segment of the serialization of my next book, Quality Value Investing: How to Pick the Winning Stocks of Enduring Enterprises (working title and subtitle). I am writing the book on LinkedIn as part of the QVI Newsletter and look forward to subscribers’ support and feedback as we produce the manuscript over the next 24 months.

Book Segment #2 explores how to define the value proposition of the products or services of a targeted company and then explain it confidently via an elevator pitch. At a minimum, quality-driven investors first assess the business’s value proposition or durable competitive advantages when conducting due diligence on a stock.

Defining the Value Proposition

Invest in slices of outstanding companies producing in-demand and profitable products or services that are assisting consumers worldwide in solving personal and business problems, wants, or needs.

The value proposition defines the competitive advantages a company’s product or services offer its customers compared to the industry, sector, or marketplace. How do quality-driven value investors gauge the durable competitive advantages of a business?

Due diligence resources provide a more in-depth analysis when researching a company’s all-inclusive value proposition. For example, visit the company’s investor relations webpage and its most recent Form 10-K Annual Report submitted to the US Securities and Exchange Commission or SEC.

The company’s profile briefly defines the business and its products or services. Do we understand the business model? Is it within our investing circle of competence?

The economic moat is the subjective measure of the competitive advantages of the goods or services of a company in the marketplace. An economic moat is an enterprise’s unique competitive advantage over other companies within the same industry.

An investor can analyze company performance versus its sector and the broader market by charting the selected stock’s historical total return performance against its peers.

A value proposition elevator pitch describes in one or two sentences why we believe the targeted company is a high-quality, enduring enterprise.

Competitive Advantages of the Products or Services

Uncovering the business’s value proposition before taking an ownership slice is crucial when researching a targeted stock.

Profitable retail common stock portfolios resemble collections of owned slices of well-managed companies producing in-demand products or services with enduring competitive advantages. Based on the relentless commitment to price and quality, how do quality-driven value investors define the competitive advantages of the product or services offered by the company and the perceived enduring value relative to the stock’s market price?

One recommended approach is to gauge how the company’s value proposition rewards each of its stakeholders.

Successful quality-driven investors won’t buy something because it sounds or feels right. Alternatively, they allocate hard-earned dollars to the common shares of businesses that are understood and appreciated.

Unfortunately, the value proposition is often overlooked or taken for granted by retail investors. At the other extreme, institutional investors, such as portfolio managers and analysts, tend to over-analyze the value proposition of the products or services of selected companies with piles of deep-dive research to justify the fees and bonus structure. As a result, underperforming retail stock pickers are buying shares of enterprises despite limited knowledge of what each produces or how it benefits the company’s targeted market for its goods and services.

Quality-driven investors know the common stocks of companies providing valuable, in-demand products and services endure across market cycles, despite a few erratic price movements in between from the nearsightedness of the crowd, inclusive of individuals and professionals.

For example, suppose we own a slice of a quality company purchased at favorable share prices, and the enterprise’s value proposition remains intact over sustained periods. Why sell other than to fund new opportunities or finance an upcoming milestone in life with the proceeds?

Seek businesses with a long history of offering a sustainable value proposition to their customers, coupled with steady returns for their shareholders.

SEC Filings and Investor Relations Webpage

Read the filings submitted by senior management to the US Securities and Exchange Commission or SEC, such as the 10-K annual reports, 10-Q quarterly reports, and 8-K current events.

Beyond anything already known about the company’s products, services, and competitive advantages, investors have troves of public information available to vet the value proposition. The most reliable data on hand for the enterprise lies in its filings with the SEC. Access this information on the investor relations section of the company website, at an online broker, or a favorite investing website.

Take the time to delve into the organization’s online presence, including its website, social media presence, marketing channels such as advertising, and public and investor relations. As the starting point of diligent investment research, reading the Form 10-K Annual Report and reviewing the investor relations site are priorities one and two for quality-driven investors.

For example, the 10-K, mainly the section titled Item 1 Business, is where management discusses the enterprise with vigor. Topics include the background and history of the company, corporate strategy, specific products and services, markets and distribution, competition, supply chains, research and development, intellectual property, foreign and domestic operations, and other related items specific to the industry. Despite being detailed to the point of sleep-inducing, the information provides a roadmap of the products’ or services’ potential to propel the stock price upward over a long-term holding period.

