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Have you ever heard of the lipstick theory?

It's the idea that during tough economic times, sales of cosmetics, particularly lipstick, tend to rise. The theory suggests that in times of economic uncertainty, people tend to focus on small indulgences, such as a new tube of lipstick, to boost their mood and feel better about their appearance, even if they can't afford to splurge on larger luxuries.

But what does this theory mean for investors? Let's explore.

The lipstick effect is a real phenomenon. It's been observed during past economic downturns, such as the Great Recession of 2008, and is likely to occur again in future recessions (and the current[?]). For investors, this means that certain industries, such as cosmetics, could see increased sales during tough economic times while others may struggle.

The concept of the lipstick theory can be extended beyond the cosmetics industry to other sectors. It involves the transfer of higher-cost items to lower-cost alternatives due to economic conditions. For instance,people are opting to purchase used cars or repair their existing vehicles instead of buying new ones due to the decreasing disposable income. Similarly, instead of traveling to resorts for a week-long vacation, people are opting for domestic or weekend trips. In an economic downturn, individuals must prioritize and compromise their spending.

While some industries, such as gambling, alcohol, and sex toys, have seen an increase in sales during economic downturns, this theory does not apply to luxury goods. High-end products are more stable than mid-end and low-end products due to the wealth of their customer base. Customers who can afford to spend tens of thousands on luxury items do not compromise on quality, as they have a considerable amount of disposable income. In contrast, mid-end and low-end customers have less disposable income and are more sensitive to price changes.

Even high-end companies are affected during economic downturns. Mid-end customers who have ventured into the high-end market may revert back to the mid-end market once the economy stabilizes. Therefore, the impact of the lipstick theory varies across industries and customer segments.

The lipstick theory comes down to the positioning of the company and its strategy. Reverting back to the framework of Michael Porter and his Power model. See my article on the model. Two strategies he proposed for a company to pursue are low-cost provider and differentiation. We are seeing how these two strategies benefit two different kinds of companies, the low-end companies, as more will be prudent with their spending, and the high-end companies’ customer group is stable through an economic downturn.

Additionally, the lipstick effect may not be as pronounced in today's economy as it was in the past. With the rise of social media and the emphasis on personal branding, people may be more likely to invest in higher-end makeup products rather than just picking up a drugstore tube of lipstick.

So, what should investors keep in mind when considering the lipstick theory? Here are a few key takeaways:

In summary, the lipstick theory can provide investors with some insights into consumer behavior during economic downturns, but it should not be the only factor in investment decisions. Investors need to dig deeper and consider a variety of factors when evaluating potential investments.

As an investor, one of the most critical skills to possess is adaptability. The world of finance and investing is constantly evolving, and being able to adapt to changing circumstances can make the

difference between success and failure.

One of the most significant changes investors have faced recently is the shift from a low-interest and low-inflation environment to a high-interest and inflation environment. For decades, interest rates and inflation remained relatively stable, with central banks around the world keeping rates low in an effort to spur economic growth. However, over the past few years, interest rates have started to rise, and inflation has picked up the pace, leading many investors to wonder how to navigate this new environment.

The first step to adapting as an investor in this new environment is to understand the changes that are happening. In a high-interest and inflation environment, the cost of borrowing money goes up, making it more expensive for businesses to borrow and invest in growth. This can lead to slower economic growth, lower corporate profits, and lower stock prices. Additionally, as inflation rises, the value of money declines, making it more difficult to maintain purchasing power over time.

Given these challenges, it's crucial for investors to adjust their investment strategies accordingly. For example, in a high-interest environment, investors may want to focus on bonds and other fixed-income investments that can provide a steady stream of income. However, they will also need to be aware of the risks associated with these investments, such as interest rate risk and credit risk, and ensure they are adequately diversified. Just look at what happened to the regional banks in the US. At the same time, investors may want to consider investing in commodities such as gold or oil, as these tend to perform well in inflationary environments. Additionally, they may want to look at sectors such as real estate, which can be a hedge against inflation due to the potential for rental income and appreciation in property values.

