Stock in Focus: The power of the business model
All too often, the hunt for multi-bagger stocks is the folly of private investors. How many times have we been convinced that our diligent research/scuttlebutt anecdotes/sophisticated data model (delete as appropriate) has landed us a winner - a stock that can catapult our portfolio skywards.
Many of you will have had a taste of such success. Perhaps you bought Bioventix at its 2014 IPO, or Asos when its warehouse was destroyed by the Buncefield oil explosion in 2005. Or maybe you went big in the US and bought Apple shares (if you invested in the world’s biggest company any time before 2020, you’re currently sitting on a multi-bagger).
I have not yet landed my multi-bagger (for now, at least, my portfolio is being propped up by my S&P500 index tracker), and it’s easy to look back on those wild successes with a sense of gloom: “current markets just don’t offer opportunities like that”.
But that isn’t true. And the winning stocks of yesteryear can offer us clues which can help us identify multi-baggers of the future. Because multi-baggers share common traits, and the most common of those traits is a strong protective moat.
Lesson from history: Coca-Cola’s masterclass in moat digging
In 1885, John Pemberton - a confederate general in the American Civil War - sought an alternative pain relief to the morphine he had become reliant on following a wartime injury. His solution: a tonic created by the mixture of cocaine and alcohol, which he named Pemberton’s French Coca. Then came prohibition and with it a demand for Pemberton’s non-alcoholic version of his tonic, which he named Coca-Cola: The Temperance Drink.
From controversial beginnings Coca-Cola has risen to become one of the world’s most recognisable drinks. It’s available in every country in the world except Cuba and North Korea (apparently) and is at the heart of a company which generated $43bn of sales last year.
But Coca-Cola is not distinct for its flavour - it’s a sugary liquid which tastes much the same as all other colas available. And yet, Coca-Cola drinkers turn their noses up at generic alternatives, while bar staff adopt a look of deplorable sorrow if they’re ever forced to respond to an order for Coca-Cola with the question: “will Pepsi be ok?”
Why is that? Because the powerful brand built by the Coca-Cola business model.
It starts with the visuals: the curly C (which is identifiable even without the rest of the word) and the distinct curvy shape of the glass bottle. And then there is the scaleability of the business model, which hinges on the fact that the company sells mostly concentrated syrups to a network of approved bottlers worldwide who add their own water and carbon dioxide (for the bubbles). This means Coca-Cola can reach global markets without having to spend huge amounts of money on bottling or distribution.
These traits are reflected in a handful of very attractive financial metrics. Operating margins have averaged more than 25% for the last decade - a sign of excellent leverage (it doesn’t cost a lot to boost sales, meaning a rising top line has an immediate positive impact on profits). Return on capital employed (ROCE) rarely drops below 15%, which shows that the company can efficiently turn its capital investment into further profits. And sales growth comes from a healthy mix of volume growth and price expansion - a strong, desirable brand can protect companies through challenging economic times.
Coca-Cola is a prime example of a company with a unique and protected product and a business model which allows for rapid and efficient scalability. From just one (relatively simple) product, it has grown to become one of the biggest consumer goods companies in the world. The company listed in the US in 1983 and its share price has risen 5000% since then. It’s also increased its dividend every year for 61 years - not many stocks have a track record like that.