Why You Should Put This Stock on Your Watch List

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Most investors would drastically improve their long-term track records if they only bought wide-moat companies at attractive prices. The latter part of the equation is a near impossibility now that stock prices have run up 150% since their 2009 lows, but identifying wide-moat companies when the market is up enables investors to quickly pull the trigger when stocks get cheap.

The wide-moat company discussed in this article, Omnicom (NYSE: OMC), is a leader in the advertising industry. Many companies in this industry have attractive business models, but none is better-positioned to succeed than Omnicom.

Best in the business

Most advertising agencies earn stable profit margins due to the large variable costs in the business; when business is good, the companies hire more staff and spend more on projects, and the inverse is true as well.

Margin stability makes the industry attractive, but also competitive. Both Omnicom and rival WPP Group (NASDAQ: WPPGY) typically earn 10% to 12% operating margins. Interpublic (NYSE: IPG) would earn the same if not for a few disastrous acquisitions; management has since sworn off acquisitions and has developed a plan to improve its margins to Omnicom's level.

In any case, businesses in the industry typically perform about as well as all the others in the industry, at least on the operating level. As a result, the primary competitive benchmark is not how high a company's profit margins are, but how big a share of the market the company has.

Though Omnicom earns margins in line with the rest of the industry, it has a built-in advantage for building and maintaining market share. Omnicom is essentially a holding company that owns the three highest-rated advertising firms in the world: BBDO, DDB Worldwide, and TBWA Worldwide. Although few outside the industry have heard of these agencies, the three firms regularly sweep the year-end industry awards for excellence.

Omnicom's three outstanding agencies not only attract new customers, they also help retain existing ones. Management has been careful not to integrate the businesses; in fact, they largely operate as three separate advertising agencies. As a result, a customer that is unhappy with one of the three agencies can be shuttled to one of the other two and Omnicom will still keep their business. This creates unusually high customer retention, allowing Omnicom to defend its market share better than its competitors can protect their own.

Competition is one notch lower

Interpublic and WPP Group are not without their own advantages. Interpublic's McCann Worldgroup is regarded as one of the most creative agencies in the world. Meanwhile, WPP Group's head start in Asian markets allows it to earn a temporary windfall as competitors scramble to catch up. But neither company has Omnicom's trifecta of world-renowned ad agencies that attracts and retains customers based on reputation alone.

In fact, Interpublic and WPP Group have problems of their own. Interpublic's failure to integrate past acquisitions has led many analysts to question whether the company will ever improve its margins to previous levels. WPP Group has also made expensive acquisitions -- something that Omnicom's management is universally praised for avoiding. In addition, the mature advertising industry will make large market share grabs near impossible, ensuring that the status quo will persist with Omnicom on top, save for further value-destroying acquisitions by Interpublic and WPP Group.

Bottom line

Omnicom is top dog in the advertising business. It earns stable and reliable profits, and management makes sensible acquisitions. At 16 times earnings, the stock is fairly priced. But a market crash could cause that multiple to drop precipitously overnight -- and patient investors can cash in when that happens.


Ted Cooper has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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