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Profiting from Franchise Value

Written by : Joshua Kennon
One way to help ensure your portfolio has above average results over the long-term is to purchase shares of business that possess significant franchise value. Considering there are over fourteen thousand publicly traded companies in the United States alone, investors may believe that finding these companies is difficult or even impossible. The truth is, companies with strong franchise values have such obvious characteristics that you will probably have thought of at least five by the time you are done reading this article.

The definition of franchise value

In the investment world, franchise value refers to the popularity of a particular brand or product with consumers. In your own mind, the concept of bleach and Clorox, tissue and Kleenex, soda and Coca-Cola, soup and Campbell's, are probably not different. In fact, the franchise value of some businesses is so high that many people actually substitute the brand name for the item in every day conversation (in the Midwest, for example, any and all carbonated beverages are referred to as "Coke").

Spotting franchise value

If you are trying to decide if a business has franchise value, ask yourself these three questions:
  1. Am I willing to pay more for the brand (e.g., Hershey's) as opposed to another, cheaper brand (e.g., the generic chocolate bar)?

  2. If a store didn't have the brand in which I was interested, would I walk across the street to buy the product I wanted?

  3. If I started a business in direct competition with this product, what are my chances of success? Would I be able to make a dent in its market share or is the product so firmly entrenched it would be difficult to wrestle away even a small portion?

  4. Profiting from franchise value

    You may wonder why the owner of business possessing high franchise value is, on average, more prosperous than his counterpart operating a commodity-type business. The reason is simple: if a product has strong consumer demand, the company that manufactures that product can raise prices to offset increased labor, production, inflation, and other costs. The company that does not have franchise value is forced to compete on a price basis; it is constantly required to undersell its competitors regardless of the profitability of such sales if it does not wish to lose market share. In an industry with high fixed costs, this is a recipe for disaster (consider the major airlines).

    Price is still the ultimate determinant of your investment return

    Due to the laws of mathematics, the return you realize on an investment is absolutely dependent upon the price you paid. Paying too high a price for any asset in relation to its conservatively estimated intrinsic value moves the investor out of the realm of investment and into speculation. In the case of an excellent business with strong franchise value, however, an investor should be willing to forgo a steep discount and pay up to intrinsic value. The superior economics of the business should result in above-average returns over the long-term. As long as the underlying characteristics of the business do not change, holding the equities for life, regardless of subsequent price fluctuations in the shares, may be the investor's wisest course of action.

    Source: Joshua Kennon

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