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How To Identify A Stock With A Competitive Advantage: Cross Your Fingers

When selecting a long-term stock investment, most investors take a page out of Warren Buffett’s playbook and look for companies with strong competitive advantages. History has shown that the odds of identifying such advantages are no better than the flip of a coin. Protecting the Castle A competitive advantage is one of the most sought after characteristics of any long-term investment. Wall Street analysts grade stocks almost exclusively on the strength and sustainability of a company’s competitive advantage. Value investors demand stocks that have track records of fending off competition and sustaining high profit margins. Warren Buffett describes a business with a competitive advantage as a castle with a moat around it. The wider, deeper, and more treacherous the moat, the better the investment. In a 1999 article in Fortune Magazine, Buffett said: “The key to investing is not assessing how much an industry is going to affect society, or how much it will grow, but rather determining the competitive advantage of any given company and, above all, the durability of that advantage. The products or services that have wide, sustainable moats around them are the ones that deliver rewards to investors.” This makes sense. Without some sort of advantage, a profitable business will not be profitable for long. Deterioration Not only are economic moats hard to find, they are hard to maintain. Furthermore, predicting which companies will have strong competitive advantages in the future can be downright impossible. Economic theory shows that once a business obtains an advantage in the marketplace, competitors will attempt to copy and improve upon the successful business model. This will ultimately eat away at the company’s profits and deteriorate its competitive advantage. Here, we’ll look at two case studies which have played out over the last 20 years. In one case, the company possessed all the advantages of an economic moat. In the other case, the company was rapidly losing market share and had a miserably bleak future. Today, one company is out of the business and the other has multiplied hundreds of times over. Blockbuster Video A perfect example of a deteriorating competitive advantage can be found in the case of Blockbuster Video. After opening its first location in 1985, the company became synonymous with movie rentals in the 1990s. By the late 90s Blockbuster had been able to maintain its competitive advantage and fend off its toughest competitor – Hollywood Video. Once the new millennium began, Blockbuster had a whole new set of competitors – Netflix (NASDAQ: NFLX ) and Redbox. Where Blockbuster charged over $5.00 per rental and required customers to pick up movies in person, Redbox charged only $1.00 and Netflix offered unlimited DVD rentals by mail for one flat monthly price. When both companies were in their infancies, Blockbuster could have easily copied their business models or bought them out. In 2000, Netflix offered to sell its operations to Blockbuster for only $50 million. Blockbuster passed on the opportunity to own the company that would eventually be the cause of its demise. Eight years later, as Blockbuster’s business model was teetering on the brink of collapse, management still had its head in the sand. Here’s what Blockbuster CEO said in 2008: “Netflix doesn’t really have or do anything that we can’t or don’t already do ourselves.” It can be argued that Redbox had just as big – if not a bigger – impact on Blockbuster than Netflix. After launching its first video rental kiosks in 2004, Redbox quickly became a cheap and convenient way to rent new release movies on a nightly basis. It wasn’t until 2010 that Blockbuster decided to aggressively pursue this business model with its Blockbuster Express kiosks. By then, it was too late. Apple If Blockbuster is the perfect example of a profitable business losing its competitive advantage, Apple (NASDAQ: AAPL ) is the perfect example of a company regaining its competitive advantage. Less than 15 years after selling its first computer, the company posted its most profitable year in 1990. However, things started to turn south quickly for Apple. While both founders – Steve Jobs and Steve Wozniak – moved on to other ventures, the company started losing market share. By 1996, industry experts and Wall Street analysts had left the company for dead. At the time, no one could foresee the return of Steve Jobs and the innovative products he would bring to the company. Rather than competing head-on with Microsoft (NASDAQ: MSFT ) in the PC market, Jobs decided Apple would gain a competitive advantage by focusing on music-related products. First came the iPod, then iTunes and the rest is history. Today, iPhones and iPads have transformed Apple from a $3 billion company in 1996 to a market cap of $600+ billion in 2016. Identifying a Moat Looking back, it’s easy to say that Apple