Selecting Businesses for Long Term

Businesses can be classified into three categories.

Price Competitive Business

Durable Competitive Business 

Price Competitive Business with Economic Moat

Price Competitive Business: Price competitive businesses are ones where the consumer chooses to purchase goods or services from the company based on the price they offer it for.

Ex. Metals (Vedanta), Airlines (Spice Jet)

Durable Competitive Business: Durable competitive businesses are ones where the consumer chooses to purchase goods or services from the company based on the quality of the same.

Ex. Food Industries (Britannia), Services (Infosys)

Price Competitive Business with Economic Moat: Price Competitive Business with Economic Moat are price competitive businesses that have a moat that makes the business resistant towards the competition from its peers.

Ex. Johnson & Johnson, Cadbury, Page Industries

Alternative Classification

Cyclical Businesses: Cyclical Businesses are companies which are highly affected by the variations in economic cycle. The demand for the goods or services vary based on the economic conditions. During economic booms these sectors tend to grow at a very high rate whereas during economic depression they tend to grow very slowly. These companies lack consistency in growth.

Ex. Automobiles

Defensive Businesses: Defensive Businesses are businesses which are very consistent with respect to growth and they are least affected by changes in the economic cycle. The demand for the goods or services tends to grow at a consistent rate that in turn will help the company to grow consistently.

Ex. Pharmacy, Food Industries

Selection of Businesses

While selecting businesses to invest, it has to be made clear as to which type among the three can the business be classified under.

If the business is Price Competitive then the competition will force the company to sell their goods or services a lower price which will affect the profit margins to a great extent. If profit margins get hit, good growth in sales cannot turn into good profit. The other factor, which affects the profitability, is that these companies are not able to raise the price of their goods or services to catch up to Inflation. These sectors are very slow growing and with an investment point of view they are the least preferred

If the business is Durable Competitive then these sectors generally grow at fast pace. Since competitors are not able to provide quality of goods or service offered by the business, acts as a moat. These business will maintain their profit margins and also adjust the prices as per the change in Inflation, makes these businesses very efficient and therefore as investments, these are the business which can provide very high return on capital.