An Attractive Business

A contestant that ranks high in a business beauty pageant is one that doesn't have to continuously put significant capital into their business in order to generate growing earnings. One reason a business is able to do this is they have pricing power. Having the ability to increase prices without investing a bunch of capital to improve their product suggests that the business has a significant brand value and leadership position. This leads to attractive returns on equity since earnings can keep growing without the amount of equity growing at an equally large rate. You might justifiably feel more confident paying a higher multiple of book value for a company like this since there is a reasonably good chance that ROE will grow without the drag of a sprinting denominator (equity via more assets needed such as plants and equipment- or even capitalized R&D for that matter- on the balance sheet).

This "investment light" pricing power would be difficult to obtain with quickly obsolescent products where reinventing (through reinvestment in R&D or new equipment) is most often absolutely necessary to remain competitive. However, in these types of businesses some companies have proven over years that they are excellent at playing the game of reinvention and consistently are first to market with break-throughs in design and/or functionality-- yet this is certainly a hill that seems more likely for a king to be knocked from.

Alas, a multitude of these beauty queens don't exist and even fewer at defensible prices, but every now and then the contest judges make a bad call and a should-be queen receives less attention than deserved. It's during these times that it pays especially well to know what you're looking for.

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