Another important consideration for investors is the impact of high-interest rates on debt. Higher interest rates can make it more difficult for individuals and businesses to service their debt, which can lead to defaults and bankruptcies. As such, investors should be cautious when investing in companies with high levels of debt, as they may be more vulnerable in a high-interest environment.

As an equity investor, you need to change what you look for, as growth does not have the same value as one year ago. If a company grows 10% and inflation is 10%, the real growth is actually 0%. Therefore it is more important to look at the margins in this kind of economy, and as mentioned above, the financial net and debt position are probably the most important to keep an eye on in a company’s financials. Growth, market share, and the total addressable market are not as important as one year ago. Of course, it is still important for a company long term.

Investors need to shift their focus when it comes to equity investment in a high-inflation environment. A company's growth, market share, and total addressable market are no longer as important as they used to be, as the real growth could be zero when the inflation rate is high. Instead, investors should pay closer attention to gross and profit margins, free cash flow, and net debt position. With rising inflation, gross margins are under

pressure due to the increased cost of materials, while higher salaries, external services, and financing costs affect profit margins. Therefore, focusing on profits is essential instead of EBITDA and EBIT.

Although profits and earnings can be manipulated for a period through accounting, cash flow provides a more accurate picture of the company's financial situation. Determining if the company needs more funding is

crucial, especially in the current environment, where investors are no longer investing in long-term growth stories is crucial.

Lastly, investors should check if the company has a net cash or net debt position, with the former being preferable in a high-interest environment. It's also essential to consider the interest coverage ratio and net debt to EBITDA, particularly if the interest rate is fixed or variable. Investors should be cautious of bonds that need refinancing in the near future as interest payments may increase significantly, affecting the interest coverage ratio. Therefore, past interest coverage ratios may not be a reliable predictor of future coverage ratios.

Returning to the topic of growth, it's essential to examine the factors driving it. If growth is solely driven by price increases without any corresponding growth in volumes, it's considered low-quality growth. The situation worsens if the volumes are declining, and price increases merely compensate for the lost volume, constituting the entire growth.Therefore, it's crucial to remember that all growth is not of the same quality.

In conclusion, adapting as an investor in a high-interest and inflation environment requires a willingness to adjust investment strategies to reflect changing market conditions. This means being aware of the risks and opportunities associated with different asset classes, maintaining a diversified portfolio, and being prepared to make changes as needed. By doing so, investors can confidently navigate this new environment and achieve their long-term financial goals.

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Xbox boss Phil Spencer says that a store that would rival Appstore and Play store could be launched as soon as the next year.

Interesting that Microsoft $MSFT takes up the competition with Apple and Google. Trying to leverage their position on computers to mobile games.

Very interesting, as Unity has tried to create one themselves and failed.

Microsoft is certainly going after Google's lunch with attacks on both search and now Play Store.

I think this is very interesting for one company in Sweden. Flexion Mobile.

What could be a problem is that Microsoft wants to handle all the onboarding of games themselves and not let the middleman do it.

Will we have phase two of the mobile platform wars? The aftermath of Epic vs Apple.

My take is Microsoft wants to become the mega Chad of gaming by owning the infrastructure and games (Zenimax/Bethesda and ATVI acquisition). Now attacks the infrastructure of mobile gaming.

Due to mobile gaming growing faster than console and computer games. The trend of more and more people´s first experience with games is through the smartphone. Getting users in early on their games platform can make them keep using the MSFT platform on all three platforms.

The article:

Investors are often likened to wizards or alchemists in certain books, as they appear to generate greater value with a smaller amount of investment. This is why some people equate investing with gambling, as they fail to recognize the value-adding actions taken by investors.

As investors, we exchange capital+time+analysis/understanding=return on investment. The primary challenge stems from the fact that ROI can be negative, putting our capital, time, and confidence in our analysis at risk. This can be an expensive and psychologically taxing experience for many investors. Considering the vast number of publicly traded options (16,000+ according to Börsdata), evaluating each one individually is impractical, and we must make strategic investment decisions to generate profits. Mitigate the issue of information overload.

