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As I tried to understand the investment thesis for debt/equity investing, I realized that the key was understanding the competitive positioning of the company or more specifically its competitive advantage relative to the industry participants. To help me better understand the sectors, I developed this tool using US public equity data, but I reckon that underlying methodology/philosophy is as applicable to any investment.


This analysis started out as a way to empirically test Bruce Greenwald's "Three Slices of Value" (Value Investing, p44). It then evolved as I applied some ideas from Michael Porter's "Competitive Strategy", Seth Klarman's "Margin of Safety", Joel Greenblatt's "Magic Formula Investing" and Altmans work on balance sheet correlation with default.




Two basic ideas stuck.
(i) Similar business models have similar asset footprints - so the aggregatated balance sheets of similar companies in the same industry would be indicative of the strategic forces at work in that industry. This is a concept borrowed from Altman.
(ii) Companies invest non-revenue producing capital to erect barriers to entry, in the hope that the investment will prevent erosion of margin. This is done by spending on marketing, research and development, advertizing, building out leverageable infrastructure etc. Usually an industry "over-invests" in a certain strategy. Analysing a company relative to its sector specfically for this quantity is interesting - this is done by looking at the "Market Value Decomposition" chart (example in Figure A below).

Figure A) Asset Footprint or Market Value Decomposition: A variation of Greenwald's "Three Slices of Value" (Value Investing, p44) that I use to analyze sectors and individual companies.

Looking at Invested Capital and Reproduction Value as a % of Market Value today indicates the amount of investment needed to generate current margins by keeping competitors at bay.



Viewing the aggregated industry averages gives a idea of the relative attractiveness of each sector and the ability of that industry to generate an EBITDA margin. Drilling down to the company level recursively illustrates the "competitive advantage" of that company vis-a-vis its peers.

Based on this analysis, one can observe that competitive advantage generally lies in operating efficiency, unique assets or scarcity value.

Figure B) Industry Map: An illustration of how Fuels have gained in both margins as well a competitive advantage relative to other industry sectors, the last boom period (2004-2008).

Also notice how the map indicates that Retail is among the sectors with the lowest competitive advantage (on average) and Pharmaceuticals is among the highest.






The objectives of this project were:
a) to understand profitability across industry segments and structural dynamics that impact competition
b) within those segments, understand the levers of erecting and sustaining competitive advantages
c) and lastly, learn to recognize competitive advantage - whether sustainable or not


PCA is a metric to illustrate industry structure and help distinquish between business models.

-- It crystallizes to a fairly reasonable degree, the profitability and attractiveness of business models by using measures of asset intensity and market value.

-- Margins flatten logarithmically vs. PCA - with increasing competitive advantage, margins do not increase at the same pace. But, industries with scarcity value, regulation or unique assets are the outliers. Based on a logaritimic regression, PCA explains ~57% of the variance in EBITDA


What is presented is more of a tool and an empirical analysis. The metric proposed fits the data and is somewhat intuitive. But, simplifying assumptions have been made to generate the asset values from publicly filed balance sheet information and nothing can substitute thorough analyst level research.

This analysis only focusses on large public companies. I screened appx. 1600 public companies with at least $250mm in market capitalization and $50 million in EBITDA. over appx.130 industry segments that mapped to 22 sectors. I modified some of the existing metrics proposed by various practitioners to adapt it for this exercise.


Above are links to analyses as of the indicated dates. Note that each of the bubbles can be clicked to drill down futher into the sector or industry. Clicking on an individual company illustrates the 5-year performance.

Please feel free to contact me at contactpca@gmail.com