Last Updated on December 2, 2024
Overview – Is It Worth Putting Your Money Into Brand Name Companies?
An investment term that’s used quite frequently is “blue-chip”, or more specifically, “blue-chip stocks”. These are typically the stocks of brand-name companies which are widely viewed as some of the largest, most prominent enterprises in the world.
Apple, Amazon, Shell, Visa, Microsoft: these are just a handful of some brand-name companies that have been investment darlings for countless investors over the years and have served as cornerstones for countless investment portfolios.
Because of their high-profile status, they typically command very high stock prices, offer attractive returns in the form of high dividend payments and/or capital appreciation, and are traded by all sorts of investors, from retail investors with modest means all the way to some of the largest institutional investors on the planet.
If these companies attract so much attention from all sorts of parties, does this mean that investors should pour all their capital into the biggest, most prominent businesses out there? After all, if everyone wants a piece of the pie, then surely it would make sense to secure yourself a piece as well, right?
Ultimately, it depends on the circumstances: under the right circumstances, it makes perfect sense to put your money into these brand-name companies, in other circumstances, not so much.
Understanding the Power of a Strong Brand
Let’s say you’re at the mall one day, and you decide to buy a cup of coffee. When you check the mall’s directory, you notice that there are three coffee shops to choose from: two small, local coffee shops, and Starbucks.
Despite the local coffee shops offering lower prices while also promising superb quality, you end up going to Starbucks instead, despite the heftier price tag and longer lines.
There are hundreds of car manufacturers around the world, with most of them more or less producing the same types of vehicles. Whenever you drive around you probably don’t pay attention to the specific car brands around you – after all, most of them look the same anyways.
However, if you were to come across a bright red Ferrari, chances are it would immediately grab your attention, as well as the attention of those around you.
Why is it that some brands such as Starbucks and Ferrari command so much attention, while other, competing brands are mostly overlooked? It all boils down to brand strength, or as others like to call it, brand equity.
Brand strength/equity is the perceived value of a well-known brand name. Companies, institutions, or even people with strong brand names can generate more revenue and/or attention simply because consumers recognize the strength and reputation behind the name and/or image.
There are countless other coffee brands other than Starbucks, many of which offer lower prices, and perhaps even better coffee. The barrier of entry to starting a coffee shop isn’t very high either (relatively speaking, of course): find a place to set up shop, find suppliers for your coffee and other materials, put together a menu of your offerings, promote your shop, then start welcoming customers.
Despite the myriad options available to consumers and the competition continuing to charge lower prices, Starbucks consistently remains at the top of the coffee industry year after year.
Ferrari’s car lineup is comprised entirely of supercars that sell for hundreds of thousands, or even millions, of dollars. Not only that, but the process of buying a Ferrari is very selective: even if you’re lucky enough to get one there are a strict set of rules that owners must follow, lest they run the risk of having to give up their Ferrari(s) or being blacklisted from purchasing future models.
Despite this extreme level of exclusivity and the very limited customer base, Ferrari consistently earns hundreds of millions, and recently, even billions, of dollars in revenue.
Starbucks, Ferrari, and other strong brands are able to succeed despite fierce competition because of their brand equity. These brands have established a solid reputation for the goods they provide, and whenever they’re mentioned they evoke a certain image in people’s minds of what sort of experience they can expect to receive.
Because of its myriad benefits, creating a strong brand is something virtually every business tries to accomplish (including Ilucidy!), so it’s not surprising that topics such as brand recognition and brand development are of great interest to business owners and marketers alike.
If strong, brand-name companies are able to generate impressive amounts of revenue year after year and can generally bolster the business, then how does brand strength relate to investment merit?
The Relationship Between Brand Strength and Investment Merit
If brand name companies are able to financially succeed because of how consumers perceive them, then that means brand strength can help bolster a company’s investment merit too, right?
Although the relationship between a strong brand and strong sales is well understood, things become a bit more complicated when investment merit enters the discussion.
It’s important to remember that investment merit is comprised of several elements: quantitative factors such as earnings growth, debt levels, free cash flow, capital expenditures, and qualitative factors such as management competence, business prospects, and, of course, brand strength.
It’s tempting to think along the lines of “strong brand -> lots of revenue -> high investment merit”, but just because a company has a strong brand doesn’t automatically mean they’re worth investing in.
Brands, on their own, are inherently worthless – they’re just names, symbols, or slogans. Anyone can come up with a name, symbol, or slogan and call it a “brand”. The true strength of a brand lies behind what it can lead to – an increase in sales, more customers, customer loyalty/retention, establishing an excellent reputation, the ability to expand and succeed in other markets, etc.
In a way, a brand is an intangible asset. Just like any other assets that a business owns, its worth is determined by its ability to produce a future financial benefit.
When it comes to assessing investment merit, the same logic applies: a strong brand is only useful to an investor if it directly leads to some sort of tangible business benefits such as an increase in revenue, consistent profit, lower debt levels, or the ability to outperform the competition.
