Looking for the firm with an economic moat (Evaluating Profitability)

The first thing we need to do is look for hard evidence that a firm has an economic moat by examining its financial results. (Figuring out whether a company might have a moat in the FUTURE is much tougher.)

What we are looking for are firms that can earn profits (ROIC) in excess of their cost of capital (WACC) - companies that can generate substantial cash relative to the amount of investments they make.

Use the metrics in the following questions to evaluate profitability:

1. Does the firm generate free cash flow? If so, how much?
Firms that generate free cash flow essentially have money left over after reinvesting whatever they need to keep their businesses humming along. In a sense, free cash flow is money that could be extracted from the firm every year without damaging the core business.

FCF Margin:  Divide FCF by sales (or revenues). This tells what proportion of each dollar in revenue the firm is able to convert into excess profits.

If a firm's FCF/Sales is around 5% or better, you've found a cash machine.

Strong FCF is an excellent sign that a firm has an economic moat.

(FCF/Total Capital Employed or FCF/Enterprice Value are some measures.)


2. What are the firm's net margins?
Net margins look at probability from another angle.

Net margin = net income/ Sales

It tells how much profits the firm generates per dollar of sales.

In general, firms that can post net margins above 15% are doing something right.

3. What are the returns on equity?
ROE = net income/shareholders' equity
It measures profits per dollar of the capital shareholders have invested in a company.

Although ROE does have some flaws -it still works well as one tool for assessing overall profitability.

As a rule of thumb, firms that are able to consistently post ROEs above 15% are generating solid returns on shareholders' money, which means they're likely to have economic moats.

4. What are returns on assets?
ROA = (net income + Aftertax Interest Expense )/ firm's average assets
It measures how efficient a firm is at translating its assets into profits.

Use 6% to 7% as a rough benchmark - if a firm is able to consistently post ROAs above these rates, it may have some competitive advantage over its peers.

The company's aftertax interest expense is added back to net income in the calculation.  Why is that?  ROA measures the profitability a company achieves on all of its assets, regardless if they are financed by equity holders or debtholders; therefore, we add back in what the debtholders are charging the company to borrow money.


Study these metrics over 5 or 10 years

When looking at all four of these metrics, look at more than just one year.

A firm that has consistently cranked out solid ROEs, ROA, good FCF, and decent net margins over a number of years is much more likely to truly have an economic moat than a firm with more erratic results.

Five years is the absolute minimum time period for evaluation, 10 years is even better, if you can.


Consistency is Important

Consistency is important when evaluating companies, because it's the ability to keep competitors at bay for an extended period of time - not just for a year or two - that really makes a firm valuable.



These benchmarks are rules of thumb, not hard-and-fast cut-offs.

Comparing firms with industry averages is always a good idea, as is examining the trend in profitability metrics - are they getting higher or lower?

There is a more sophisticated way of measuring a firm's profitability that involves calculating return on invested capital (ROIC), estimating a weighted average cost of capital (WACC), and then looking at the difference between the two.

Using a combination of FCF, ROE, ROE and net margins will steer you in the right direction.


Additional notes:

DuPont Equation

ROA = Net Profits / Average Assets
ROA = Asset Turnover x Net Profit Margin

ROA
= (Sales/Average Assets) x (Net Profits/Sales)
= Net Profits/Average Assets

ROE = Net Profits / Average Shareholder's Equity
ROE = Asset Turnover x Net Profit Margin x Asset/Equity Ratio*

ROE
= (Sales/Average Assets) x (Net Profits/Sales) x (Average Assets/Average Equity)
= Net Profits./ Average Equity

*Asset/Equity Ratio = Leverage

Spotting Cash Cows

Spotting Cash Cows
by Ben McClure (Contact Author | Biography)

Cash cows are just what the name implies - companies that can be milked for further ongoing profits with little expense. Producing plenty of cash, these companies can reinvest in new systems and plants, pay for acquisitions and support themselves when the economy slows. They have the capacity to increase their dividend or reinvest that cash to boost returns further. Either way, shareholders stand to benefit. To help you spot cash cows that are worthy of your investment, we look at what sets these companies apart and offer some guidelines for assessing them.

 

The Cash Cow: An Overview
A cash cow is a company with plenty of free cash flow - that is, the cash left over after the company meets its necessary yearly expenses. Smart investors really like this kind of company because it can fund its own growth and value.

