This is a sponsored advertorial from WCM Investment Management (affiliate of Natixis Investment Managers).

WCM’s Select Global Growth Equity Team says investors can fall into value traps if they do not understand how a company’s competitive advantage is changing.

Economic moats, those durable competitive advantages that protect companies from rivals, are often hailed as the holy grail of investing. But simply identifying a moat is not enough for WCM’s Investment Team. 

It is far more important to understand a company’s moat trajectory. This is because a company’s competitive advantage can change significantly throughout the holding period of an investment.

The Team thinks investors should invest in companies that are improving and so increasing the gap on their competition. In other words, companies with “positive moat trajectories.”

It is the trajectory of a moat that matters

To assess how a company’s competitive advantages are evolving, they suggest analysing various factors, including: 

• Is the company investing in ways that strengthen its market position? 
• Can it navigate technological disruption, regulatory changes, and evolving consumer preferences?

Conversely, they avoid companies where the best thing you can say about them is that they are “still a great company.” This usually implies that the business is worse than it was in the past, and so could be a value trap.

Which companies have positive moat trajectories?

According to the Team, Southeast Asian e-commerce and fintech platform Sea Limited is a good example of a company with an improving competitive advantage. It underperformed for a number of years, and investors were bearish on its prospects. 

However, as the competitive landscape evolved, the dominant e-commerce platforms, like Sea Limited, became more profitable and widened their lead over competitors. The Team also recognised the potential of Sea Limited’s growing fintech business, drawing parallels with the success of Mercado Libre in Latin America. 

These types of companies can be found all over the world, according to Daniel Wiechert, client portfolio manager for WCM, who noted the Team’s early investments in European industrials, such as Saab, driven by increased defence spending in NATO-aligned countries. These companies, according to Wiechert, have seen their “economics improve tremendously with significant runway ahead.”

Wiechert also highlighted the importance of looking beyond the obvious beneficiaries of mega-trends. While many investors focused on the Magnificent 7, they identified compelling opportunities in Celestica, which makes white label network switches, and Argan Incorporated, a contractor building natural gas turbine complexes. 

“We conducted extensive research on the MAG 7 cohort. Other than Amazon, when sizing up their growth drivers, we have historically found clearer moat trajectories at much more compelling valuations in other businesses, with lower market capitalisations,” he added.

The power of inflection stories

Alongside identifying positive moat trajectories, the Team actively seeks out “inflection stories.” These are companies which are going to be perceived very differently two or three years down the road due to a narrative change, a shift in market perception where the company’s future value is not yet recognised. In essence, the Team aims to identify companies on the cusp of a transformation, where a catalyst is poised to unlock significant value and reshape market perception.

When looking at emerging markets, they believe there is an emerging ‘value’ theme in Korea. Historically, Korea has had cheap valuations driven by poor corporate governance. However, in recent years, Japan has undergone a successful corporate value transformation, and there seems to be a strong impetus to replicate that improvement in corporate governance in Korea, supported by new laws.

Investing in the future, rather than the present

By focusing on moat trajectories and inflection stories, the Team aims to identify companies that are poised to become even more successful in the future. They combine this focus with a rigorous analysis of industry nuances to try to uncover investment opportunities that traditional static analysis might miss. “We see plenty of unexplored territory attached to current mega themes, and are actively searching for positive moat trajectory cases that will benefit from these trends”, concluded Weichert.

Find out more about the WCM growth equity investing and their approach to invest in companies with widening competitive advantage primed for narrative inflection.

 

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This is a sponsored advertorial from WCM Investment Management (affiliate of Natixis Investment Managers).