Why investing in stocks with noted brands may not be safe... - The 5 Minute WrapUp by Equitymaster
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Why investing in stocks with noted brands may not be safe...

Jul 4, 2015

In this issue:
» Is India well positioned to repay its near term debt obligations?
» Most of the populist UPA schemes were misdirected
» An update on markets
» ...and more!

Our Co-head of Research, Rahul Shah, is an ardent Warren Buffett fan. His thought process is highly influenced by the value investing style that Buffett follows. Since I sit very next to him I also figured out that he has one trait quite similar to the Oracle of Omaha. Though I am not talking about any investing similarity here the resemblance is quite striking. Well, like Buffett even he likes to gulp Coke. Not the cherry flavour though. It is the dietary version of the aerated drink that tickles his taste buds quite well.

Considering that the soft drink market is a duopoly with Pepsi and Coke dominating the scene, consumer stickiness and brand loyalty matter a lot. So, one day while he was having Coke I asked him a question whether he would have the same drink if labelled in a different can. Of course not, came in his prompt reply and quite understandably so. Not only him but if you would have asked this question to anyone else, the answer would have been the same. Such is the power of brand. It brings in consumer stickiness and recall. Brand also ensures good quality. So, a consumer stays loyal to it.

From an investing perspective, if a brand is consumption oriented it has far less risk over the long term. Even Lenovo and Sony are brands for that matter. But technological obsolescence can make them redundant. Think of Nokia for example.

So, basically a top class brand in the consumption space makes the business infallible to some extent. Buffett knew this very well and hence he started buying Coke since 1988.

However, recently when I came across an article my view that brands are invincible was shaken a bit. It said that smaller regional aerated drink makers are taking away the market share from Coke and Pepsi!

The impact is so huge that these regional players have now become a part of board room discussions for these two giants. At the first instance, this is a bit difficult to digest as apart from being strong brands, Coke and Pepsi have unmatched distribution network. You may easily find Coke in my hometown which has no 24 hour electricity. Such is their reach.

Hence, believing that local aerated drink makers can give such brands a run for their fizz is illusionary. But it has started to happen. So, what is their USP? Well, offering quality products at cheaper price is what has helped them. However, the bigger advantage is that they are regional. Being regional means there is no cannibalization amongst these players. However, since Coke and Pepsi are omnipresent they have to bear the brunt of this regional supremacy of smaller players.

If there were just one or two strong regional players, the impact on brands would have been minimal. However, since many new regional players are mushrooming Coke and Pepsi are losing market share. In fact, in some regions competition has also forced these brands to lower their prices.

This has given an interesting insight into what innovation and changes in market dynamics can do to brands. Thus, while brands are a very strong moat even they are susceptible to risks. The Maggi fiasco is another example of how a brand can come down to its knees.

Hence, investors should keep such factors in mind while investing in any company that has a moat of a strong brand. Analyze the longevity factor of such a moat. Assess whether external factors can influence it or not. Only when you get satisfactory answers, it would make sense to invest in the company from a long term perspective.

Do you have any company in your portfolio with a strong brand that has not generated the kind of returns you desired? If yes, what do you think is the reason for it? Let us know your comments or share your views in the Equitymaster Club.

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 Chart of the day
After RBI governor Raghuram Rajan sounded off yesterday that an economic recovery may be on its way, here's another piece of good news. India's ability to withstand external shocks has been steadily improving. As you can see in today's chart, external debt to be paid off in one year or less as a percentage of foreign exchange reserves has been going down from its FY13 levels. It touched a high of 59% in FY13. It is now down to 54.9%. In fact, short-term debt as a proportion of total external debt in FY15 is also down to a multi-year low. Put together, these two facts mean that our defences against any short term volatility on the external front are on the rise. In the backdrop of the uncertainties emanating from the Greece crisis and China's slowdown fears among others, these are comforting developments indeed.

How is India placed to meet its debt obligations?

That the UPA reign was marked with corruption, policy paralysis and general apathy is a fact well known. Indeed, all these factors eventually led to the party losing badly to the current Modi government in last year's general elections. Although it is no longer in power, some of the populist schemes that it proposed to be introduced continue to draw a lot of flak. The Food Security Act and the Land Acquisition Act are classic examples of this. And this has become all the more apparent if one examines these Acts in light of the government's socio-economic and caste status (SECC 2011). Take the Food Security Act, which was the brainchild of the erstwhile UPA government. As reported in an article in Firstpost, of the 17.91 crore rural households covered, around 75% of these would be considered deprived and eligible for subsidized food supplies. This puts the figure at somewhere around 13.4 crore households. However, the census data puts this number at 8.69 crore households. This means that the UPA has simply overstated the number and the government would have ended up just throwing money where it was not required.

The Land Acquisition Act is another pain point. The UPA assumed that the farmers will be big losers and based on this it came with a version of the Act that made land acquisition expensive and cumbersome. But once again the socio-economic census puts this assumption to the test. Around 70% of rural India needs jobs rather than land for its well-being. And these jobs will not come unless land is used for building infrastructure, homes, schools and hospitals. In such a scenario government will have to do a lot of work in changing perceptions and drive home the fact that land acquisition is not something that will only favour the rich. Whether it will succeed in doing so remains to be seen.

It was a bad week for global stock markets. The sell-off in Chinese markets continued (down 12.1%) this week. The bursting of the Chinese stock market bubble was inevitable and it is anyone's guess when the carnage will end. However, the center of the storm was in Europe, specifically Greece. The country defaulted on its sovereign debt (Euro 1.54 bn owed to the IMF) on 30th June. The crisis has only escalated since then. The government has called for a referendum on Sunday, 05th July to decide if it should accept the further bailout terms or not. A 'No vote' could set the stage for an eventual exit of Greece from the Eurozone. The European markets were understandably hit hard this week due to these unprecedented developments.

The US stocks too ended the week in the red (down 1.2%). This was largely on account of concerns regarding ongoing crisis in Greece. The US markets remain driven on liquidity. Thus, the timing of the start of the interest rate hike cycle by the US Fed will keep the markets on tenterhooks for the foreseeable future.

Coming to Indian stock markets, the benchmark indices posted moderate gains this week. The resilience of the Indian markets can be attributed to the better than forecasted rainfall thus far as well as hopes of a pickup in the capex cycle. The BSE-Sensex gained 1% over the week.

Performance during the week ended 03 July, 2015
Data source: Yahoo Finance

 Weekend investing mantra
"Forecasts may tell you a great deal about the forecaster; they tell you nothing about the future" - Warren Buffett

This edition of The 5 Minute WrapUp is authored by Jinesh Joshi (Research Analyst).

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2 Responses to "Why investing in stocks with noted brands may not be safe..."


Jul 9, 2015

I see frequent mention of firstpost in your articles. Firstpost is the last place that i want to visit to get any information partly because of their biased news which seems to show the govt in more negative view. Hope you can quote some credible unbiased source of information in your article.



Jul 4, 2015

People should understand that nothing is permanent . Every co. must be on its toes reg. its moat, innovation, price differential, market preferences etc. Classic eg is NIRMA VS UNILEVER, COLGATE VS.P&G,Typewriter cos ,Nokia ,now Desktop computer systems, even our IT cos.

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