To do this, we need to establish effective criteria to streamline our selection process while avoiding the exclusion of potentially profitable investments. Although some significant winners may inevitably be missed, a thoughtful approach to limitations can lead to catching more promising opportunities.

We want to increase our odds of finding good investments, and these are a few ways to do it through limitations.

Start where you stand

Starting from your current position provides two advantages: your scope is limited, and you likely possess greater familiarity with the products and services you utilize than some abstract machine that converts used

tires into oil. Consider the products you enjoy using or those that people in your circle typically consume. Remain open to new opportunities, but don't overlook the products and services you've relied on for years. Above all, cultivate a sense of curiosity.

Keep yourself within your circle of competence

Like the notion of starting from your current position, beginning with what you know can be highly beneficial. Consider your educational background, the industry you work in, and your personal hobbies. By introspecting, you're likely to identify areas of interest and proficiency.

Screening

Employing stock screeners is a useful approach to winnowing down the vast number of companies to research, from over 16,000 to perhaps 30. If you're unfamiliar with screeners, I recommend perusing this post on financial tools and websites. Focusing on limitations, let's consider screening variables that eliminate the most unfavorable companies. First, ensure the company has revenue; otherwise, its business model is untested, and the risks are significant. Second, confirm the company is profitable and has positive cash flow. Steer clear of firms that must issue new shares to remain operational. Third, screen for a Net Debt to EBITDA ratio of 1.5 or

lower, meaning the debt can be repaid within 1.5 years. Fourth, look for growth in the last three years that doesn't stem from unique situations like a pandemic or similar events. By starting with these criteria,

you'll avoid buying the worst-performing companies in the world and get off to a solid start.

Investment checklist

With an investment checklist, you make sure to cover all the bases you want to cover and that you focus on the important points when researching a company. It can be just some simple steps in order to do everything in a specific order. I divide my analysis into People, Business, Market, and Numbers. Then I have questions I want to answer when I do my research.

Theme investing

Investing in themes can prove highly beneficial since structural trends foster growth among all companies in the same theme. Additionally, themes provide a rapid way to gain familiarity with the relevant industry.

Limit the number of positions in your portfolio

Establishing a predetermined number of positions in your portfolio compels you to assess one investment opportunity against another. This approach urges you to weigh the risks and rewards of each opportunity.

There's another advantage to this strategy as well: by limiting the number of positions, it's simpler to keep track of and stay informed about each company.

Avoid biotech

The biotech industry is intricate; by applying the earlier restrictions, you may even choose to avoid investing in this sector altogether. The chances of a favorable outcome are minimal, and the average odds are not in your favor. Furthermore, comprehending the specific disease or symptom in question would require significant time and effort if you delve into the industry. Even if you identify a promising company within biotech, it's crucial to consider that financing studies for each phase are costly, which could result in the issuance of multiple rounds of new shares.

Stay away from binary outcomes

Binary outcomes are never favorable; the result is either 100% positive or 0% negative. Even if you assume a 50/50 chance, it is essential to re-evaluate your assumptions. In reality, those binary outcomes tend to lean towards the negative outcome based on the number of times such situations have occurred.

Do you set any limitations on your investing strategy? That will increase your return on your portfolio, save time, or make it easier to understand a company.

Capital allocation is the process of deploying a company's financial resources in the most effective way possible to achieve its goals and objectives. There are several ways in which companies can allocate their capital. This article will discuss the five most common ways to allocate capital: internal investments, paying off debt, acquisitions, share buybacks, and dividends. But first, we need to talk about the basics of capital allocation. The foundation of a sound capital allocation decision is to generate a higher return on the investment than the cost of capital.

If a company has a cost of capital (discount rate or WACC) of 15%, they are presented with the decision options below. They need to choose investments that generate 15% and above; otherwise, the investment will

deteriorate the value of the company.

Let’s go through the options a company has when it comes to allocating capital.