I challenge individual investors who are prone to skip annual reports and other SEC filings to find organizational, product, regulatory, and financial facts about the company they were unaware of before reading. To be sure, these documents are avalanches of legalese and numbers crunching. However, a thorough read often uncovers slices of information that bring us inside—at least on a virtual level—the plants, stores, e-commerce operations, C-suites, and boardrooms.

Create Company and Stock Profiles

The sector is the market classification of a group of related industries. It includes communication services, consumer discretionary, consumer staples, energy, financials, real estate, health care, materials, industrials, information technology, and utilities.

Quality-driven investors stick with sectors and industries within their circle of competence. For example, our family portfolio’s stock screen doesn’t include sectors outside my acquired expertise, including energy, real estate, materials, and utilities.

In other words, the speculative commodity-driven energy and materials sectors are avoided. However, I empathize with retirees investing in real estate investment trusts (REITs) and utilities for stable income opportunities.

Major exchange denotes whether shares are trading on either the New York Stock Exchange (NYSE) or NASDAQ, including foreign-based companies’ American depositary receipts (ADRs)—avoid over-the-counter (OTC) issues because of the more speculative and illiquid trading paradigm.

Market capitalization denotes whether the market has capitalized the stock as a large- mid- or small-cap company. Avoid microcaps as they are too volatile and speculative. And no penny stocks or issues trading at less than five to ten dollars a share.

Products and services are the company’s offerings, whether tangible goods or intangible services. Avoid taking ownership of slices of businesses with sophisticated or confusing products and services. Quality-driven investors buy and hold only what is?known and understood within their circle of competence.

The closing share price is the market price of one share of common stock as of the last reported daily, monthly, or yearly closing dates.

The stock price’s total return is the increase (or decrease) percentage of the closing share price from the previous target date, adjusted for dividends and stock splits. For example, the one-year average total return is the adjusted gain/loss in stock price since the market close for the twelve months preceding the previous period’s end date.

S&P 500 total return is the gain/loss of the benchmark index price—adjusted for dividends and splits—since the last market close for the preceding period’s end date.

Assign an Economic Moat Rating

Alpha-rich investors target companies with clear competitive advantages from their products or services. An investor can streamline the value proposition of an enterprise with an economic moat assignment of wide, narrow, or none.

Specifically, the economic moat is a company’s durable competitive advantage over other businesses within the same industry. Target companies that are surrounded by wide or narrow moats that create a perceived barrier to entry for potential competitors. The financial media widely credits Warren Buffett for coining the term.

Morningstar is the leading proprietary data provider of economic moat ratings. Theoretically, wide and narrow-moated stocks tend to have higher floors in down markets due to superior competitive advantages. If a Morningstar moat rating is unavailable for a targeted equity, conduct due diligence and assign a wide, narrow, or none rating. Posting a moat rating to a stock requires mere thought and a pinch of common sense.

A company enjoying market dominance within a limited pool of competitors, or an oligopoly, is an ideal wide-moat play for quality-driven value investors. Oligopolies are more attractive to investors than monopolies, as the single dominant player is vulnerable to government antitrust enforcement at home and abroad.

Performance Versus Sector and Market

Look for companies with a history of alpha achievement, as investing in individual common stocks should aim to beat the benchmark indices over time. If not, average returns from index investing make more sense than underperforming the market.

For example, the best-performing stock in our family portfolio is Microsoft (MSFT). Since being added in June 2011 at a cost basis of $20.27 per share, adjusted for splits and dividends as of the date of this writing. MSFT’s total return was +1,900% vs. +864% for the information technology sector (XLK) and +388% for the S&P 500 (SPY). Remember that past returns are not indicators of future results.

The Value Proposition Elevator Pitch

Next, define the business’s competitive advantages in an elevator pitch containing one or two sentences or phrases. In other words, describe why we believe the targeted company is a high-quality, enduring enterprise.

Below are examples of elevator pitch value propositions of companies owned in our family portfolio at the time of writing this segment:

Alphabet?(GOOGL) dominates search, data analytics, click advertising, maps, mobile devices, web browsing, email, free productivity tools, and video, and is a rising star in the cloud and artificial intelligence.

The TJX Companies (TJX) has superior inventory management, a powerhouse global buyer network, and consistent financial performance.

