Thursday, July 27, 2006

Growth Investing :: Monopoly Matters Part II

If sales growth is driven by commensurate growth in operating assets then nothing is accomplished. The company is bigger but not better. Increased sales from the same asset base, are a sign that assets (including human assets) are used effectively. Sales driven growth companies are steadily increasing their total asset turnover, year over year. Declines in total asset turnover are a hallmark of declining and stagnating companies

Of course if a company is increasing sales by lowering margins, then again nothing is accomplished. While several factors can influence margins, the most important is to what extent is the company a monopoly. Going back to Microeconomics 101, the two extremes of competition are

  1. A perfectly competitive market, in which no excess economic profits is made.

  2. A monopolistic market, in which the maximum amount of economic profit is made.

The classic example would be Microsoft (MSFT) with an operating system monopoly, vs. Intel whose chips are essential to Microsoft’s success, but which faces some competition in each of its product lines, and Wal*Mart which competes with just about every retailer in existence.

Yahoo! Finance Chart of MSFT,INTC, and WMT from 1987-2006

The closer a company is to having a monopoly; the better the chances are for having good profit margins, and earning excess profits. Software and Life Sciences companies are good examples of this; proprietary technologies and patents give these companies mini-monopolies in their niches. Hence the importance of investing in future market leaders that can earn excess profits.


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