Stock Analysis – Part 2

In this part of Stock Analysis, we shall focus on the most important part of fundamental analysis. It is finding moat in companies/stock in which you as an investor wants to invest your money.

You can also read our previous post on How to analyse a company for stock investment - Stock Analysis - Part 1 afterwards.

(A) Invest in companies with moat

While performing analysis of financial performance of companies, investors evaluate how profitable the company has been over past many years. Such evaluation brings an idea that if a company has been profitable in past over the various economic cycles, the chances of the company continuing the trend ahead increases.

Though, past performance analysis is quite essential for stock analysis. But it does not guarantee company's future performance.

Actually analyzing profits of company over past is just a start to finding ‘Moat’ of that company. Thus, it is an important part of research but finding the reasons for such performance is also very important for stock analysis.

Moat is characteristics/factor/feature or by whatever other name we call it, helps the company to stay profitable in future as well.

(B) Finding Moat

The way to find moat in a company includes researching on -

• ‘Why’ the company has been able to maintain & increase the profits for so long and consistently?
• ‘What’ is that the competitors are not able to steal its profits?
• For ‘How long’ the company be able to keep its profitability?  i.e. the competitive advantage that the company has, whether it has an expiry to it.
• Or what is that the management is doing every year & envisages to do further, that will assist in continuing past trends.
• Also, how the peers are competing. Some industries include players with close pricing competition amongst them. If a company is competing on the basis of reducing prices or cost cutting then the investors should be cautious.

(C) Evaluate Profitability & the Moat

Firstly, prior to evaluating the company’s moat, investors need to find evidence that the company might have economic moat. Thus, financial performance needs to be analysed.

We will take examples of distinct market players that have consistently performed financially over past many years. This is because of moats in these companies.

(i) Pidilite Industries Ltd

The company's cash flows & margins for past 10 years remained strong. Thus, the evidence for its strong financial performance as per few important ratios:

Moat in Pidilite - Product differentiation with a trusted Brand

• 84% of the revenue is from Consumer & Bazaar product segment which includes 56% (of total revenue) Adhesives & sealants, 20% construction & paint chemicals & 8% art/crafts/other material.
• The company is the market leader with its consumer & bazaar products in India.
• Brand Fevicol is synonymous with adhesives to Indian consumers & is ranked amongst the most trusted brands in the country.
• Market share in adhesives & sealants category is around 70% i.e. the company enjoys monopoly.
• Apart from brand 'fevicol', the other famous brands of the company include - 'Dr Fixit', 'Fevikwik', 'M-Seal'.
• Back in 2014, Pidilite acquired the adhesive business of Ahmedabad-based Blue Coat, engaged in adhesives & textile chemicals.
• Then in 2015, the company acquire Nina Waterproofing Systems to outweigh the competitors in this category.
• Then in Feb 2020, Pidilite announces acquisition of 70% stake in Tenax India Stone Products which sells adhesives, coatings, surface treatment chemicals and abrasives for the marble, granite and stone industry in India.

The evidence of its competitive advantage:

Click to enlarge the images

(ii) Dr Lal Pathlabs Ltd

Moat in Dr Lal Pathlabs Ltd - Differentiated expansion model:

• Dr Lal Pathlabs works with hub and spoke business model.
• The company has pan-India integrated coverage with 200 clinical labs (including National Reference Lab at Delhi and Regional Ref Lab at Kolkata), 2,569 Patient Service Centers (PSC) and 6,426 Pick-up Points (PUP).
• Company's patient service centers (PSC) is the quickest way of expansion.
• The hub and spoke business model provided the company a competitive advantage against standalone chains.Thus, the company has a strong presence in North India.
• Moreover, the company has strong franchise network.
• This strategy reduces the requirement of high capex reference labs at each place.
• To read the Detailed Analysis of Dr Lal Pathlabs - Click here

Evidence of Moat in Dr Lal Pathlabs:

(D) More examples of moat analysis

There are more examples of moats in various companies & evident in their performance so far. To just brief a few more -

(i) Relaxo Footwear

From a small capacity of 2.9 lakh pieces per day in the past, Relaxo increased the capacity of manufacturing footwear to 7.5 lakh pairs per day by FY19. The company is also maintaining quality & pricing products quite competitively.

(ii) HDFC Bank

The company expanded vastly like no other private sector bank. Along with that Bank's CASA Ratio is one of the highest amongst the private sector banks.

(iii) Nestle India

Nestle India has a premium position over its peers & holds unique pricing power in its niche food products. Nestle's food products diversification is quite vast.

(E) Why a company holds sustainable competitive advantage?

It can be one or all of the following things:

• Product differentiation with superior technology, features, quality
• Product differentiation with trusted brand, reputation
• Cost Controls
• High level of adaptability in customers
• Also, some business strategy of expansion/diversification which restricts other players to succeed.

Moat, being the most important part of fundamental analysis, requires in-depth research of the company from past many years. Thus, we mentioned in our previous post to read at least 10 annual reports of a company. Further, other fundamental analysis basis shall continue with our upcoming blog posts on Stock Analysis.

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Disclaimer: The report only represents personal opinions and views of the author. Therefore, No part of the report should be considered as recommendation for buying/selling any stock. Also, the report & references mentioned are only for the information of the readers about the industry stated.