When assessing the investment potential of a company, one important factor for investors to include in their due diligence process is a review of the brands and products it owns. Brands are a key piece of intellectual property that can help to identify companies with good future returns potential, though they do not guarantee it.

The advantages of brands

At Investec, our equity selection process places a strong emphasis on cash flow return on an investment. When our analysts apply this methodology to our research, the most attractive companies tend to have one thing in common: a strong brand or portfolio of brands.

The competitive advantage that a strong brand gives a company cannot be underestimated or, indeed, captured in a valuation metric.

Some of the other advantages that brands provide are:

  • Loyalty from businesses and consumers
  • A platform to create their own market
  • Self-sufficiency
Brands prevail in a crisis

The COVID-19 pandemic has reminded us of the benefits of having a strong brand.

During turbulent times, companies with essential products such as food, beverages and cleaning products remain in demand, thus tend to be less volatile. These, therefore, should be considered as a cornerstone in a portfolio. Stocks such as Diageo, Nestle and Unilever fit this profile.

Cash flow is key

When considering self-sufficiency, what we are seeking is cash flow generation. These cash flows can then be reinvested into the business, to self-fund growth either by developing new products, acquisition (think Kraft’s purchase of Cadbury) or on marketing activities.

It also allows a company to adapt to new trends and fund research and development. To illustrate this, consider Unilever’s commitment to reducing plastic waste. By 2025, it will halve its use and collect and process more plastic than it sells.

Cash flow also provides defence at times of business disruption, for example, despite severe disruption within the hospitality sector in 2020, Diageo’s diversification and resulting cash flow allowed it to continue to pay shareholders a dividend at a time when many companies were suspending or cutting dividends.

Brands are not indestructible

This is not to suggest that buying a company’s shares based purely on a brand is the answer.

For example, take the situations of Nokia and Aston Martin. Nokia’s failure to adapt to changes in the mobile phone market saw it rapidly overtaken by competitors such as Apple and Samsung. Aston Martin has a luxury brand, globally recognised, but its IPO in 2018 gave investors a bumpy ride. Despite the brand, the company had a weak balance sheet which placed constraints on the business, resulting in a collapse in the share price.

Selecting brands for investment

Each year the brand consultancy Interbrand produces a list of the best global brands by value. In 2020, the list contained many companies that feature as part of our investor portfolios. Indeed, in the 2020 report, they comment that “strong brands have become stronger as a result of the COVID effect”, which provides a level of reassurance to our framework.

As global companies, many may not be listed on the UK stock market, however, our internal international research coverage encompasses US and European companies, allowing us to consider many of these for investment. In addition, it is also something that we consider when analysing a fund manager’s investment process.

In essence, identifying a company with a market-leading brand (subject to the usual financial analysis) is a good place to start when searching for companies that can form a cornerstone to an investor’s portfolio. Generally, volatility can be lower from higher-quality companies, which can allow investors to allocate their remaining risk budget to other, perhaps more cyclical opportunities, depending on their overall investment objectives.

About the author

To contact or read more about Michael Matthews visit his biography here.

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