was the better investment in 1996. A share of Apple has multiplied more than 200 times over in the last 20 years. By contrast, an investment in Blockbuster Video would have gone to zero. But was it possible to have seen this at the time? In investing, the past is history. The future is where profits are made. Let’s put ourselves in the shoes of a stock market investor in 1996 and try to identify which company had the better competitive advantage. According to Pat Dorsey, Equity Research Analyst at Morningstar, there are four types of economic moats: Intangible Assets Customer Switching Costs The Network Effect Cost Advantages Dorsey says, “At Morningstar, thinking about economic moats, or structural competitive advantages, is central to how we do equity research.” He claims that having any or all of the above characteristics, “give superior companies the power to stay on top.” Breaking It Down By breaking down each advantage we should be able to compare Blockbuster with Apple and see what an investor would have thought about the future prospects of each. Intangible Assets: Brand recognition, customer loyalty, patents or trademarks, etc. In 1996, Blockbuster video had strong brand recognition and customer loyalty. The company’s slogan, Make it a Blockbuster night was on everyone’s mind when they wanted a night in. The name familiarity gave customers confidence that the local Blockbuster would have a broad selection of the latest new releases and all the old classics. In order to rent from Blockbuster, customers had to have a membership card. Keeping this card in their wallets reminded customers on a daily basis that Blockbuster was where they went to rent movies. Customer Switching Costs: Time, money, or inconvenience to switch to a competitor. Opening an account with a movie rental company in the mid-1990s was like setting up an IRA. It required multiple forms of ID, proof of residence, a complete family-tree and the family dog for collateral. The Network Effect: Everyone uses it because everyone uses it. Everyone had a Blockbuster card in their wallets, so there was a Blockbuster in every town. The more customers Blockbuster obtained, the more locations they would open. The more locations they opened, the more customers they obtained. It became very convenient to be a Blockbuster customer because the stores were everywhere. Cost Advantages: Scale-based cost advantages allow for huge profit margins on additional sales. Blockbuster received payments dozens, hundreds, or even thousands of times on one VHS or DVD. If one more customer decided to rent a movie on a Friday night, it would not cost the company anything. The additional rental would be pure profit to Blockbuster. The VHS or DVD had already been paid for by Blockbuster. The customer was required to give the movie back to Blockbuster for them to rent again. On The Other Hand By contrast, Apple had none of these competitive advantages in 1996. The OS business was controlled by Microsoft, and Dell controlled the PC market. Apple was a tiny player which the market valued for less than its liquidation value. At the end of 1996, Apple qualified as a Benjamin Graham NCAV stock . It was literally valued more dead than alive. Putting It into Practice Today, there are all kinds of companies which appear to have wide moats protecting their profits. Even more so are the companies which appear to be past their prime and rapidly losing market share. The problem with insisting on investing only where sustainable moats exist, is that strong competitive advantages are impossible to foresee. It’s one thing to identify companies where moats currently exist, it’s another thing to know whether those moats will exist in 5, 10 or 25 years from now. Can you confidently predict which stocks will be the next Blockbuster and which will be the next Apple?

Beyond Miners, 5 ETFs Crushing The Market To Start Q2

Overriding concerns over weak corporate earnings, U.S. stocks hit fresh highs of 2016. This is especially true as conservative earnings estimates are actually setting the stage for positive surprises. In fact, a handsome earnings beat by one of the six largest banks – JPMorgan (NYSE: JPM ) – spread optimism into financial sector, which is the backbone of the global economy. As per the Zacks Earnings Trend , earnings beat ratio for 8.8% of the S&P 500 companies that have reported so far is impressive at 71.9%. Additionally, better-than-expected trade data in China eased global growth fears, sending the stocks higher. Further, stabilization of crude oil at around $40 per barrel is the greatest achievement in the current oversupplied oil market. Though the dollar has been weakening since the start of the second quarter, it has gained some momentum this week on more stimulus hopes from Bank of Japan (read: 5 ETFs to Buy if Oil Stays at $40 ). Apart from these recent developments, the dovishness of the Fed, an accelerating job market, a pick-up in inflation and increasing consumer confidence have continued to