• A cash cow can reinvest free cash to grow its own business - thereby boosting shareholder returns - without sacrificing profitability or turning to shareholders for additional capital.
• Alternatively, it can return the free cash flow to shareholders through bigger dividend payments or share buybacks.

 

Cash cows tend to be slow-growing, mature companies that dominate their industries. Their strong market share and competitive barriers to entry translate into

• recurring revenues,
• high profit margins and
• robust cash flow.

Compared to younger companies - which tend to reinvest their profits more aggressively to fuel future growth - more mature businesses (with less room for growth) often generate more free cash since the initial capital outlay required to establish their businesses has already been made.

 

Finally, a cash cow can often be a tempting takeover target. If a cash cow company seems like it can no longer use its excess cash to boost value for shareholders, it is likely to attract acquirers that can. (For more on what this means, see The Basics of Mergers and Acquisitions.)

 

The Life of the Cash Cow: Free Cash Flow
To see if a company is worthy of cash-cow status, you of course need to calculate its free cash flow. To do so, you take cash from operations and subtract capital expenditures for the same period:

Free Cash Flow = Cash Flow from Operations - Capital Expenditure

 

 

(For more on calculating free cash flow, see Free Cash Flow: Free, But Not Always Easy.)

 

The more free cash the company produces the better. A good rule of thumb is to look for companies with free cash flow that is more than 10% of sales revenue.

 

Consumer products giant Procter & Gamble (PG), for example, fits the cash cow mold. Procter & Gamble's brand name power and its dominant market share have given it its cash-generating power. Take a look at the company's Form 10-K 2004 Annual Report's (filed on Sept 9, 2004) Consolidated Statement of Cash Flows (scroll to sec. 39, p.166). You'll see that the company consistently generated high free cash flows - these even exceeded its reported net income: at end-2004, Procter & Gamble's free cash flow was $7.34 billion (operating cash flow - capital expenditure = $9.36B - $2.02B), or more than 14% of its $51.4 billion sales revenue (net sales on the Consolidated Statements of Earnings). In 2004, PG produced real cash for its shareholders - a lot of it.

 

Cows That Stand Apart from the Herd: Price and Efficiency
A Low Cash Flow Multiple
Once you've spotted a cash cow stock, is it worth buying? For starters, look for companies with a low free cash flow multiple: simply, divide the company's stock price (more precisely, its market capitalization) by its underlying free cash flow. With that calculation, you can compare how much cash power the share price buys - or, conversely, you see how much investors pay for one dollar of free cash flow.

 

To find PG's free cash flow multiple, we'll look at its stock price on the day it filed its 2004 10-K form, which was Sept 9, 2004. On that day, the stock closed at $56.09 (see PG's trading quote that day on Investopedia's stock research resource). With about 2.5 billion shares outstanding, Procter & Gamble's market value was about $140.2 billion.

 

So, at the financial year-end 2004, PG was trading at about 19 times its current free cash flow ($140.2 billion market value divided by 2004 free cash flow of $7.34 billion). By comparison, direct competitor Unilever traded at about 25 times free cash flow, suggesting that Procter & Gamble was reasonably priced.

 

Free cash flow multiples are a good starting point for finding reasonably priced cash cows. But be careful:

• sometimes a company will have a temporarily low free cash flow multiple because its share price has plummeted due to a serious problem.
• Or its cash flow may be erratic and unpredictable.
• So, take care with very small companies and those with wild performance swings.

 

High Efficiency Ratios
Besides looking for low free cash flow multiples, seek out attractive efficiency ratios. An attractive return on equity (ROE) can help you ensure that the company is reinvesting its cash at a high rate of return.

 

Return on Equity = (Annual Net Income / Average Shareholders' Equity)

 

You can find net income (also known as "net earnings") on the income statement (also known as "statement of earnings"), and shareholders' equity appears near the bottom of a company's balance sheet.

 

On this front, PG performed exceedingly well. The company's 2004 net earnings was $6.5 billion - see the Consolidated Statement of Earnings p.35 (p.161 in the PDF) on the 10-K - and its shareholders' equity was $17.28 billion - see the Consolidated Balance Sheets p.37 (p.163 in the PDF). That means ROE amounted to nearly 38%. In other words, Procter & Gamble was able to milk 38 cents worth of profits from each dollar invested by shareholders. (For more on evaluating this metric, see Keep Your Eyes On The ROE.)

