Effective Business Valuation 103and American Express have rewarded people who have invested in
them for the long term. Odds are next to nil that a new mega - store
home improvement retailing chain will open up. It would take way
too much time and capital.The Real Value of Competitive Advantages
Value investors often speak of efforts to seek out wonderful busi-
nesses run by capable, competent management with a durable
competitive or economic advantage. But what does a “ competitive
advantage ” really mean for a company?
A true competitive advantage exists in only a few forms. The
simplest type occurs when a government grants licenses to a few
companies and excludes everyone else. Cable companies, electric
utilities, and telephone companies are the most common. But these
companies don ’ t enjoy the same incumbent competitive advantages
they did 50 years ago.
Other competitive advantages exist when a company is the low -
cost producer (such as USG in wallboard), holds a patent (which is
good for a fi nite period of time), or possesses another attribute that
turns potential competitors away. However, to truly understand the
value of competitive advantage, it ’ s best to follow Charlie Munger ’ s
advice and “ invert ” the process: understand where competitive
advantages don ’ t exist.
Commodity - type businesses rarely have sustainable competitive
advantages. Ultimately, they must share the market space with many
competitors until the economic profi t is zero or, in other words, the
cost of capital is equal to the required rate of return that investors
demand on their money.
To illustrate my point: A hypothetical company, Soft Pillow Inc.,
makes pillows. Soft Pillow has been quite successful and has earned
$ 10 million each year for the past three years. Its investors are will-
ing to accept a 10 percent return on their investment. This givesCH006.indd 103CH006.indd 103 9/2/09 6:58:08 PM9/2/09 6:58:08 PM