The Coca-Cola Company (KO) is a legendary and dominant global player with a ubiquitous brand name that likely isn’t going anywhere except consumers’ refrigerators, pantries, and cupholders.

Berkshire Hathaway (BRK.B) is the Warren Buffett-built conglomerate of diversified businesses wholly owned or through its massive stock portfolio, and, thus, better than an index fund because of its emphasis on quality and value.

Johnson & Johnson (JNJ) is like owning a mutual fund of quality brandname healthcare products but with blue chip low risk and no advisory fees.

Union Pacific (UNP) owns the highest quality business model in the North American freight rail oligopoly.

Apple?(AAPL) is the reigning king of productivity hardware and services, whether business or personal, mobile, wearables, television, or desktop, each anchored by its unparalleled iOS ecosystem.

Begin with the Value Proposition in Mind

The value proposition of a publicly traded company is the sum of the competitive advantages of its products and services in the markets it serves.

How well quality-driven investors know and understand the competitive landscape of the publicly traded companies’ products or services represented by their shares is a prerequisite to building an alpha-achieving portfolio of common stocks. If unable to define or understand the enterprise’s value proposition with conviction, consider taking a pass on the stock.

Read the filings submitted by senior management to the Securities and Exchange Commission or SEC, such as the 10-K annual reports, 10-Q quarterly reports, and 8-K current events. Acquire valuable knowledge of the products or services and the employees, suppliers, markets, governments, and customers producing, trading, regulating, and consuming the goods or services.

Next, create profiles of the company and its common stock and assign an economic moat rating.

Morningstar is the leading provider of moat research.

While conducting due diligence on a business, ask, “What value do the products or services offer to existing and potential business customers or retail consumers?” If in the general market for either, would we purchase the goods or services of the company?

Our answers to these hypothetical questions validate understanding and confidence in the prospects of the targeted business from the value proposition or durable competitive advantage toward continued growth and prosperity, as reflected in the stock price over time. Publicly traded companies exhibiting clear and compelling value propositions are more coveted than stocks merely trading at attractive valuation multiples.

Now, attempt to define the value proposition of the offerings from the enterprise in a short phrase or elevator pitch. Then, if comfortable with a basic understanding of the business, continue the checklist due diligence from Book Segment #1 toward possible ownership of a slice of the company via its common shares.

Too many crowdsourced investors buy and sell shares based on market sentiment, trends, and fads without understanding the company’s value proposition represented by the underlying stock. That’s because the crowd buys and sells what does or doesn’t sound or feel good.?Unfortunately, they pay less attention to the value proposition and instead focus on overanalyzing speculative metrics such as technical charts, news, and quarterly earnings. Avoid the crowd and get acquainted with the enterprise generating the equity’s facts and figures instead.

Understanding the products or services and durable competitive advantages with conviction is essential to the thriving quality-driven value investor. The more we know about the companies invested in, the higher the chances that the underlying shares will achieve alpha over time.

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About the Author

David J. Waldron is the founder and contributing editor of Quality Value Investing and author of the international-selling book Build Wealth with Common Stocks. David’s mission is to inspire the achievement of his readers’ financial goals and dreams. He previously enjoyed a 25-year career as a post-secondary education administrator. David received a Bachelor of Science in business studies as a Garden State Scholar at Stockton University and completed?The Practice of Management Program?at Brown University.

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Disclosure: I/we have beneficial long positions through the direct ownership of AAPL, BRK.B, GOOGL, JNJ, KO, MSFT, and TJX common shares in our family portfolio. I wrote this post myself, and it expresses my own opinions. I am not receiving compensation for it other than from Substack paid subscriptions. I have no business relationship with any company whose stock is mentioned in this post.

Additional Disclosure: Quality Value Investing by David J. Waldron’s newsletter posts are for informational purposes only. The accuracy of the data cannot be guaranteed. Narrative and analytics are impersonal, i.e., not tailored to individual needs nor intended for portfolio construction beyond his family portfolio, which is presented solely for educational purposes. David is an individual investor and author, not an investment adviser. Readers should always engage in their own research or due diligence and consider (as appropriate) consulting a fee-only certified financial planner, licensed discount broker/dealer, flat fee registered investment adviser, certified public accountant, or specialized attorney before making any investment, income tax, or estate planning decisions.

Copyright 2024 by David J. Waldron. All rights reserved worldwide.