In a recent article, I wrote that the stock market has become fickle. There are too many traders as opposed to investors. There are too many people that sell on news not pertinent to a company’s financial health. April was the perfect characterisation of this. Just look at the share price fall in Sag. Just look at the volatility of Facebook shares.
Talking of the latter I can’t believe people actually sold their shares in Facebook in the $150s. The Cambridge Analytica scandal caused shares FB to plunge 15% from their February highs – resulting in the company losing roughly $100 billion in market value in the process. This plunge left investors wondering if the company’s best days are behind it. But as seen from the recent FB results statement, the answer is clearly not. In spite of the controversies surrounding Facebook, the world continues to log in. Billions of users continue to interact with each other, sharing stories, “liking” photos, and consuming content from companies, movies, musicians, and other advertisers. They’re not leaving en masse. Facebook is too big of a part of their daily lives. And for most users, there’s really nothing else like it. Facebook has no competition. It has a monopoly on user data and advertisers cannot get enough.
Facebook’s business possesses the most powerful “network effect” I’ve ever seen. Its business gets better as it gets bigger. The more users who log in to Facebook and share their stories and photos, the more attractive the website is for that next user to join. And as more consumers join the site, more information is shared, and so on. And of course, the more users, the more valuable their data and eyeballs are to advertisers.
In short, with a powerful network effect, growth begets more growth. Momentum increases. And the winner tends to take all – or at least take most. That’s what has happened with Facebook. It is the clear winner in the social networking space (at least, outside of China). With more than 2 billion monthly active users, it’s many times more popular than the next largest competitor. And that makes Facebook an incredibly powerful economic engine and cash-flow machine. The company has no debt and has more than $41 billion in net cash on its balance sheet.
This network effect forms the basis of facebooks competitive advantage allowing the company to reap the benefits of above average profitability for a longer than normal period of time. I’ve written before on competitive advantages/economic moats so it is worthwhile to have a read of that article. The jist of it is this, in the capitalistic world we live in, high profits attract competition which in turn leads to lower profits. But, a small minority of companies have figured out ways of insulating themselves from competition and enjoy many years of high returns on capital. How exactly, by creating structural competitive advantages, or economic moats.
Looking at my purchases this month, the companies – Experian, Sage, RelX – have good competitive advantages. Experian has a tremendous brand the confers legitimacy – having the Experian brand next to a credit check has a lot of power in the financial world. Sage has high switching costs – if you are a business that uses Sage, chances are you will continue using it as its not worth the cost – money, time, risk – of switching to a different accounting software provider. RelX has advantages via a combination of network effects and its brand.
Apart from the economic moats, the second advantage that Sage, Experian and RelX possess are that they are highly scalable businesses. They have Low CAC (word of mouth), Low marginal cost, Scale economics, Few employees, Pricing Power, Low distribution costs, Low support costs, Low churn. Basically, they posses most of the traits you would want in a business that you’d be happy to invest in the long-term.
Whilst the moats in Experian, Sage and RelX are not as strong as that of Facebook, I believe the market is discounting them to a fair degree. It is for this reason that I bought shares in these companies in April as seen below:
- Experian – Bought 10 shares for £15.3 a piece
- Sage – Bought 24 shares for £6.60 a piece
- RelX – Bought 9 shares for £15.30 each
Apart from these two purchases, I also bought 163 shares in PZ Cusson for £2.29 a piece. The rational for buying PZ cuzzons is a little different. But as this post is a getting a little long, I will not go into it here but will write on it in the future if I get a chance to keep adding shares.
The total dividend income from these purchases is £24. This brings my total annual dividend income from my portfolio to £2,174. I’m slowly closing in on that £2,500 a year in annual dividend income goal. Onwards and upwards!