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Super Normal Returns in Long term Investing

BP Inani 
on 23 July 2018

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In the last decade and a half into my investing life, I have come strongly to believe that B2C businesses are the only ones which can deliver super-normal returns over a longer time frame. It might be known to much of the investing fraternity, however, sometimes people have to travel themselves to realize the deeper secrets. Various reasons that push me to think favorably for B2C companies. Some of them are explicit like mentioned below:

Natural Moat

  • Companies over time, in B2C space create brand equity, recall value and customer loyalty. Such attributes are pretty hard to break for a new entrant. In such scenario, costing of the product takes a back seat. Quality & Positioning of the product becomes an important aspect. If the company or the product keeps that creativity intact – it has only one way to move and that is “going UP”. Moreover, “Creativity” in itself is an infinite space to work with – with loads of outsourcing agencies available.
  • Whereas in B2B businesses – the reduction in costing is the only secret to survival. “Cost Cutting” is not an infinite area unlike creativity as mentioned above. Every-time that you are able to find ways of reducing product costs, the space for further improvement only shrinks that much. And with every such step of Product cost reduction – one lands up creating a new benchmark for self to be broken alongside “shrinking” ways to do so. This becomes a cascading phenomenon and at some point, in future, it peaks-out and the company starts going south.

PE expansion

  • Market capitalization of companies grow because of two reasons – Growth in bottom-line and expansion in Price-Earnings multiples.
  • When B2C businesses grow – their Price to earnings multiple also expands. This is unlike the B2B businesses which have static PE multiples and their market cap grows only with expansion in Bottom-line. Which means for every similar basis points of Bottom-line growth – the B2C business accelerates vis-à-vis a B2B business. This, when compounded, throws a massive difference over time. And why we say time – because B2C businesses survive more as compared to B2B businesses which get caught in the cascading vicious phenomenon as mentioned earlier.

Brand Leveraging

  • B2C businesses also have another big advantage of leveraging their “Brand” value into adding new revenue streams thereby generating more income. And all this income is purely asset light further adding to the Return on Capital employed. We have seen this happening all across – be it Tommy Hilfiger, Tanishq, Titan etc.
  • B2B – don’t have this inherent advantage and can only work towards increasing capacities to reduce costs an asset-heavy method of churning profits.

Asset light model

  • B2C businesses can slowly upgrade themselves towards asset-light model which a typical B2B can’t. And with turning Asset-Light – the Margins expand. Such expansions are suitably rewarded in accelerated mode by way of PE expansions as explained earlier – a Double Impact – and so the huge PE multiples to growing B2C companies.
  • Due to the Asset-light model – the ROCE improves drastically for B2C companies further enhancing their Market capitalization and reach.
  • With being Asset-light, pivoting into newer areas is a lot easier v/s an asset-heavy business - improving the chances of survival more.

Growth Capital

  • For established B2C companies - raising resources either from Debt markets or Equity markets is not only easier but also rewarding vis-à-vis B2B companies. This fund-raising is done at premium valuations due to increased PE multiples - resulting into less dilution of Equity for more money. Whereas the same logic works exactly the reverse way in case of B2B companies – which are Asset heavy and work on book value concept.
  • The above reasoning means - shareholders of B2C companies create a separate/exclusive league of their own and charge the premium for any new entrant (read new shareholder). Such inherent rewards of on-board equity holders vis-à-vis the new entrants in a B2C company is suitably captured in Higher PE valuations for such businesses. A virtuous cycle for B2C v/s B2B.

Product innovation

  • Innovations & Inventions are always a disruption to established players. B2C businesses do have a fair degree of risks with new products taking over their established turf. But this risk remains equally true even for B2B businesses.
  • So, with the same degree of risks (if you ask me it is more for a B2B business v/s B2C) – the rewards are far higher for an established B2C business - if it survives.

Sunken cost

  • Advertisement / Product promotion is the only bane for a B2C company and this could turn out to be sunken cost vis-à-vis any B2B company which might be asset heavy.
  • But later in life when the businesses mature - the same reasoning goes against a B2B company. Assume if, both the businesses have to go out of league – then B2C might still carry a terminal value in terms of “Brand” whereas the B2B will only have a depreciated outdated equipment worth scrap.

However, the caveat to such investing is - B2C businesses have high infant mortality rates and so investing in them can make sense if done when the business matures. But by then, the premium gets captured and chances of making money reduce equally. So, either you have the expertise to catch such businesses young or the second option is a take a SIP route of investing in such matured companies. The second option will still give you returns to beat the inflation big time.

Happy investing.


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