Fool's Eye View

[ March 10, 2000 ]

Great Investing Myths -- Buying Brands

By Rob Davies (TMF Essex)

In recent years, buying brand names has become an accepted way of making investors rich. Among the many exponents of this philosophy have been Peter Lynch and Warren Buffett. This weekend will see the publication of Berkshire Hathaway's annual report to shareholders, which will probably attract even more attention than usual. The A shares closed last night at $42,300, substantially below their peak of $80,900 achieved in June 1998. That doesn't look like a good advert for the strategy.

Even the boring old S&P 500 has gained 23.5% since then, and the racy Nasdaq has gained 163%. Buffet has long held the view that he won't buy technology stocks because he doesn't understand them and is not convinced that the business will still be there in 20 years. That viewpoint I can sympathise with. However, I am not so sure that I agree with his views on buying brands like Coca-Cola (NYSE: KO) and Gillette (NYSE: G). Both these shares have had tough times recently and it seems that nothing can restore them to their previous glory. It is true that the valuations of both these companies reached elevated levels a few years ago, and all that is happening now is that they are coming back to more normal levels.

TMF Mayn wrote about one of Britain's famous brands, Manchester United (LSE: MNU), in a Fool's Eye View yesterday. He concluded that the company had a good future, but much of it was already discounted in the current share price. A price to earnings (P/E) ratio of 68 doesn't allow for much bad news especially if, as Maynard points out, some of the fickle fans migrate to the next hot team.

Another brand that has been much in the news recently is lastminute.com. This Internet bucket shop has cornered the market in advertising hype in the last few weeks in the run-up to its IPO. Few Internet-savvy people can fail to have heard of this company and its mediaphile co-owners. However, lastminute.com and its advisers seemed to be pushing that branding for all they are worth with a cheeky move yesterday. They sought to capitalise on this wave of interest by raising the indicated price range for the IPO from 190-230p to 320-380p. Not surprisingly, the discussion board glowed hot under the stream of protests.

Some of the posts make the very pertinent point that, for a company with revenue of £409,000 in the three months to December 31st, a valuation of up to £570m was a touch on the racy side. Others posters said that brand loyalty built on low price was unlikely to last long. Users smart enough to exploit lastminute.com are probably going to switch the next good deal that comes along. Customers delivered by one marketing campaign can presumably be drawn to the next one by similar means.

And herein lies the paradox of investing in brands. The maximum brand awareness usually coincides with the zenith of the marketing campaign. Or, as Buffett would say, when the stock market is dominated by the voting mentality, not the weighing mentality. And if everyone thinks the same, who is left to buy the shares? Once the infatuation with the brand declines, in parallel with the shrinking advertising budget, what is left to support the share price? A fading brand is not quite so appealing. When that happens the share price will be set by the cold reality of valuation, not the adman's hype.

But that's only my view. Tell us what you think about buying brand names on the Fool's Eye View discussion board or on the investment strategies discussion board.

Related Links
• Maynard Paton (TMFMayn) on Manchester United
• Fool's Eye View discussion board