Looking At The Metrics That Really Matter While Avoiding Pride And Prejudice In Investing

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Stuart Jackson is a Partner and former Global Managing Partner at strategy consulting firm L.E.K. Consulting

Fifteen years ago, in my book Where Value Hides, I introduced the concept of strategic market position. The idea behind it is that to understand a business’s true prospects, you should not look at crude metrics of scale versus competitors. Instead, you need to look at market share and relative scale that takes account of what drives competitive advantage in each industry. That is what strategic market position measures. For example, in the airline industry, competitive advantage is driven less by global market share and more by the share of regional hubs or city pairs that leads to better operating efficiencies and higher preference from consumers. The strategic market position takes those industry-specific factors into account.

The goal of the book, and of the strategic market position concept, was to help CEOs understand and identify untapped opportunities within their portfolio of business units, channels and product lines so they can direct investments toward the highest returns.

But the concept can also be applied to investing in equities, and, in the book, I compared some famous rivals: Walmart versus Kmart, Nintendo versus Sega, BMW versus Daimler, AMETEK versus Magnetek, Southwest versus AmericaWest.

Fifteen years later, I thought it would be interesting to look back at the total shareholder returns (dividends plus price appreciation) for companies I highlighted as winners back in 2006. I calculated the total shareholder returns based on dividend and share price appreciation — reported by S&P Capital IQ — between October 2006 and September 2021.

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Starting with an investment of one share and adding all the shares gained from dividend reinvestment (reinvested at the closing price on the day they were paid out), I then multiplied the number of shares by the closing price on 9/29/2021 for the total value. From there, the initial value of the share was subtracted and then divided by that same amount before multiplying by 100 to get a percentage.

From 2007-21, my calculations showed the “winners” saw estimated total shareholder returns of:

• Walmart — 287%

• Nintendo — 185%

• BMW — 199%

• AMETEK — 980%

• Southwest Airlines — 238%

The average of those five companies is 378% and the S&P 500 average return was 227%.

There is good news and bad news. I am proud to say the average performance of my picks continued to exceed the market average, and that the “winners” I highlighted have continued to perform well against their rivals, some of which no longer exist.

But in truth, putting my pride aside, I am forced to admit I was completely bailed out by AMETEK’s performance. In the book, I highlighted their electric motors division and the fact that the company seemed to have a knack for carving out market leadership and competitive advantage in market segments that competitors don’t seem to understand as well. Since then, the company has refined this knack into a repeatable corporate capability, extending into new areas of automation and precision motion control and building an enviable portfolio of advanced analytical, test and measurement instrumentation for aerospace, medical, energy and industrial markets(Full disclosure: AMETEK has been a long-term client of L.E.K. Consulting.)

What did I miss? I missed out by not emphasizing technology investments more. This was partly pedagogical — I was looking for clear teaching examples, and traditional businesses are easier to understand and explain. But I was also prejudiced in trying to force emerging technology businesses into old technology frameworks.

For example, in mid-2017, Tesla was building cars at the rate of 100,000 per year and was hemorrhaging losses of $1.6 billion per year. How, I asked, could a company losing money, making one-fiftieth the number of vehicles per year as Honda, have a market capitalization of $70 billion compared to Honda’s $50 billion? The answer is that I was guilty of looking at the wrong metric when considering the scale and competitive advantage (exactly what I warned against doing in my book).

At the time, Tesla had a 90% share of electric vehicles sold. Electric vehicles are the future. Scale in conventional vehicle production is irrelevant at best, and may be a boat anchor rather than an advantage — as the recent union demands for no job reductions at Volkswagen have made clear.

Understanding strategic market position and competitive advantage can be a powerful tool, but with the accelerated rate of technology adoption we are now seeing, it’s necessary to take great care in how it is applied. Avoid the pride of thinking that old, generic metrics can capture the dynamics of specific industries. Leave the prejudice of interpreting emerging-industry performance in the same way you model mature, stable, established industries and companies. Striking that balance is essential if you are going to reap the benefit of a strategic market position and truly understand the competitive advantage of the companies under your consideration.

The information provided here is not investment, tax or financial advice. You should consult with a licensed professional for advice concerning your specific situation.


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