Internal investments are the activities a company allocates towards its operations, which may involve financing research and development, creating new products or services, or broadening its business activities. Such investments are commonly employed by companies focused on growth, seeking to extend their market dominance or generate novel sources of income. However, internal investments necessitate substantial resources and involve potential risks, such as the possibility of suboptimal returns or project failure.

Paying off debt can increase the value of a company in several ways:

increase in its valuation.

rating makes it easier and cheaper for a company to borrow money in the future. This improved creditworthiness can increase investor confidence and a higher stock price, increasing the company's overall value.

Paying off debt can improve a company's financial health and increase investor confidence, which can increase its overall value.

Acquisitions can help companies diversify their revenue streams, expand their market share, and gain access to new technologies or products. However, acquisitions are often expensive and can carry significant risks,

including overpaying for assets or failing to integrate them successfully into the business.

This reduces the number of outstanding shares, which increases earnings per share and can boost the company's stock price. Share buybacks are often used by companies with excess cash and looking to return value to shareholders. Buybacks can also prevent dilution of ownership when employees exercise stock options. Share buybacks are problematic because of the timing issue of the valuation of the share. Iltimed share buybacks can be value-destroying for a company if carried out on a high valuation.

Dividends are typically paid out in cash or stock, and the company's board of directors determines the dividend amount. Mature companies with limited growth prospects often use rewards to transfer excess capital to shareholders. They should be carried out when the above options provide lower returns than the company's cost of capital. Dividends keep the company lean and the return on invested capital high.

Effective capital allocation requires companies to make informed decisions based on carefully analyzing available options. By allocating capital wisely, companies can maximize their return on investment and create value for

their shareholders. There are several fundamental principles that businesses should consider when allocating capital:

Before making any investments, businesses must evaluate each opportunity's potential risks and returns. Riskier investments may offer higher returns, but they also pose a greater threat to the company's financial stability. It's important to strike a balance between risk and return to ensure that investments align with the company's goals and objectives.

Not all investments are created equal, and businesses must prioritize their investments accordingly. Investments that align with the company's strategic priorities and have a higher potential return on investment should be given priority over other options.

Often multiple investment options are available to businesses, and it's essential to evaluate each thoroughly. This includes assessing the potential risks and rewards and considering the opportunity cost of passing up other investment opportunities.

Capital allocation is an ongoing process, and businesses must continuously monitor their investments and adjust their strategies as necessary. This includes regularly reviewing financial performance and assessing whether investments meet their expected returns.

Effective communication is critical when it comes to capital allocation. Businesses must be transparent about their investment decisions and regularly update shareholders and other stakeholders. The world is full of companies with lousy capital allocation. Due to it being a decision by the management and board of directors, the decision-making

can be clouded by several biases. Biases and reasons why management fails to make sound capital allocation decisions.

The goal of the management/board of directors is not to deliver value, or they perceive it as providing value when the company becomes larger.

Many companies strive to increase their dividends each year once they start paying them and may be reluctant to cancel them, even when it's the prudent decision due to changes in the company's financial situation. There has even been a trend in Sweden to carry out a new issuing of shares to have the necessary funds to pay dividends.

Without influential owners or a presence of ownership within the board of directors and management, the company may not prioritize delivering maximum value to shareholders, as their interests may not align.

Furthermore, if the board's primary concern is preserving their salaries, they may hesitate to take risks that could lead to the best outcomes for the company.

Dividends and share buybacks are simple ways to transfer value to shareholders. The simplicity of it has pros and cons. It can be the easy route when evaluating the options available, and it can also be reluctance against it because it feels lazy and counterproductive.

During a bull market, acquisitions are joint, but some of the worst ones occur when companies diversify their revenue streams. Although a new business can offer stability and reduce earnings volatility, an acquisition without any connection, synergy or overlapping interests between the two businesses is never a wise decision. The buyer may lack the necessary knowledge to manage the new business, leading to neglect and, ultimately, a loss of shareholder value.

Return on invested capital is not a widely discussed concept in management and is typically only addressed in finance studies. Consequently, the board of directors and management rarely consider it. This is evident from the low number of companies that include a return on capital in their financial objectives, whether it be invested, employed, equity, or assets. The notion that returns must exceed the cost of capital is even rarer in discussions among the board of directors and management. Furthermore, it's uncommon for a company to set a high-water mark for return on investments to maintain a certain level of return for shareholders.

