Stock Shastra #5: Great Brands are an unbreachable moat

In Stock Shastra #4, we said that to invest in a wonderful company, you need to look at a business with an unbreachable moat (a sustainable competitive advantage that helps the company remain a winner, even in tough times). We talked about 5 different moats that a business can have: Brand, Secret, Switching, Toll and Price. But, how does each moat make the company a winner? And what are some good examples of companies in India with these moats? Let start with the first Moat i.e. Brand.

What is a Brand?

Did you know this?

Every Indian consumer uses, interacts or at least comes across 2 Godrej products every day in his/her life. It can be a Godrej cupboard, appliance, furniture, safe or lock.  Right from consumer products like soaps & hair-dyes to equipment parts for spacecrafts, Godrej has a presence in almost every sphere.

This is the power of a Brand. It connects emotionally with consumers and becomes an integral part of their lives.

Brands are represented by a name, phrase, sign, symbol or a combination of these. It is the unique identity, association, emotion; which a product or service creates for itself in the mind of the consumers.

Brands become synonymous with the products & services used by consumers. Take the example of adhesive bandages. When we go to a medical store we ask for Band-Aid. Most of us maybe unaware that Band-Aid is the brand name for Johnson & Johnson’s adhesive bandages. Its popularity across countries has made the brand name synonymous with the product. Examples like Fevicol or Fevistick in the adhesive category, Amul in the Milk & Milk product category; further prove this point.

Companies which have a brand as a moat can generate profits consistently in the long run & emerge a winner during tough times. Let us see how brands become a moat.

Why is Brand a Moat?

When a company creates a successful brand, it creates loyal consumers. When consumers are happy & satisfied with a brand they are unlikely to switch. When happy consumers talk enthusiastically about their favorite brand they help the brand attract more consumers at virtually no marketing cost. This leads to higher profitable market share. Financially, this translates as higher sales & profits for the company.

Brands make the process of taking decisions easier for the consumers & bring peace of mind to them. As consumers love the brand, they do not mind paying a premium for its products & services. Take the example of Asian Paints. It is a classic example of a successful brand which charges a premium in the paints category.

In this age of advertising clutter, successful brands break through the clutter and become a part of the consumer’s consideration set i.e. the shortlist of brands a consumer will consider buying from. Take the example of small cars. Maruti brands will most certainly be a part of every consumer’s shortlist while buying a small car.

A company with a strong & successful brand also has the ability to expand to other product & service categories with ease. Titan is one such brand. It is the largest manufacturer of watches in the organized sector in India. Over the years, Titan has diversified to other categories like Jewellery & Eyewear. It has been quite successful in these product categories too. The company has been able to diversify because of the trust and value that the brand commands. You can refer to our “Company Shastra” to know more about this great brand.

Translating the Brand Moat to outstanding financial track record

While successful brands are a moat, it takes more to translate it into an outstanding financial track record.

First, while brands can earn money, it cannot prevent companies from poor investment decisions, spending disproportionately to achieve short term results, giving away more than required to channel partners, succumbing to price wars etc. Every category has competition. When successful brands do not evolve and maintain the edge over competition, over a period of time they get diluted and the brand ceases to be a moat. This means brands require innovation and investment in the long term. Management that fails to act on this, end up losing an asset that has taken years to build.

When you look at any product category, you would be aware of the top 2 or 3 brands in that category. Find out which company owns these brands. Then look at the 5 critical parameters to know the financial track record of these companies. Such companies with an excellent track record over 10 years clearly own great brands and know how to use this as a moat to keep succeeding. These are stocks you should consider buying, of-course at the right price.

The next Stock Shastra will talk about the second moat i.e. Secret/Patent. See you soon with Stock Shastra#6.

You should also read the following:

1. Stock Shastra #1: Stock Investing is not Rocket Science!
2. Stock Shastra #2 – Buy a wonderful business and not just a stock!
3. Stock Shastra #4: Look for companies with unbreachable moats
4. Stock Shastra #6: A company with Patents/Trade Secrets is well protected from competition
5. Stock Shastra #8: ‘High Switching Costs’- a recipe for companies to hold customers for life