 

To double check that the company is not using debt leverage to give ROE an artificial boost, you may also want to examine return on assets (ROA). (For more on this topic, see Understanding The Subtleties Of ROA Vs ROE.)

 

ROA = Return on Assets = (Annual Net Income / Total Assets)

 

Turning again to Procter & Gamble's 2004 Consolidated Statement of Earnings and Balance Sheets, you'll see that the company delivered an impressive 11.4% ROA (net earnings / total assets = $6.5B / $57.05B). An ROA higher than 5% is normally considered a solid performance for most companies. Procter & Gamble's ROA should have reassured investors that it was doing a good job of reinvesting its free cash flow.

 

Conclusion
Cash cows generate a heap of cash. That's certainly exciting, but not enough for investors. If they provide other attractions, such as high return on equity and return on assets, and if they trade at a reasonable price, then cash cows are worth a closer look.

 

by Ben McClure, (Contact Author | Biography)

 

Ben is director of McClure & Co., an independent research and consulting firm that specializes in investment analysis and intelligence. Before founding McClure & Co., Ben was a highly-rated European equities analyst at London-based Old Mutual Securities.

 

 

http://www.investopedia.com/articles/stocks/05/cashcow.asp

Return on Shareholders' Equity

Return on Shareholders' Equity

This measures profitability, specifically the percentage return that was delivered to a company's owners.

Why it is important

ROE is a fundamental indication of a company's ability to increase its earnings per share and thus the quality of its stocks, because it reveals how well a company is using its money to generate additional earnings.

• It is a relatively straightforward benchmark, easy to calculate, and is applicable to a majority of industries.
• ROE allows investors to compare a company's use of their equity with other investments, and to compare the performance of companies in the same industry.
• ROE can also help to evaluate trends in a business.

Businesses that generate high returns on equity are businesses that pay off their shareholders handsomely and create substantial assets for each dollar invested.

How it works in practice

To calculate ROE, divide the net income shown on the income statement (usually of the past year) by shareholders' equity, which appears on the balance sheet:

ROE
= net income/owner's equity

TRICKS OF THE TRADE

• Because new variations of the ROE ratio do appear, it is important to know how the figure is calculated.
  
• ROE for most companies certainly should be in double figures; investors often look for 15% or higher, while a return of 20% or more is considered excellent.
  
• Seasoned investors also review 5-year average ROE, to gauge consistency.
  
• A word of caution: financial statements usually report assets at book value, which is the purchase price minus depreciation; they do not show replacement costs. A business with older assets should show higher rates of ROE than a business with newer assets.
  
• Examining ROE with ROA (return on assets) can indicate if a company is debt-heavy. If a company owes very little debt, then it is reasonable to assume that its management is earning high profits and/or using assets effectively.
  
• A high ROE also could be due to leverage (a method of corporate fudning in which a higher proportion of funds is raised through borrowing than share issue). If liabilities are high the balance sheet will reveal it, hence the need to review it.
  

ROTC, ROA, ROE and Buffett's Durable Competitive Advantage

1. Warren Buffett has learned that a consistently high return on total capital is indicative of a durable competitive advantage. He is looking for a consistent ROTC of 12% or better.

2. With banks and finance companies he looks at the return of total assets ROA to determine if the company is benefitting from some kind of durable competitive advantage. Warren Buffett looks for a consistent return on assets ROA in excess of 1% (anything over 1% is good, anything over 1.5% is fantastic) and a consistent ROE in excess of 12%.

3. In situations where the entire net worth of the company is paid out, creating a negative net worth, Warren Buffett has only made investments in those companies that show a consistent ROTC of 20% or more. The high ROTC is indicative of a durable competitive advantage.

Also Read:

1. Return on Total Capital (ROTC)
2. The Right Rate of Return on Total Capital (ROTC)
3. ROA of Banks, Investment Banks and Financial Companies
4. Using ROTC Where the Entire Net Worth of the Company has been taken out
5. ROTC, ROA, ROE and Buffett's Durable Competitive Advantage
   

ROE in Action

ROE in Action

Using Value Line as the source, IBM's ROE was a paltry 5% in the 1991-1993 timeframe. At that point, now-retired chairman and CEO Louis Gerstner took over. Through a balanced combination of profitability, productivity and capital structure initiatives, ROE rose quickly to the 20-25% range in 1995, and has been over 30% for most years since. Even maintaining ROE at a steady figure requires performance improvement, unless all returns are paid to shareholders.

