Chapter 2: Begin With the Enterprise's Value Proposition
Book Serialization | Quality Value Investing: How to Pick the Winning Stocks of Enduring Enterprises
Welcome to Chapter 2 of the draft manuscript serialization of my next book, Quality Value Investing: How to Pick the Winning Stocks of Enduring Enterprises.
I am writing the book on Substack Finance as part of the QVI Newsletter and look forward to subscribers’ support and feedback as we produce the final manuscript in real time.
Chapter 2 explores defining the value proposition or durable competitive advantages of a targeted company’s products or services.
Chapter 2
Begin With the Enterprise’s 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.
At a minimum, quality-driven investors first define the business’s value proposition or durable competitive advantages of its goods or services when conducting due diligence on a stock, then explain it confidently via an elevator pitch.
Due diligence resources explored in this chapter include mandatory government filings, investor relations webpages, company and stock profiling, and economic moats. Plus, how to use the value proposition research to write an elevator pitch of why, or why not, the enterprise is worthy of a slice of ownership via its common shares.
Defining the Value Proposition
The value proposition illustrates the competitive advantages a company’s products or services offer its customers compared to the industry, sector, and broader stock market. 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 business’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 (SEC) or the equivalent report to the presiding agency in the enterprise’s domiciled country.
The company’s profile briefly defines the business and its goods 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 company’s competitive advantages in the marketplace. The protective moat surrounds an enterprise’s unique competitive advantages over other companies or start-ups within the same industry.
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 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.
Alpha-seeking 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. On the other hand, institutional investors, such as portfolio managers and analysts, tend to over-analyze the value propositions of the selected companies with piles of deep-dive research to justify the overriding fees and bonus structures. 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 own the common stocks of companies providing valuable, in-demand products and services that 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 their customers an enduring value proposition of sustainable competitive advantages and steady returns for their shareholders.
SEC Filings and Investor Relations Webpages
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 or equivalence in other countries.
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. Readily access this information on the investor relations section of the company website, an online broker, or a preferred investing website.
Take the time to delve into the organization’s online presence, including its customer-facing website, social media presence, and marketing channels such as advertising and public relations. As the starting point of diligent investment research, reading the Form 10-K Annual Report or similar and reviewing the investor relations site are priorities one and two for quality-driven investors.
For example, in the 10-K, mainly the section titled Item 1 Business, 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 business’s earnings potential to propel the stock price upward over a long-term holding period.
I challenge individual investors prone to skip annual reports and other SEC or government agency 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 factories, warehouses, stores, e-commerce operations, C-suites, and boardrooms.
Create Company and Stock Profiles
The stock market sector is the 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, I avoid the speculative commodity-driven energy and materials sectors while empathizing with retirees investing in real estate investment trusts (REITs) and utilities for stable income opportunities.
Major exchanges denote whether shares trade on the New York Stock Exchange (NYSE) or Nasdaq Stock Market (NASDAQ), including foreign-based companies’ American depositary receipts (ADRs). Avoid over-the-counter (OTC) issues as a speculative and illiquid trading paradigm.
Market capitalization indicates whether the market has capitalized the stock as a large- mid- or small-sized company. Avoid microcaps and penny stocks or issues trading at less than five to ten dollars a share for being too volatile and speculative.
Products and services are the company’s essential offerings, whether tangible goods or intangible services. Bypass ownership of slices of businesses with sophisticated or confusing value propositions. 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 the stock price since the market closed 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. Investors 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. Quality-driven investors target companies surrounded by wide or at least 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 rational 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.
Write 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 the 11 companies owned in the QVI Real-Time Stock Picks Concentrated Portfolio at the time of writing this chapter:
Alphabet (NASDAQ: GOOGL) dominates search, data analytics, and maps with Google, mobile devices with Android, web browsing with Chrome, collaboration with Gmail and Drive, video with YouTube, and it’s a rising star in the cloud and artificial intelligence.