In summary, capital allocation is vital for companies to manage their financial resources effectively. The five primary methods for allocating capital are internal investments, debt repayment, acquisitions, share buybacks, and dividends.

Each method carries unique advantages and risks, requiring careful evaluation by investors to determine the best approach for a given company. Ultimately, a company's success or failure can depend on its ability to allocate capital wisely, making it crucial for investors to assess the skills of a company's management team when making investment decisions.

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Happy hunting!

Today is the first day of a new chapter in my life. I decided three months ago to resign from being an equity analyst in other to pursue my passions.

I am very thankful for the time with my former employee, and I have learned a lot, especially do I take with me the new relationships I have gained.

At times two journeys don't go together, and here I departed to start my own journey.

I may be influenced by my mother and the rest of my relatives, that have been self-employed for the majority of their life. I want to test my own wings.

If you want to read more, I just posted a longer article on my substack.

Introduction

SWOT analysis is a great way to evaluate a company's qualities and potential to succeed in the market. Which is essential when evaluating if a company is a quality company or not. It is very helpful to have a template to go through the strengths, weaknesses, opportunities, and

threats.

What is SWOT analysis?

SWOT analysis is a tool used in business and marketing. It can help you identify the strengths, weaknesses, opportunities, and threats that affect your business or product.

Strengths are internal factors that support you in achieving your goals. Examples include competitive advantages that give you a competitive edge over other businesses in the market like economies of scale (a large company has greater buying power), proprietary technology or patents (giving it an advantage over its competitors), or intellectual property rights such as trademarks and copyrights (allowing it to protect against unauthorized use).

Weaknesses are internal factors that limit what you can do or the extent to which you can succeed at achieving your goals. Examples include lack of experience with new markets/industries, outdated processes/technology/equipment preventing efficient operation of the organization’s processes and products; lack of resources such as capital required for research & development activities; inability to attract talented employees due to low pay compared with industry standards, etc., which may hamper growth potentials going forward if not addressed quickly enough before they become significant deterrents towards achievement.

Strengths are the things that you have going for you, and they can be both tangible and intangible. For example, one of your strengths may be the fact that your company has always been a leader in innovation. Another might be that customers are loyal to your brand because it has an excellent reputation for customer service.

Answering this question can help you identify ways in which to build on past successes and grow from them.

Weaknesses

Your company’s weaknesses are areas where you are not performing well. They can also be considered opportunities for improvement. Weaknesses can be used by competitors to create a competitive advantage. Some common areas that may be considered weaknesses include:

Opportunities

Opportunities are external factors that can be exploited to the company's advantage. They might be any of the following:

Threats

Threats are external factors that can harm your business. They can be related to the economy, competition, and other external factors.

product or service. This can be a threat; if they don't want to buy from

you anymore, then it's bad news for your company.

lower price than yours, then people will start buying their product.

Sometimes is it very difficult to determine whether an issue is an opportunity or a threat. As they can be both, an opportunity for one actor and a threat to one another. SWOT is very useful when evaluating a company's qualities

SWOT analysis is a useful tool to summarize a company's business in a single classifier environment. Investment research, is used to evaluate the investment attractiveness of companies. SWOT analysis can be used to analyze any entity with which you have an interest or thus, it can be applied in various fields.

It helps you identify the strengths and weaknesses of your organization and also provides information about opportunities for improvement and threats that might affect its future prospects.

Conclusion

The SWOT analysis is a great tool to help you evaluate your business and see the areas that need improvement. It helps us identify the strengths, weaknesses, opportunities, and threats that exist within our company and how we can use these to be more successful in our market. It is very important for an investor to have pictures of the company's qualities and

it’s standing in the market compared with competitors.

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Thanks for reading!

