A stock which meets our ‘Expanding Moat’ and aligned culture criteria

Brian Huerta

WCM Global Growth

Investors today need to consider more than the hard numbers of target investments. Where most people spend 95% of their time crunching numbers, the majority of our effort is spent on identifying businesses with growing competitive advantages and an aligned corporate culture.

In our experience, we’ve identified three key attributes to look for in great growth companies. These include:

  1. A tailwind, or growth path ahead,
  2. An expanding ‘economic moat’, or growing competitive advantage, and
  3. An aligned corporate culture.

1. The “price of admission”

Having tailwinds is essential to success. If the global demand for a company’s products is shrinking—or worse, if the product has been made irrelevant by a change in consumer preferences—this can be quite dangerous. We tend to own businesses in the ‘growthier’ sectors such as tech, healthcare and consumer. If you think about the emerging middle class around the globe, as people get wealthier they're going to buy products from the companies we own. That's a theme that isn’t going away for fifteen or twenty years.

The idea of focusing on businesses with tailwinds seems rather obvious. We call it a “price of admission” characteristic. Making sure it’s present won’t set you apart much, but if you forget to think about it, you are asking for trouble.

2. Businesses are like castles

Warren Buffett used the ‘moat’ metaphor to describe a competitive advantage. He likened a business to a castle and suggested that the company’s edge—the thing that keeps competitors from just copying your business and destroying your profits—was the moat around the castle.

The critical idea to note is how the competitive advantage or ‘moat’ is changing—is it getting stronger, or is it getting weaker? A lot of people think you just want the biggest moat. Our contention is you need to pay attention to a moat that is growing. We call this dynamic aspect of ‘moat trajectory’. The big idea is that the size of the moat is not what matters; it’s the direction of change.

3. An aligned culture

Culture is simply the set of values that animate the behaviours in an organisation. Those behaviours need to be aligned with the competitive advantage of a business. An organisation can have the greatest products, a robust brand and reputation, effective policies and processes and a long history of trading; but if the culture is poor, it is much less likely to succeed when compared with a business that has a healthy culture.

Culture is a huge differentiator between successful organisations and unsuccessful organisations, and we put a huge premium on this factor. The magic combination of a great growth company is a culture that encourages the behaviours that enhance the company’s competitive advantage. This can keep a business ahead of its competitors for years and years.

One stock with an expanding moat and aligned culture

We believe Sherwin-Williams (NYSE: SHW) ticks these three boxes.

Sherwin-Williams is the world’s leading paints and coating company with 5,000 stores worldwide. Its focus is primarily on the professional contractor with a store-driven model that prioritises high-touch customer service. We expect the company to grow at a mid-single-digit growth rate through a combination of:

  • increased store productivity;
  • pricing power; and
  • continued share gains from sub-scale local paint stores that often lack the inventory and digital capabilities to compete in today’s environment.

Sherwin-Williams’ business has proven to be resilient – it has only experienced 3 years of sales declines over the last 30+ years (all of which were modest declines during recessions). We expect the secular shift from do-it-yourself (DIY) to do-it-for-me (DIFM), with customers outsourcing home decoration, is a tailwind that will continue over time.

An expanding economic moat

Across Northern America, most paint is sold through independent local businesses as well as home centres such as Home Depot & Lowes. Sherwin-Williams’ one-stop-shop, the store-driven model enables it to:

a) protect the integrity of the brand,

b) control pricing and eliminate the risk of channel discounting, and

c) get direct feedback from professionals which in turn, they can use to introduce new products and services.

The contractor needs a quality product from a supplier they can trust, and to have confidence that it’ll arrive on time so they can get the job done on time. Sherwin-William’s vast network of stores enables them to achieve this goal by carrying sufficient inventory and a wide selection of product to all of its customers. It would be very difficult to replicate such a network of stores.

The customer-centric strategy and philosophy has led to industry-leading profit margins and very high ROIC for Sherwin-Williams.

How the culture supports its competitive advantage

Their customer-centric store experience, and the relationships that have been cultivated over many years with their professional clients, epitomise the corporate culture at Sherwin-Williams. Paints and coating is its business. As one senior manager told us, “at Sherwin-Williams you are either selling paint or helping someone else sell paint.”

Delivering paint to a contractor on time with the proper specs can make the difference in determining whether a project is economical to the professional. The associates at Sherwin-Williams are well-trained experts who are encouraged to go the ‘extra mile’ to help a customer get the job done. They know it can take just one bad experience for a contractor to take their business elsewhere.

In turn, employees are incentivised and rewarded for their superior customer service and most importantly, recognised as invaluable stakeholders in the business. In fact, the company also has one of the best management trainee programs we have seen which helps attract and retain talent. This has led to one of the lowest rates of employee turnover across the retail sector, with many associates remaining at the company throughout their entire professional career. Sherwin-Williams has very high employee ownership, which helps reinforce an owner-mentality in the stores. It’s that type of culture that really shines and that we think enables Sherwin-Williams to continue to outdo its competition.

Summary

What we do is very different from most other firms. We've found that, if you're just looking for high quality, wide-moat businesses selling cheaply, you’re going to find yourself in a lot of value traps. We've made the mistake in the past of buying high quality, wide-moat businesses cheaply. What we learned from these is to stay focused on the direction of the competitive advantage, and the alignment of the corporate culture to that advantage. There aren't that many great cultures with alignment to their competitive advantage, so when you find them, you hold them for a long time.

Invest in quality global stocks

The WCM Global Growth Fund focuses on quality global stocks with expanding economic moats in high growth sectors such as technology, healthcare and consumer. Click here to find out more.


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Client Portfolio Manager
WCM Global Growth

Brian joined WCM in 2020; his primary responsibility is communicating the firm’s investment thinking while servicing investment consultants and institutional clients.

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