Pre-Review: Competitive Advantage

You may be wondering why I decided to read Competitive Advantage by Michael Porter as opposed to some other more instructive investing book. You may be thinking to yourself, “Actually, Competitive Advantage isn’t an investing book at all. It’s a veritable tome on business strategy and competition.” Who needs to read such an academic book on competition? That’s not investing, right?

Au contraire. The modern value investor has to concern himself with much more than just financial metrics and valuation. These days Graham-ian net-nets (stocks trading well under their liquidation value) have become nearly extinct. New valuation techniques value companies on the basis of earnings as well as intrinsic worth. I suspect that Bruce Greenwald, author of Value Investing from Graham to Buffet and Beyond, would agree that these valuation strategies are highly dependent on the sustainability of the company in question’s business. Actually, he makes just those kinds of arguments in his book though with less of a focus on how to determine “sustainability.”

The modern value investor, and really any investor with a longer time horizon, needs to be concerned with the ability any potential investment has to stay viable. When it comes to stocks and the companies they own, this means the ability of the company to create and maintain competitive advantages. Without a competitive advantage, as anyone who has taken an economics class can tell you, any company which is currently making profits on its business will see new competitors enter the market and snipe away at their business until the industry is left in a state of perfect competition. Perfect competition may be good for consumers, but its bad for investors because this means there are little, if any, profits to be had. And, as we all know profits (read: earnings) drive share price in the long term.

So, to be a good investor, it’s necessary to get down and dirty on the fundamentals of how it is that a company competes. Armed with this knowledge, you can look at Google’s outsized returns and confidently invest in the likely growth (or at least sustainability) of Google’s profits. Who better to learn all of this from than Michael Porter, the Harvard Professor and business guru who founded the highly regarded consulting firm, Monitor Group? I’ll let you know how it all goes when I finish.

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