Be aware of when it is important to win and when it is important to not lose! We have been in a loser's game scenario the last year or so, have you played it to not lose or try to win? 🏆😵

An model to identiy moats and better understand a companies position in the value chain

Porter's five forces model is a tool that helps businesses to understand the competitive environment in which they operate and develop an understanding of how attractive the industry or market is. It was developed by Michael Porter, also known as one of the greatest minds in business management. The model was initially designed to help airlines compete with other carriers in an increasingly complex global marketplace. However, the model has been applied to industries beyond commercial aviation, including healthcare, telecommunications, and retailing.

Porter’s model was created to provide a framework for assessing the attractiveness of an industry. It is designed to help companies decide where to compete and where not to compete. This can be done by determining whether the firm has an advantage over its competitors or if it should focus on niche markets instead.

The theory also helps companies determine their strategic positioning, which

impacts resource allocation decisions and competitive strategy development.

Porter’s five forces model is a framework that helps businesses determine the profitability of an industry and the likelihood of achieving a competitive advantage within that industry. Michael E. Porter developed the five forces model and provides an outlook for analyzing an industry's attractiveness and position in other sectors.

The five forces are:

Existing competition - How does it look against the existing competition? Is the market fragmented, or has one clear leader?

Competitive rivalry is a measure of the extent of competition among existing firms. There are several competitive moves that may limit profitability and lead to competitive activities (Dhliwayo, Witness 2022). These actions include price cuts, increased advertising expenditures, and investments in service/product enhancements and innovation. A company's competitiveness is primarily determined by the intensity of its competitive rivalry in most industries. Having an understanding of industry rivals is vital to successfully marketing a product. A product's positioning is determined by how the public perceives it and what distinguishes it from its competitors. An organization must monitor the marketing strategies and pricing of competitors, and any changes should be addressed promptly.

Competition among competitors is fierce, and industry profitability is low due to the following factors:

Threat of new threats - As new entrants seek to gain market share, they pressure existing organizations. This puts pressure on prices, costs, and the rate of investment needed to sustain a business within the industry. If new entrants enter a new market from an existing one is, the threat exceptionally high as it can leverage the existing expertise, cash flow, and brand identity, which pressures the current company’s profitability.

Barriers of entry will reduce the threat of new entrants. Meanwhile, if the barriers are low, it will be the opposite, and new entrants can flood the market. Michael E. Porter lists seven major sources of barriers to entry.

going and to deliver a product before any revenues can be produced. Clearly, the Internet has influenced this factor dramatically, and Websites and apps can be launched cheaply and easily as opposed to the brick-and-mortar industries of the past.

A substitute product uses a different technology to solve the same economic need. Examples of substitutes are meat, poultry, and fish; landlines and cellular telephones; airlines, automobiles, trains, and ships; beer and wine; and so on. For example, tap water is a substitute for Coke, but Pepsi is a product that uses the same technology (albeit different

ingredients) to compete head-to-head with Coke, so it is not a substitute. Increased marketing for drinking tap water might "shrink the pie" for both Coke and Pepsi. In contrast, increased Pepsi advertising would likely "grow the pie" (increase consumption of all soft drinks) while giving Pepsi a larger market share at Coke's expense.

Potential factors:

however, contractual and legal barriers are also practical.

The bargaining power of customers is also described as the market of outputs: the ability of customers to put the firm under pressure, which also affects the customer's sensitivity to price changes. Firms can take measures to reduce buyer power, such as implementing a loyalty program. Buyers' power is high if buyers have many alternatives, and it is low if they

have few choices.

Potential factors:

chicken run with the suppliers as the margins are so small.

meanwhile some products actually go up in demand with price increases. Important to look at the price dynamics.

The bargaining power of suppliers is also described as the market of inputs. Suppliers of raw materials, components, labor, and services (such as expertise) to the firm can be a source of power over the firm when there are few substitutes. If you are making biscuits and there is only one person who sells flour, you have no alternative but to buy it from them. Suppliers may refuse to work with the firm or charge excessively high prices for unique resources.

Potential factors:

important input of its product. If the labor market is out of balance, can, the employee raises the salary claims, and the personnel costs will increase. Labor unions will also be impacting this factor.