Amazon(.)com (NASDAQ: AMZN) enjoys retail market dominance, including the ever-growing reliance of businesses on Amazon Web Services, consumers and small businesses on Prime, and authors and book buyers on Kindle Direct Publishing.
Apple (NASDAQ: AAPL) is the preeminent leader in productivity hardware and services, whether business or personal, mobile, wearables, television, or desktop, each anchored by its unparalleled iOS ecosystem.
Berkshire Hathaway (NYSE: BRK.B) is the Warren Buffett-built conglomerate of diversified businesses owned wholly or held in its massive stock portfolio, and, thus, better than an index fund because of its emphasis on quality and value.
The Coca-Cola Company (NYSE: KO) is a legendary global powerhouse with a ubiquitous brand name that likely isn’t going anywhere except retailers’ shelves, fountains, and vending machines, and consumers’ refrigerators, pantries, and cupholders.
The Kroger Company (NYSE: KR) originated the supermarket model and now leverages its experience and scale to outperform direct competitors, the non-cyclical consumer sector, and the broader stock market.
McKesson (NYSE: MCK) is best of breed in the legal drug and medical supplies distributor oligopoly, equating to a long-term competitive position in the healthcare-dominated 21st Century.
Microsoft (NASDAQ: MSFT) is the reigning king of productivity applications software, whether business, personal, cloud, or desktop.
The TJX Companies (NYSE: TJX) has superior inventory management, a powerhouse global buyer network, loyal shoppers, and historically consistent financial performance.
The Walt Disney Company (NYSE: DIS) reigns as the original content king in film, television, and themed resort entertainment.
Union Pacific (NYSE: UNP) owns the highest quality business model in the North American freight rail oligopoly.
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 publicly traded companies as represented by their share prices 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 a slice of the business.
Read the filings submitted by senior management to the SEC, especially the most recent 10-K annual report or the equivalent agency report in the country where the comapny is domiciled. Become an informed investor by acquiring valuable knowledge of the business’s products or services, including the employees, supply chains, markets, governments, and customers collectively producing, trading, regulating, and consuming the company’s offerings.
Next, construct or curate company and stock profiles, including assigning an economic moat rating.
While conducting due diligence on a business, ask:
What value do the products or services offer 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 a confident understanding of the targeted business’s prospects from the value proposition or durable competitive advantages toward continued growth and prosperity, as reflected in the stock price over time.
Publicly traded companies with resolute employees producing clear and compelling value propositions are more coveted than faceless stocks trading at attractive valuation multiples or momentum stock prices on an unnecessarily sophisticated chart.
Remember to define the value proposition of the offerings from a targeted enterprise in a short phrase or elevator pitch. Finally, if comfortable with a basic understanding of the business, continue the current wealth and present value checklist of due diligence toward initiating a possible ownership slice of the company.
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. Sidestep the crowd and get acquainted with the enterprise generating the equity’s facts and figures instead.
Understanding the durable competitive advantages with conviction is essential to thriving quality-driven value investors. The more we learn and comprehend the value propositions of companies invested in, the higher the chances that the underlying shares will achieve alpha over time.
Copyright 2024 by David J. Waldron. All rights reserved worldwide.
About the Author
David J. Waldron is the contributing editor of Quality Value Investing, and author of the international-selling book Build Wealth with Common Stocks: Market-Beating Strategies for the Individual Investor. David’s mission is to inspire the achievement of his readers’ financial goals and dreams. His work has been featured on Seeking Alpha, TalkMarkets, ValueWalk, MSN Money, Yahoo Finance, QAV (Australia’s #1 Value Investing Podcast), Money Life with Chuck Jaffe, LifeBlood with George Grombacher, The Acquirer’s Multiple, Capital Employed, Amazon, Barnes & Noble, Apple Books, the BookLife Prize, and Publisher’s Weekly. David previously enjoyed a 25-year career as a postsecondary education executive. He 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.
