Monopolies, Duopolies, and Oligopolies Make the Best Investments
Joshua is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
As every investor knows, there are two main goals for any potential investment. The preservation of capital is the first goal. This is paramount as it ensures that your hard earned wealth will not be taken away through a single poor decision. Warren Buffett famously described the first goal of investing when he said the first rule of investment is to never lose money and the second rule is to never forget the first rule. The second goal of investing is the growth of your capital. Healthy returns allow your portfolio to grow slowly, surely and steadily, thus multiplying your wealth.
Basic economic theory states monopolies, and in a lesser form duopolies and oligopolies, are some of the best ways for an investor to achieve these goals. When corporations are the only seller or one of the few sellers of a good they put the customer at the mercy of their pricing. With only a select number of products, a customer has much less pricing power. An example of this is the smartphone market, where Android and iPhone make up 85% of the market. Apple, Inc. (NASDAQ: AAPL) has seen massive growth in profits and revenue over the past decade and it is no surprise that it is a duopolist or oligopolist in its major markets.
Finding oligopolists is a good way to start the investment search but it is not a guaranteed path to profits. In addition to the dominance of the company in a market an investor must examine the nature of the market. There are many ways to describe a market. Understanding a market as expanding, declining, or cyclical is one of the simplest methods. A cyclical market can have such volatility that even oligopolists can be forced to declare bankruptcy. The terms expanding, declining, or cyclical are not exclusive, but for the purpose of understanding a market it is easiest to start off with only one term. The four firm concentration ratio is a metric commonly used to determine the degree of competition in a market. When this ratio is above 50% then the market is said to be oligopolistic.
The auto market is a good example of a cyclical oligopolistic market. According to the Wall Street Journal the 2012 YTD market share numbers state that General Motors Company (NYSE: GM), Ford Motor Company (NYSE: F), Chrysler, and Toyota Motor Corp (NYSE: TM) have a combined market share of 59.5%. The benefit of being an oligopolist is enormous for a company and its investors. Regardless of one's political leaning, it is clearly evident that the Government help given to General Motors and Chrysler was significant and couldn't have existed without their power in the auto market. Ford was able to survive the recession without going bankrupt, but it still benefits from the Government's help to GM and Chrysler. The historical precedent set by these Government bailouts means that Ford will be able to argue it's right for equal treatment if it were ever to ask for Government assistance. Toyota is not a U.S. based automaker but it still has major operations on the continent with nine factories in the United States and 13 in all of North America. The thousands of American jobs it provides means that it may also be able to develop a preferential and beneficial relation with the U.S. government.
As an investor, the fact that the Government may be willing to provide billions of dollars in aid in order to help support your specific investments helps to achieve the first rule of investing; the preservation of capital. Many small business owners needed help during the 2008 recession but the government did not provide them with billions in aid. The sizes of the auto manufactures and their large employment base give them extra power to influence Government decisions and thus help support their operations and their investors.
Even though a market is cyclical, it does not mean that companies that operate in it cannot use their power to their advantage. When investing and fighting for the preservation of capital it is important to look at the ability of companies to influence government. Capitalism in a purely theoretically neoclassical sense may ignore governments, but the real world does not function in such a form. Investors need all of the help they can get and investing in companies that have the ability to inform and influence the governments which shape and maintain their markets can be very advantageous. Leaving an investment to the whims of fickle consumers increases unknowns, volatility, and the risk of losing your portfolio and being forced to retire on social security alone.
Free cash flow analysis and using a PE ratio based on average earnings are great ways to value a company, but they are not enough. The Government bailouts of the auto industry in 2008 are not a blip on the screen but an outcome of the fundamental makeup of this oligopolistic market. As an investor, placing that hard earned capital in a monopolist or oligopolist provides an extra degree of safety, and I believe investors need to be reminded of this.
MrCanadian1 has no positions in the stocks mentioned above. The Motley Fool owns shares of Apple and Ford. Motley Fool newsletter services recommend Apple, Ford, and General Motors Company. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.