Here's a mental model for thinking about a company's growth:
• Is the growth rate high?
• Is the growth predictable?
High + Predictable = Investable
Anything else = Perhaps best to avoid
Where do you invest?
Image
Here's my mental model for understanding how value creation, pricing power, barriers to entry and switching costs all come together.
VALUE CREATION:
Profit growth requires selling more, raising prices and cutting costs.
PRICING POWER:
Raising prices requires pricing power. Customers only put up with price hikes if there is no alternative (unique product), if the alternative is lower quality (superior product), if the alternative is a higher price (cheaper product) or if using the alternative is inconvenient (switching cost).
BARRIERS TO ENTRY:
There is only no alternative if companies can't replicate their competitors. Competitors can't replicate if they don't know how (knowledge barrier), don't have the capability (capability barrier), don't have the resource (resource barrier) or aren't allowed (IP barrier).
SWITCHING COST:
It may be inconvenient for a customer to switch products, if there is a loss of access to customised components, if there are compatability issues or if it involves breaking a long-term contract.
Image
PS: This is about a company’s growth, rather than its valuation. I’m not disputing about valuation, just clarifying,
One more thing, the three most important qualities of a quality business:
1. Predictable growth
2. Capital efficiency
3. Pricing power
What would you add?
Comments