Share buybacks have been one of the keys to ROE performance. When Gerstner took over, IBM had about 2.3 billion shares outstanding. Today, that figure hovers at about 1.5 billion - IBM has retired about a third of its shares. Meanwhile, per-share cash flow has risen from about $3 to over $10 per share.

Looking at IBM's track record, it's clear that Gertsner placed particular emphasis on managing ROE and its components. He managed the owner's bottom line - not just sales growth, earnings reports, and image. He took the concept of ROE to heart.

2008

-----

One of the best ways to understand a concept or approach to investing is by example. It's hard to find a "pure" example of strategic financial excellence culminating in a world-class ROE performance.

Companies may perform well and indeed have ROE in their sights, but difficult business conditions or changing markets make actual performance in all areas and "drivers" a mixed bag.

A search of typical "value" businesses, even in the Buffett/Berkshire portfolio, yields mostly mixed results.

Understanding the Importance of ROE

The importance of Return on Equity (ROE)

Profits and growth drive intrinsic value.

For any fairly priced asset to increase in value over time, the value of the returns must grow.

If it isn't easy to pin down growth and the value of growth, it gets a little easier to step back and identify business characteristics that drive growth.

Sustained return on equity (ROE) implies sustained growth and blare out, "well-managed company!"

The management can control the component drivers of ROE (profitability, productivity and capital structure) to achieve growth, ROE, and hence, intrinsic value.

Whether or not you indulge in intrinsic value calculations, be aware that earnings and growth do matter.

When you look at a business, you seek consistent, growing returns on a quality asset base - achieving reasonable returns without taking on unreasonable risk.

ROE Components and Strategic Profit Formula ("DuPont formula")

ROE Components and the Strategic Profit Formula ("DuPont formula")

Some years back, the finance department at DuPont originated the "strategic profit formula." In some circles, this is called the "DuPont formula."

Return on equity = [profits/sales] x [sales/assets] x [assets/equity]

It is easy to see the links in this chain: profitability, productivity and capital structure.

These strategic business fundamentals that directly influence ROE are controlled or influenced by management. Management can influence or control these business fundamentals to maintain or increase ROE. Good managers work on each one.

When all three are strong and tight, ROE outcome is destined for success. If there is a "weakest link" (a business fundamental that is poor, failing, or declining), it can weaken the entire chain and hamper ROE indefinitely.

For each of these business fundamentals in the formula, we observe its value,

• in what direction it's going (trend) and
• how it compares to others in the industry.

High steady ROE and increasing ROE

Many investors, Warren Buffett himself included, get pretty excited when they see steady ROE over a number of years, particularly when already at a high level, say, greater than 15 percent.


Why?


ROE is defined as net earnings divided by owner's equity. What happens to net earnings, each year, in well-managed companies? They become part of owner's equity as retained earnings. Then, over time, the denominator of the ROE equation goes up, as earnings become equity (unless a portion of earnings are paid out as dividends).


That brings the following important observations:

• Maintaining a constant ROE percentage requires steady earnings growth.


• A company with increasing ROE, without undue exposure to debt or leverage, is especially attractive.

On the surface, a steady ROE would appear to indicate a ho-hum business. Same old, smae old, year in and year out. But the truth as illustrated is quite different. One can be excited that the business is growing to stay the same, as evidenced by a high constant ROE. :-)

ROE vs Earnings Growth Rate (EPSGR)

In fact, over time, ROE trends towards the earnings growth rate of the company.

A company with a 5 percent earnings growth rate and a 20 percent ROE today will see ROE gradually diminishing toward 5 percent.


A company with a 20 percent earnings growth rate and a 10 percent ROE will see ROE move toward 20 percent, as the numerator grows faster than the denominator.


Also read:
ROE versus ROTC
****Stock selection for long term investors

ROE versus ROTC

ROTC, or return on total capital, is another measure of owner returns, which has gained popularity recently. The difference between ROTC and ROE is the denominator "TC," or total capital, vs, the "E," or equity.

Total capital is owner's equity plus long-term debt. Using the more"holistic" total capital gives a more complete measure of business performance; that is, how much the company is earning on its total investment, including borrowed funds.

ROTC helps investors see through the effects of leverage. If a company is growing ROE but not ROTC, chances are, the company is doing it by borrowing to fund growth-producing assets, thus leveraging the comapny (this can be a good thing in moderation).

