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.
My company is a Blackberry shop, but we are starting to adopt Androids. RIM is hopelessly behind the times and they haven’t really improved their Curve models in years. The one feature we really need for our field people is a Mobile Hotspot, but they still don’t have it. You still have to connect a cable from your phone to your laptop and use a 128K link. They are toast if they don’t get it together soon.
Wide Economic Moat is a flimsy concept. It is what you make it out to be. Does it mean that it would take huge amounts of capital to enter into competition? Virgin made clear that money is no obstacle to eliminating moats, especially if governments assist with anti-monopoly laws. Brand-power? Johnson & Johnson have so far survived the Tylenol and other scares, but it was close there. Ten years ago, RIMM and Motorola were wide-moats, albeit those where Tech Moats, not Economic moats. In any case, it’s clear that moats must be reviewed annually, less they fail.
I would disagree. RIMM and Motorola never had wide economic moats. Technology companies rarely have any moats. Large capital requirements and regulations do help to form moats. Any moat can be breached but a wide one takes years to conquer.
I bet Blockbuster thought they had a moat too…as did most airlines…
Most Fortune 100 companies operate like they are invincible very frustrating.
They need to be a whole lot quicker at adapting to change.
Hey Mark,
I love reading your blog, it’s a refreshingly honest look at a lot of areas of money and finance for a lot of people like myself trying to learn more about ways to make smarter decisions about my money. This article on economic moats is great, I love learning this stuff!
My problem though is that I am very much a complete beginner when it comes to investing, and it’s been hard for me to find really good, straightforward lessons to begin investing. I read some great articles at Investopedia.com and Wealthlift.com, but other than that, it’s been hard to find good advice for beginners. What sites would you personally recommend for beginning investors? I have a lot of friends asking me the same thing now that I’ve begun learning, and I plan on sending your suggestions to my friends and family as well.
Thanks,
Georgia
Thanks Georgia. I can send you a list of some good financial resources.