brace the market. Meanwhile, the appeal for government bonds and precious metals has diminished on risk-on investors’ sentiment. That being said, we highlight five ETFs that are surging to start the second quarter and are expected to continue this trend. ALPS Medical Breakthroughs ETF (NYSEARCA: SBIO ) – Up 11.5% This fund targets companies with one or more drugs in Phase II or Phase III FDA clinical trials by tracking the Poliwogg Medical Breakthroughs Index. It is a small cap centric fund, having amassed $104.2 million in its asset base. The product holds 95 stocks in its basket with a well-diversified portfolio as each security holds less than 4.6% of assets. The product charges 50 bps in fees per year from investors and trades in a moderate average daily volume of about 77,000 shares. It has a Zacks ETF Rank of 3 or ‘Hold’ rating. WisdomTree Weak Dollar U.S. Equity ETF (NYSEARCA: USWD ) – Up 10.3% This fund offers exposure to export-oriented companies that may benefit from a weakening U.S. dollar by tracking the WisdomTree Weak Dollar U.S. Equity Index. It holds 201 securities in its basket with none accounting for more than 1.84% of assets. However, about one-fourth of the portfolio is dominated by information technology while industrials, health care, consumer discretionary and materials round off the next four spots with a double-digit exposure each. USWD is an unpopular an illiquid fund with AUM of $1.2 million and average daily volume of under 1,000 shares. Expense ratio came in at 0.33%. SPDR SSGA Risk Aware ETF (NYSEARCA: RORO ) – Up 10.3% This is an actively managed ETF that seeks to provide capital appreciation and competitive returns compared to the broad U.S. equity market. Holding 90 stocks in its portfolio, the fund is moderately concentrated across the firms with each holding less than 5.4% share. From a sector look, consumer discretionary, health care, consumer staples, financial services and utilities are the top sectors with a double-digit allocation each. It has managed $2 million in its asset base and charges 50 bps in annual fees. Volume is light exchanging less than 1,000 shares a day on average. United States Brent Oil Fund (NYSEARCA: BNO ) – Up 9.2% This fund provides direct exposure to the spot price of Brent crude oil on a daily basis through futures contracts. It has amassed $121.3 million in its asset base and trades in a good volume of roughly 267,000 shares a day. The ETF charges 75 bps in annual fees and expenses. SPDR S&P Oil & Gas Exploration & Production ETF (NYSEARCA: XOP ) – Up 9.2% This fund provides an equal weight exposure to 60 firms by tracking the S&P Oil & Gas Exploration & Production Select Industry Index. Each holding makes up for less than 2.8% of the total assets. XOP is one of the largest and popular funds in the energy space with AUM of over $2 billion and expense ratio of 0.35%. It trades in heavy volume of around 19.1 million shares a day on average. The fund has a Zacks ETF Rank of 5 or ‘Strong Sell’ rating. Link to the original post on Zacks.com

An Undisclosed SEC Investigation Of TerraForm Power Was Underway Even Before SunEdison Delayed Filing Its 10-K

Our Disclosure Insight® reports, like those coming from other financial news and data providers, deliver to the investing public commentary and analysis on public company interactions with investors and with the SEC. They are journalistically based in large part on our expertise with federal filings using the Freedom of Information Act. SunEdison, Inc. – (SUNE ) TerraForm Power, Inc. – (NASDAQ: TERP ) Vivint Solar, Inc. – (NYSE: VSLR ) TerraForm Power – Confirmed, undisclosed SEC probe; added to our Watch List of Companies with Undisclosed SEC Probes Analyst Summary : This is one of those cases of who-knew-what-when and whether those who were in the know can now be trusted. At the end of Mar-2016, SunEdison disclosed both a DOJ and SEC investigation. This followed the company’s delayed 10-K filing announced at the end of Feb-2016. Yet information recently received from the SEC shows TerraForm Power, a “yieldco” of SunEdison, was already under investigation by the SEC prior to either of these two events occurring at SunEdison. To this day, the SEC investigation of TerraForm Power, which was confirmed as on-going as of 14-Mar-2016, remains undisclosed. Facts of Interest or Concern : There is recent news of DOJ and SEC investigations of SunEdison. Plus, an array of internal investigations, resignations, and delayed filings occurred at both SunEdison and TerraForm Power. We present a brief timeline of relevant disclosures and events as compared to what we have in our database. TerraForm Power and TerraForm Global (NASDAQ: GLBL ) are each known as yieldco’s of SunEdison. However, this report speaks only to SunEdison, TerraForm Power, and Vivint Solar. We’ve no research history on TerraForm Global. SunEdison and Vivint Solar: 20-Jul-2015, the two companies enter into a merger agreement. From the Probes Reporter database – SunEdison : On 