So, many investors look at ROTC and ROE together. They should march side by side and change in unison.

Some information sources like Yahoo! Finance and Value Line list both figures simultaneously.


Also read:
****Stock selection for long term investors

Understanding ROE: a handy performance yardstick

Japan: Where Capital Goes to Die
By Toby Shute January 14, 2009 Comments (3)

Ah, Japan: land of the rising sun, homeland of the hot dog-eating champions, and capital-sucking vortex.

"Capital-sucking vortex?" That's a wee bit harsh, no?

No, it's really not Japan is where capital goes to die, and I have the stats to prove it.

Firing up my super-duper stock screener (not sold in stores), I see 2,371 companies with a primary listing on the Tokyo Stock Exchange. That excludes non-Japanese firms that happen to have local listings, like Dow Chemical (NYSE: DOW) and Aflac (NYSE: AFL). Out of all those businesses, how many do you think managed a greater-than -4% return on equity -- a solid but not stunning result -- over each of the years 2005, 2006, and 2007?

Make sure you don't guess too high, or you'll be disqualified. I'll give you a hint: The answer is less than 800.

The price is wrong! In fact, only 35 firms hit that mark! Add in the 925 companies on the Jasdaq exchange, plus the stragglers listed on other local exchanges, and the number climbs to ... 36. In total, fewer than 1% of Japanese equities pass this simple test of Capital Allocation 101.

Why does return on equity (ROE) matter to Foolish investors?

Here's a primer, but the simple fact is that the "E" in ROE is shareholders' money. If management is retaining earnings to reinvest in the business, one of its basic requirements is to continuously generate an attractive return on the owners' investment. There are plenty of "profitable" companies in Japan, but those wealth-withering single-digit returns on equity just don't cut the wasabi.

Return on equity isn't the end-all and be-all of performance yardsticks, but it's a very handy one, especially if you remember that managers can juice this figure by taking on more debt. Note that I didn't limit my Japanese search to a maximum level of indebtedness. Some of the companies that passed the test only did so by leveraging to the hilt.
Do we avoid the archipelago entirely? After running this sobering screen, I'll definitely refrain from throwing investment dollars at something like the iShares MSCI Japan Index (NYSE: EWJ), no matter how cheap the broad market looks.

However, I'm not going to rule out every single Japanese company. After all, I've got three dozen here that are at least worth a look.

Take Komatsu, for example. This equipment heavyweight is the Japanese version of Deere (NYSE: DE). After checking out the numbers, I'm tempted to say that Komatsu is the superior firm.

These two outfits throw off about the same level of revenue, but Komatsu sports slightly fatter margins. In trying to suss out the difference, one statistic really jumped out at me. On its website, Komatsu lists 39,267 employees on a consolidated basis, whereas Deere recently claimed 56,700 full-timers. The resulting revenue-per-employee figure suggests that Komatsu's operations are a good deal more efficient.

I would also note that Komatsu has managed to post good returns on equity without employing nearly as much balance-sheet leverage as Deere.

Another interesting group of firms are the so-called sogo shosha, or general trading companies. Mitsubishi, Mitsui (Nasdaq: MITSY), Itochu, and Marubeni all passed my simple return-on-equity screen.

What do these firms trade, exactly? Well, pretty much everything, from textiles to food products to petroleum. Some of these companies date back centuries; they seem like a natural outgrowth of the nation's limited resource endowment.

I've run across several of these firms in my energy-sector coverage, from Mitsui's profitable Petrobras (NYSE: PBR) partnership to Itochu's dinged deepwater venture. They're interesting businesses, but I find them nearly impossible to analyze. If you're a fan of conglomerates like General Electric (NYSE: GE), then the Japanese trading houses may be right up your alley.

A Foolish final word I'm still parsing this list of Japanese firms, but here's a preliminary observation. Of the 36 firms, only six have a market capitalization north of $10 billion. In other words, the big boys are blowing it. That should make you even more wary of taking an index-based approach to your Japan exposure, unless you pick up one of the small-cap ETFs.

In Japan, just as we've discovered here at home, the market's best stocks are ignored, obscure, and small.


