Part three of what has changed over 30 years of teaching Security Analysis @Columbia_Biz and @CenterDodd. The course has four sections - the third is on competitive strategy analysis (i.e., is this a good business with a sustainable competitive advantage?)
2/ To reiterate one of the early lessons from Al Rappaport: valuation and competitive strategy analysis go together. You can't value a business intelligently without understanding its competitive position, and the measure of a good strategy is that it creates value.
3/ Early on I taught mostly Michael Porter: 1/ Five Forces, which assesses a business's competitive operating environment, 2/value chain, which breaks down a company into strategic activities; and 3/generic strategies--ways to distinguish and win. Still a great place to start.
4/ I read the original Porter books, Competitive Strategy (1980) and Competitive Advantage (1985) and found them rich but not easy. I now recommend reading Joan Magretta's book, Understanding Michael Porter. Clear, concise, and well written: amazon.com
5/ In the mid-1990s, I met Brian Arthur @sfiscience and got to know his work. I learned about increasing returns (and network effects). By the late 1990s we had some good, real-time cases where the ideas applied. This was far from mainstream at the time.
hbr.org
hbr.org
6/ Also in the late 1990s, Clay Christensen published The Innovator's Dilemma, which explains the theory of disruptive innovation and helps explain why strong incumbents can lose. amazon.com
7/ Also in the 1990s, Bruce Greenwald @CenterDodd starting teaching The Economics of Strategic Behavior @Columbia_Biz. Much of this course is captured in the book, Competition Demystified. The book has a lot of useful techniques. amazon.com
8/ I tried to consolidate all of this in one place, which led to report "Measuring the Moat" (2002). This starts with the lay of the land, then adds industry analysis, and finally firm-specific analysis. It also has a checklist to guide analysis. research-doc.credit-suisse.com
9/ I couldn't find a clear definition of competitive advantage in Porter. Besanko et al. say it exists when: 1/ company earns about its cost of capital on its investments; and 2/ has higher returns than its competitors. Economics of Strategy is great. amazon.com
10/ I also now touch on game theory, especially in the settings of pricing and capacity decisions. The simple idea is that actions trigger reactions, and it's important to think through the consequences of behavior.
amazon.com
amazon.com
11/ Finally, we now spend a lot of time on capital allocation. This really stands at the intersection of valuation and competitive strategy. A friend who is a portfolio manager has a line I have borrowed: "All roads in managerial assessment lead to capital allocation."
12/ I had talked a lot about this but hadn't done serious work on it. I was inspired by Will Thorndike's excellent book, The Outsiders. He chronicles the attributes of eight CEOs who were great capital allocators. amazon.com
13/ We collected data on a much larger sample and integrated academic research. We examine decisions including M&A, cap ex, R&D, buybacks, dividends and more. We also consider incentives. There is still a lot of confusion out there. research-doc.credit-suisse.com
14/ To close, I believe that assessing sustainable value creation is a crucial component of analysis for a long-term investor. A student once asked Buffett about his core investment consideration: "sustainable competitive advantage," he replied right away. Still underappreciated.
Loading suggestions...