Applications and research

Porter’s model has been applied to several industries beyond the airline industry. For example, it has been used to study the competitiveness of U.S.-based firms in a globalized economy (Wilmot et al., 2002) and to analyze changes in labor costs over time (Mitchell & Neumann, 2005). The model has also been used as part of a research agenda on global strategy (Bryant & O'Reilly-Porter 2008).

Using Porter's Five Forces Analysis can help identify potential threats or opportunities for

an organization and factors that may affect its success at achieving its goals. Such analyses can provide insight into how competitive forces within an industry might affect competition between firms operating within that same industry; therefore allowing organizations to

understand better where they stand relative to others competing against them for them to achieve their objectives more successfully.

The Porter Diamond of National Advantage

The Porter Diamond of National Advantage is a way to visualize the five forces:

The quality dimension is represented by the strength of competition in each industry. If there's low competition, you can expect that your competitors will have more inferior quality products or services than yours will be able to provide at competitive prices. On the other hand, if there are many competing firms in the industry but few of them are

profitable enough to survive over time (i.e., survive without being bought out by larger companies), then this can lead them down a path towards failure because they won't be able to keep up with their competition while also having enough customers left over after all their

competitors have disappeared from existence! In other words: no matter how hard we work at being efficient cleaners who provide high-quality service every time we wash our customers' windows -- even if our competitors do all sorts of things wrong like charging customers much more money than they should charge us ($$$) -- eventually someone

else comes along who offers better deals on chemicals used during cleaning services...

How to use it in investing analysis?

Porter’s Power Model serves as a good tool for where to look for moats. Moats as a definition produce long-term profits and protect the market share of the company. This is what the Power Model analyzes. How a company can protect its market share, and margins, and keep growing. Porter has laid out which five players matters for this analysis: Rivals, suppliers,

customers, new entrants, and substitutions. If you figure out a company can keep its advantage against these five players will probably your company have a wide moat. Would still be a pretty wide moat if the company can have an advantage over three of these players, but the advantage is not black or white as you can understand by the potential factors listed above.

Let’s look at a highly qualitative company that all know about Apple (we focus on the iPhone for simplicity's sake). Apple’s bargaining power against customers is very high, there are only one phone made with IOS and only a few models. Bargaining power against suppliers is another thing, quality is a very important part of the experience of the iPhone. So Apple can’t go anywhere to source its parts due to the quality aspects, meanwhile, Apple is a huge player in the smartphone so it would be very high volumes and a big deal for a supplier. Then look at the competition, all other phones are made with another operating system which is a huge competitive advantage as the customers get used to how the phone works creating switching costs to an android phone for example. Samsung and other players have tried to make the switch easier with apps that transfer info from iPhone.

The smartphone market has very low barriers of entry to keep new entrants out, as there are no regulations for permits or patents holding companies out. But there is quite substantial capital that is needed to start producing phones and significant volumes before making a profit.

Looking at OnePlus approached it in the beginning with a prepaid model, pay the phone first then they build it and ship it. Much like a Kickstarter campaign. Substitution to a smartphone is a little hard to narrow in on as the smartphone does so many things today. But many are the smartphone used for communication through regular phone services such as calls, text messages, messenger apps, social media, and so on. Today may the camera in the phone be very well included in the communication part, as nobody would want to send a bad picture. Is there any other product that could satisfy this need of the smartphone? Maybe the computer and tablet, but they are not as portable as a smartphone resulting in worse performance in terms of availability and ease of substitution.

Conclusion

Porter’s model has been applied to several industries beyond the airline industry. For example, it has been used in the automobile industry to analyze competitive forces and how they affect market share. It is usually used by business actors, meanwhile, an investor can use it to identify moats against these five forces which can hurt a company’s margins and market share. Being a very powerful tool, when searching for quality in companies.

Stay hungry and keep hunting!

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After two weeks of COVID, I finally had the strength again to write a new article on how to be a better investor. This week have I written about Dupont analysis, how to use it and why it is so simple yet powerful.

Find the article here.

Happy hunting!