The trouble continues for a couple of technology companies that were beloved by the Street for the past decade. Research in Motion (RIMM) and Netflix (NFLX) have been high flying stocks that have made a ton of cash for early investors. If you got in early enough then your ownership stake may have made you rich. If you got in late then you have lost a ton of money from your investment.
High Priced Growth Stocks
The problem with stocks that trade well above their earnings growth is that when they fall they crash really hard. Netflix is down to $155 per share and Research in Motion is down to $23. Both companies reported disappointing results that caught Wall Street off guard. The stocks lost more than 20% of their value in a single day and the pain just keeps coming. These stocks are down during a market rally. There is no telling how low they could go on a day when the market is punished.
Research in Motion is getting crushed by Apple and Google as the company just cannot guide its earnings numbers down low enough. The company may trade at just 5 times earnings but that looks high when growth is negative and EPS continues to shrink. I have already stated why Netflix is a risky stock to hold onto for the long term.
One of the things that struck me about these two companies is that they have no economic moat. Warren Buffett tends to stay away from technology stocks for this very reason. There is nothing that will stop another company from hopping into the same field and becoming a dominant force. Technology companies can be hot for a few years and can easily fall off the map a few years later.
The best industries for finding companies with a wide economic moat are the utilities, energy, and banking industries, It is hard for a new competitor to enter these industries and gain significant market share because of all of the large amounts of capital and number of regulations required.
A company can also use its brand name as a major competitive advantage. Here is a perfect example:
What companies do you think of when it comes to soda?
There are two major players that dominate this industry. Coca Cola and Pepsi are the dominant companies in the industry and every other company is an afterthought. The brand names alone are a barrier to entry.
A wide economic moat is important because it helps to protect the earnings of a company from being cannibalized by competitors. If a company has decent management then it should be able to use its economic moat to its advantage and use it to help grow their enterprises over time.