Learn the stock market › Fundamental analysis: the basics › Lesson 8 of 8
What makes a company strong?
Five common advantages
Brand. Customers choose the company and pay more, even when cheaper options exist.
Switching costs. Changing is a hassle or expensive. Once a business runs on one system, moving to another can take years.
Network. The service gets better as more people use it, so big gets bigger.
Scale. The largest company can have the lowest cost per item, and new rivals struggle to catch up.
Patents, licenses and unique know-how. Others aren't allowed to do the same thing, or can't, at least for a while.
Investors often call this a moat, like the water that keeps attackers away from a castle.
The margin over several years
You can't read a competitive advantage directly. But if one exists, it should show: the company can charge well year after year. The operating margin is operating income as a share of revenue. Here are two payment networks and two retailers:
| Company | Latest | 1 yr before | 2 yr before | 3 yr before |
|---|---|---|---|---|
| Visa | 66.4% | 67.0% | 67.2% | 67.1% |
| Mastercard | 59.5% | 58.0% | 58.3% | 57.2% |
| Costco | 3.9% | 3.8% | 3.6% | 3.3% |
| Walmart | 4.2% | 4.3% | 4.2% | 3.3% |
Visa had the highest margin in its latest year, 66%, and Costco the lowest, 4%. Their fiscal years end in different months, so the columns count back from each company's latest year.
What the margin doesn't say
The table shows that differences exist, not why. These companies sell very different things, so a lower margin doesn't have to mean a weaker company. A retailer can have a strong advantage in low prices and still keep little of each sale. Compare companies that sell about the same thing, and one company over time.
A high margin can also attract rivals, and an advantage can disappear. Patents expire, customers change their habits and new technology makes the old less valuable. That is why you read several years and ask what is keeping rivals out right now.
A strong company isn't the same as a good deal
The price isn't part of this. A strong company may already have a price that counts all of that strength in, and a weaker one may have a price that expects very little. What you pay is a separate question, which the P/E lesson covers.
Test yourself
A company has had a 25% operating margin for ten years amid tough competition. What does that suggest?
More numbers are on the Visa stock page.