Fool contributor Toby Shute doesn't have a position in any company mentioned. The Motley Fool has a disclosure policy, and possesses a strong affinity for robots.

http://www.fool.com/investing/international/2009/01/14/japan-where-capital-goes-to-die.aspx

Estimating Growth in Value Investing

Estimating Growth in Value Investing
Avoid using valuation based on growth estimates

Another reason for pure value investing’s aversion to valuation based on growth estimates is that growth’s potential value can be ascertained using other accounting tools not requiring estimates.

This involves comparing valuation estimates using earnings with those using assets.

Three possibilities arise: The valuations are the same or one or the other is higher.

1. Earnings value = Asset value
When they are the same, growth bears no value as just noted.

2. Asset value > Earnings value
When asset value exceeds earnings value, managers are deploying assets sub-optimally, either due to ineptitude or excess industry capacity. No value resides there.

3. Earnings value > Asset value
When earnings value exceeds asset value, it is due to competitive advantages or barriers to entry, and these clues indicate potential value in growth. This indicates a company possessing franchise value. One measure of that value is the excess of earnings value over asset value. It is captured in the expression return on equity. This economic goodwill makes companies value investor candidates.


Also read:

1. Income Statement Value: The Earnings Payoff
2. Adjustments in Current Earnings figure
3. Avoid Pro Forma financial figures
4. Avoid Extrapolated Future Earnings Growth figures
5. Estimating Growth in Value Investing
6. Franchise Value
7. GROWTH'S VALUE
8. GROWTH'S VALUE (illustrations)

Focus on Return on Equity

The Key to Finding Stocks that Will Make You Rich? Focus on Return on Equity
By Joshua Kennon, About.com

Countless successful investors, businessmen, and financiers have emphatically stated, and proven through their own career, over long periods of time, the performance of a stock most closely correlates with the return earned on shareholders’ equity.

As one well known investor put it, even if you buy a business at a huge discount, if you hold the stock for five, ten years or more, it’s going to be highly unlikely that you will be able to earn more than the ROE generated by the underlying enterprise.

Likewise, even a more reasonable price or a slightly higher price-to-earnings ratio for a better business that earns, say sixteen or seventeen percent on capital, you’re going to have very, very good results over a twenty or thirty year period.

An excellent example is Johnson & Johnson. According to the company’s most recent annual report, “In 2006, we logged our 74th year of sales increases, our 23rd consecutive year of earnings increases adjusted for special charges and our 44th consecutive year of dividend increases. This is a record matched by very few, if any, companies in history.” The firm is diversified throughout the medical supplies, pharmaceutical, and consumer product fields. These include household names such as Tylenol, Band-Aid, Stayfree, Carefree, K-Y, Splenda, Neutrogena, Benadryl, Sudafed, Listerine, Visine, Lubriderm, and Neosporin, not to mention the eponymous baby care products such as powder, lotion, and oil. Compared to the S&P 500, the stock currently trades at a lower p/e ratio, a lower price to cash flow ratio, a lower price to book ratio, and boasts a higher cash dividend yield, all while earning a much higher return on assets and return on equity than the average publicly traded company!

Investing is a game of weighing odds and reducing risk. Can you guarantee that you will beat the market? No. You can, however, increase the chances of that happening by focusing on companies that have comparable profiles – established histories, management with huge financial interest in the company, a history of executing well, discipline in returning excess capital to shareholders through cash dividends and share repurchases, as well as a focused pipeline of opportunities for future growth. These are the stocks that have better chances of compounding uninterrupted, meaning less of your money goes to commissions, market maker spread, capital gains taxes, and other frictional expenses. That small advantage can lead to enormous gains in your net worth; only 3% more each year, over an investing lifetime (say, fifty-years), is triple the wealth!

The biggest challenge is the fact that very few firms are actually able to maintain high returns on equity over substantial stretches of time because of the breathtaking ruthlessness of capitalism. Of course, as consumers, we all benefit from this in the form of a higher standard of living through lower costs, but for owners, it can mean volatility and financial setback. That’s why you must settle inside of yourself the question of exactly how large a company’s competitive “moat” is, factoring that into your valuation. Do you think someone will be able to unseat Coca-Cola as the dominant soft drink company in the world? How about Microsoft? The latter would certainly seem more vulnerable than the former, but both are much better off than a marginal steel company trying to eek out a profit in a commodity-like business with little or no pricing power and few, if any, barriers of entry.

http://beginnersinvest.about.com/od/investstrategiesstyles/a/aa110107a_roe.htm