Never underestimate the power of a strong brand - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

Never underestimate the power of a strong brand 

A  A  A
In this issue:
» Service sector dominates list of top Indian brands
» Rigid labour laws have hampered India's growth
» Are ethics to blame for the rot in PSU banks?
» Europe getting closer to adopting outright QE...
» And more!

Warren Buffett is arguably the greatest investor of all time. Over a career spanning more than four decades, his company, Berkshire Hathaway has created unbelievable wealth for its investors. In the list of richest people in the world, Buffett is an exception. There are very few investors to be found on such lists and none right at the top. Yet his name has featured in the top five consistently since the 1990s. His amazing success and wealth has led some people to believe that there is something magical about his investing skills. Indeed, his track record is certainly magical! However, it is really not so hard to understand Buffett's investing principles.

At the very core of Warren Buffett's method, is a concept called 'economic moat'. Allow us to explain. In simple words, a moat is nothing but a competitive advantage enjoyed by a business. It allows the business to earn a higher return on invested capital, compared to its competition. A moat will enable a business to price its products/services higher than the competition and still not lose out on sales. What are the sources of such a moat? There are many. Entry barriers, a unique patent, low cost of production, high switching costs and strong brands are some of the important sources. Out of these, perhaps the toughest to analyse, is the intangible power of strong brands.

There are many brands across industries. The chart below shows some of the strongest brands in India. But a brand which is strong today may lose its appeal down the line. The few brands, such as Coca-Cola which stand the test of time, create huge wealth for the company and its shareholders. Recently, ITC was named as India's most admired company. The position that this company has established for itself is due, in large measure, to the strength of its brands. The concept of a strong brand as a source of a moat may be a simple one to understand. What is not easy, however, is to identify those brands that have the potential to make shareholders rich. This problem is compounded by the fact that on the share markets, the valuations of such companies are seldom cheap!

This is not a small problem. Even Warren Buffett nearly missed out on a great investment opportunity in 1971, over the valuation of the company, See's Candies. The company's brands were very strong but to Buffet, the valuations seemed to be slightly stretched. Thankfully, he did buy the company and it taught him one of the biggest lessons of his career: 'It is better to buy a great business at a fair price than to buy a fair business at a great price'. We could not agree more. If you were to remain invested in such a company for the long-term, the stock can certainly multiply your wealth. But how does one go about finding them? Well, we have put this principle into practice. Identifying business with strong moats lies at the heart of our ValuePro portfolio recommendation service. As an example, earlier this month in this service, we recommended a company with a moat that is powered by its strong brands. While ValuePro is a service that focuses on long-term returns, this particular stock has done quite well for itself in the short run too and is up by nearly 20%! So, if you have not benefitted from this approach of identifying such companies, we recommend that you join ValuePro now. And benefit from the great power of economic moats for years to come.

Do you think companies with strong brands are the best investments? Let us know in the Equitymaster Club or share your comments below.

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02:10  Chart of the day
A strong brand is a powerful tool for any business as it attracts consumers; allowing it to place and price products and services differently. If a company is able to leverage on this aspect, then it would have a positive impact on its overall business valuation. As aptly put by Warren Buffett in one of his letters - "Businesses logically worth far more than net tangible assets when they can be expected to earn on such assets considerably more than market rates of return. The capitalized value of this excess return is economic Goodwill. "

Today's chart of the day shows some of biggest brands in the country. This list is released by BrandZ, a WPP property. HDFC Bank, Bharti Airtel and State Bank of India lead the list of the top brands in the country. What is also interesting is that - as per the survey - seven of the top ten brands and 30% of the top 50 brands in the country came from the services sector. Another interesting point is that only 7 of the top 50 brands belong to PSUs.

The top 5 corporate brands in India

A leading daily has pointed out about India's agriculture share in GDP, which has declined from 40% in 1973-74 to 14% now. The service sector takes the large chunk in the pie now. But this paradigm shift does not seem to have helped in creating enough employment. Despite India moving away from agriculturally-oriented economy towards the service sector; agriculture still employs large chunk of population. Besides, inflexible labour laws, poor infrastructure and ample red tapism have pushed a lot of our workforce in the unorganized sector.

Clearly, the government has not made far-reaching efforts to bring about the change in this direction. The government needs to bring in massive reforms in labour laws. It also needs to take a relook at its various policies. This in turn will push labour from the unorganized sector to organized ones. It is well acknowledged that ramp up in capital spending and infrastructure goes a long way in taking a country's growth to the next level. Thus ramp up in capital spending and infrastructure can help to address this issue. On a much macro level, to raise India's growth trajectory, a broader reform agenda is needed. Thus the government will have to take measures to make the climate more conducive for capital investments by pushing through reforms and implementing them. This may seem like a considerable challenge however, it is left with no option but to take a tough stance in the longer term health and interest of the Indian economy.

"It takes 20 years to build a reputation and five minutes to ruin it. If you think about that, you'll do things differently". These words of Buffett should be the guiding light for company managements that wish to create solid business with long lasting reputation. However, the chiefs of most PSU banks in India clearly have had no such intentions. For they were busy making the most of their short tenures and recovering the bribes that they would have possibly paid to get to their posts.

The instance of bribery in PSU banks is not a one off event as claimed by the Finance Minister. Nor is it an isolated case of poor ethics. The lack of transparency in the manner in which PSU bank chiefs are selected has for a very long time perpetrated poor ethics in PSU banks. Add to that the fact that constant rotation of the top management leaves nobody accountable for the performance of the banks. The chief promoter, the government, is only interested in consistent dividend receipts from the banks as against value creation. Hence it is only the minority shareholders who bear the brunt of value destruction. Prosecuting few PSU bank chiefs without correcting the system of their recruitment and performance appraisal will not put an end to the rot according to us. And until then investors will have to be very skeptical about the choice of PSU banks, irrespective of their valuations.

Imagine the cost of capital of a firm in an economy to be around 15%. Now, what do you think will happen when this is artificially lowered to say just 5%? A lot of the companies that were unprofitable before, will now suddenly start looking profitable isn't it? They will compete for all kinds of resources viz. human as well as capital with their more accomplished counterparts and will not only create inflation but will also destroy wealth. We say destroy because if not for the lowering of cost of capital, the wealth would have been much better off in the hands of more productive firms that survive even the 15% cost of capital environment.

Now add another element in this society by way of money printing and it is not hard to realise that this money printing is certainly not going to create real wealth. What it will end up doing is enable the first users of this money to exchange something for nothing. Therefore, rather than real wealth creation, the society will end up redistributing the existing quantity of wealth.

If you want a real life example of this, look no further than the US. The world's largest economy has been carrying out exactly these measures that we have highlighted and little wonder; it hasn't moved the needle much in terms of GDP growth. What more, even the European Central Bank is seriously thinking of copying the US model. And we can say this with great degree of certainty that the results are not going to be much different than that in the US. What do you think?

After opening firm, the Indian stock markets continued to trade positive. At the time of writing, the BSE-Sensex was trading up by 182 points (0.7%). Barring metal and realty, all the sectoral indices were trading in the green led by IT and pharma stocks. Most of the Asian markets were trading strong led by Japan and Singapore. However, the Chinese market was trading lower. European markets have opened the day on a positive note.

04:55  Today's investing mantra
"We want to be right on something that will work right now, not something that might work in the future." - Warren Buffett
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