03-Oct-2012, 24-Sep-2013, 19-Aug-2014, 19-Aug-2015, and most recently on 12-Jan-2016, we received information from the SEC to indicate a lack of recent investigative activity at this company (this includes when it was previously known as MEMC Electronic Materials). Each of these responses represented a two year look-back. As always, keep in mind that new SEC investigative activity could theoretically begin after the date covered by this latest information which would not be reflected here or in any of those similar instances cited below. From the Probes Reporter database – Vivint Solar: On 04-Jan-2016, we received information from the SEC to suggest the absence of recent SEC investigative activity at this company. This represented a two year look-back into SEC records on Vivint and is the only time we’ve researched this company. From the Probes Reporter database – TerraForm Power : In a letter dated 11-Feb-2016, we received information from the SEC suggesting TerraForm Power was involved in unspecified SEC investigative activity that was undisclosed at the time. This and a response below, from Mar-2016, represent the first time we have researched this company. SunEdison : On 29-Feb-2016, SunEdison announced it would delay filing its 10-K. The company blamed internal investigations that started in late 2015 (and heretofore undisclosed), which it says were based on allegations made by former executives of the company. The company said it expected to file the Form 10-K by 15-Mar-2016 SunEdison and Vivint Solar: 07-Mar-2016, SunEdison receives notice from Vivint Solar formally terminating the merger agreement of Jul-2015. From the Probes Reporter database – TerraForm Power : In a letter to us dated 14-Mar-2016, the SEC confirmed TerraForm Power’s company’s involvement in on-going enforcement proceedings that remain undisclosed as of this date. We have no other records in our library on TerraForm Power. SunEdison : Blaming material weaknesses in its internal controls, on 16-Mar-2016, SunEdison announced it would not be able to file its 10-K by the extended due date of 15-Mar-2016. SunEdison : A story published by the Wall Street Journal on 28-Mar-2016, said the SEC was investigating SUNE’s “… disclosures to investors about how much cash the solar-power company had on hand as its stock price collapsed last year … Officials in the SEC’s enforcement unit are looking into whether SunEdison overstated its liquidity last fall when it told investors it had more than $1 billion in cash,” according to the Journal’s sources. TerraForm Power: On Wednesday, 30-Mar-2016, the company issued a press release to announce Brian Wuebbels was stepping down as TerraForm Power’s president, CEO, and board member. The related 8-K was not filed until the following Monday, 04-Apr-2016. SunEdison : In an 8-K filing made on 31-Mar-2016, SunEdison said it received a subpoena from the DOJ on 28-Mar-2016. In addition SUNE said, “Also, the Company has received a nonpublic, informal inquiry from Securities and Exchange Commission (the “SEC”) covering similar areas.” The date the SEC started its informal inquiry of SUNE was not disclosed by the company. TerraForm Power: In the same 8-K which repeated the press release announcing the departure of Mr. Wuebbels, filed on 04-Apr-2016, the company also announced this concerning existing credit agreements – Fourth Amendment to Credit and Guaranty Agreement On March 30, 2016, TerraForm Power Operating, LLC, a subsidiary of the Company, entered into a fourth amendment (the “Amendment”) to its credit and guaranty agreement with Barclays Bank PLC, as Administrative Agent and Lender, the other credit parties and certain other lenders party thereto (the “Revolver”). The Amendment provides that the date on which TerraForm Power, LLC must deliver to the Administrative Agent and the other lenders party to the Revolver its financial statements and accompanying report with respect to fiscal year 2015 shall be extended to April 30, 2016. SunEdison : 14-Apr-2016, SunEdison announces completion of investigation by Audit Committee and independent directors. The company said it found no material misstatements or fraud. Notes : The SEC did not disclose the details on investigations referenced herein. All we know is that they somehow pertain to the conduct, transactions, and/or disclosures of the companies referenced. The SEC reminds us that its assertion of the law enforcement exemption should not be construed as an indication by the Commission or its staff that any violations of law have occurred with respect to any person, entity, or security. New SEC investigative activity could theoretically begin or end after the date covered by this latest information which would not be reflected here. To learn more about our research process, including how to best use this information in your own decision-making, click here . Our Terms of Service, relevant disclosures, and other legal notices can be found here . 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