The company which you are investing in for the long-term to earn good returns, is there a huge trench outside that company which is filled with water and has a crocodile in it? In the year 2007, world-renowned investor Mr. Warren Buffett stated that he was always kept looking for a business that had a sustainable competitive advantage and a strong economic moat. That is to say, he looks for such a business that has a trench outside it, and also, there’s a crocodile in the water of that trench.
Suppose a company makes a product and there comes another company that sells the same product at a lower price so that more customers come to them. So the first company to stay intact in the market further reduces the rate of their product and that is why the returns which the company was earning here keep decreasing. Going forward, another company comes along and starts selling the same product at an even lower price. So businesses that used to get high returns on invested capital here are now getting very low returns.
There are fewer businesses that can create such a competitive advantage that they have a monopoly there and therefore continue to earn high returns on invested capital no matter how much competition there is. So Mr. Warren Buffett while talking of such businesses says that these great businesses are like a fort, and whatever competitive advantage they have, they are like a crocodile in the water in the trench outside the fort, so that the competitor canʹt stay there long.
Those good businesses, who earn high returns on invested capital, create high entry barriers in their business as well as create a competitive advantage, and establish their economic moat. Some businesses produce in large quantities because it is not possible for their other competitors and mass production also reduces the cost behind each product. Also, these businesses have a large network of distributors so that their products can reach anywhere in the country within less time. After that, these businesses create a brand by adding a large number of ads. Therefore, these businesses can earn high returns on invested capital.
These big businesses are like a fort, so mass production does not allow other competitorʹs space to grow, and hence, this mass production acts as a trench for others. Their large distribution system works like the water in that trench, and the tremendous ads and branding that it has done works like a crocodile in the water in that trench so that the competitors donʹt stay here long.
Understanding the business model of a company is very important whenever you decide to invest in the shares of a company for the long term. It is also important to check whether the business is earning High Returns on Invested Capital and High Returns on Employed Capital as well.
Can businesses that earn high returns on invested capital continue to do so in the long run? That is, how big and how deep trench has that business dug out of their business through competitive advantage? How much water is there and how many crocodiles are there in that trench? All these things will help us know how long the business will continue to earn high returns on invested capital in the long run.
If there is growth in these businesses and businesses that earn high returns on invested capital in the long run, if you look at the market valuation and invest step by step accordingly, then the history to date tells us that in the long run, we can earn good returns here.
The businesses that earn high returns on invested capital, in such businesses if you use our copy-right technique to invest in the market as per valuation and to know what your portfolio should look like, we have a special program for education purpose our Aryaamoney application, which you can take advantage of. So, anyone who subscribes to that program, we will update their portfolio for the next 5 years from that day, and you will be able to track it yourself. So if you want you can subscribe to this service.
The companies mentioned in this blog as well as the strategies mentioned here are for educational purposes only. We may or may not have our investment in the companies we have mentioned in this blog. The services we offer in our Aryaamoney application are for educational purposes only. So be it our videos or our website, social media presence, or our mobile application, all the information given here is for educational purposes only. This does not serve any buy/sell recommendation.
Whether investing in the stock market, commodity market, or currency market, or mutual fund, you should discuss your investments with your investment advisor before investing here as the stock market, commodity market, currency market as well as mutual fund investments are subject to market risk.
If you want to find information regarding figures of Returns on Capital Employed of various companies, you can view them on the Money Control website. If you want to invest in the long term, be sure to check the business model of the company you want to invest in along-with their Returns on Capital Employed.
One of the most famous investors Mr. Benjamin Graham, who also happens to be Mr. Warren Buffettʹs mentor, says: "Investment is the most intelligent when it is business-like." Meaning when you invest for the long-term, think of buying a business, not just buying shares, and hence, it would be useful to analyze the data of Return on Invested Capital. When you invest for the long term, those companies should be earning high-return on investment like forts, outside of which there will be a trench and that trench should be very deep and there should be water in the trench in which the crocodiles should be released.
Until next time…
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