The reason why companies such as Starbucks and Ferrari are able to leverage their brands so effectively is that they evoke a certain level of quality and service in the minds of customers, and they continue to deliver on those expectations time and time again. As a result, customers keep coming back, and the business continues to reap the rewards.
Having a strong brand is certainly nice to have, but it’s no guarantee that investment merit will be positively influenced as well. Citigroup and HSBC both have very strong brand recognition, but they’ve generally lost favour amongst investors due to previous corporate scandals. Now, their brand serves as a warning sign for investors to stay away.
Brand strength is merely a starting point – investors are responsible for determining if this brand strength truly does translate into some sort of tangible benefits that will ultimately strengthen the enterprise.
If the brand is able to do that, then the business may be worth exploring further, if not, then it’s probably time to look elsewhere.
Making Investment Decisions Based Solely on the Brand
Although companies with strong brands tend to attract more attention from consumers, this doesn’t mean brand names are always the best option to pursue.
Assuming you’re a sensible consumer, you probably wouldn’t immediately think of always buying brand-name goods or services without first looking for similar offerings that may offer the same level of value, but at a lower price.
Buying a good or service solely because of the brand without taking other factors into account is usually not a great idea. That’s because although companies with strong brands are well recognized this doesn’t mean they automatically offer the most value.
Starbucks coffee may cost close to $10, but coffee from McDonald’s that tastes roughly the same (or even better) may only cost $5. The markup in Starbucks coffee is primarily due to the brand name – chances are there aren’t really any major differences between the two, or at least the changes aren’t so dramatic that people would always notice.
The same logic applies to investing as well.
Although brand-name companies are usually looked upon favourably by investors, this doesn’t mean they’re always the best investments to pursue. It’s entirely possible to find other investments that aren’t household names but offer similar, or even superior, merit.
If investing was as easy as simply putting your money behind these big, brand-name companies, then everyone would already be doing so, and everyone who has done so would be incredibly wealthy by now.
However, we know that this isn’t the case in the real world – just because you buy some shares in Microsoft, Amazon, or Tesla doesn’t automatically mean you’ll soon be living the high life.
Remember, brand strength isn’t an automatic indicator of strong investment merit. Investors still need to perform thorough analysis to check if the brand-name company they want to invest in truly does offer the best value when compared to the competition.
Investing in Brand-Name Companies May Make Sense Under the Right Circumstances
One of the major barriers to buying shares of brand-name companies is that they typically command very high stock prices.
We’ve previously talked about the Efficient Market Hypothesis and how this hypothesis isn’t completely true: although markets have become more efficient, they’re still inefficient enough that occasional mispricings can still occur.
However, the problem with brand-name companies is that because so many investors are monitoring and analyzing them, it’s very rare for major mispricings to occur. Because of this, the argument can be made that the stock prices of brand-name companies sell very close to their intrinsic values.
Worse still, because the stock price is on a seemingly non-stop upwards trajectory, investors run a very big risk of overpaying.
Does this mean brand-name companies are outside the reach of investors who missed out when they were selling for much less in the past? Not exactly.
Unexpected events happen all the time that can send stock prices tumbling. Since 2020 it’s safe to say that you’ve likely seen your fair share of them, namely the pandemic and the Ukraine-Russia conflict.
These major events present a great time to pick up the shares of brand-name companies because, although their stock price has taken a hit, the underlying business fundamentals are more or less unchanged (unless the company in question happens to be involved in current events in some way).
In fact, this is how I got my hands on TD shares: in May 2020, TD shares were selling for approximately $60, which was down from their pre-pandemic price of $77-$80. I knew that TD was an inherently strong business that was simply the victim of short-term volatility. My hunch was right: at the time of this writing, TD shares are selling for more than $90, down from its peak of almost $110 before the Russia-Ukraine conflict.
While major events present an opportunity to pick up some high-quality investments, it’s important to remember that “buying the dip” isn’t necessarily something you should always do.
A sharp decrease in price is great, especially for brand-name companies, but investors are still responsible for going through all the necessary loops to make sure that the company they’re interested in still satisfies quantitative and qualitative measures of investment merit. Not only that, but it’s entirely possible for a brand-name stock to still be overpriced, even after experiencing a sharp decrease in price.
Wrapping Up
Brand-name companies are some of the largest enterprises in the world, so it’s no surprise that they attract the attention of all sorts of investors and end up in countless portfolios.
Although brand-name companies attract lots of attention, this doesn’t automatically mean they’re investment-worthy. A strong brand is only as good as what it can lead to: strong sales, more customers, and better business prospects, to name a few things.
A strong brand isn’t automatically a sign of a strong business, and subsequently, strong investment merit: this is something that remains to be seen and must be verified by investors.
It’s common to find the stock of brand-name companies selling for exorbitantly high prices, putting them outside the reach of many investors. However, under the right circumstances, such as a sudden market crash or unexpected global event, the price may drop enough for investors to be able to afford them.
Again, just because a brand-name company’s stock price drops precipitously doesn’t mean investors should scramble to buy as many shares as they can. Investors are still responsible for performing the necessary due diligence needed to make sure the investment merit they seek truly is there.
