Coke or Pepsi?
Mac or Windows?
iPhone or Android?
Chances are good you feel strongly one way or the other… and nothing will change your mind.
That’s the power of brand loyalty.
It’s an important idea that the world’s best investors—including Warren Buffett—understand… and use to find stocks that can generate steady gains for decades, in both good times and bad.
Today, I’ll explain how to spot these companies… and share two examples that will keep benefiting from their brands, no matter what happens with the economy.
Why Warren Buffett loves strong brands
To better understand the power of brands, let’s look at Warren Buffett’s definition of “franchises”—his favorite type of investment.
In his 1991 letter to shareholders, Buffett wrote:
“An economic franchise arises from a product or service that: (1) is needed or desired; (2) is thought by its customers to have no close substitute and; (3) is not subject to price regulation.”
In other words, Buffett looks for companies that are essentially immune from—or at least resistant to—competition… have a loyal fan base… and can raise prices without losing a lot of customers.
By contrast, a “business,” as defined by Buffett, earns exceptional profits only if it’s the lowest-cost operator or if supply of its product or service is tight. Even then, these “businesses” are constantly facing competition in terms of price and product quality.
In short, a strong brand acts like a “moat” to protect a company from its competitors. And because of their moats, franchises can do better than their less powerful “business” peers across all economic conditions.
That makes these companies great to own during times of high inflation, deflation, and even in a recession, as their loyal customer bases keep coming back, regardless of rising costs or a tough economy.
Put simply, franchises are a near-perfect all-weather investment. They might not be the cheapest stocks in the market—but for good reason: They’ll help you sleep well at night, regardless of market conditions. And they’ll typically generate growing profits—and rising dividends—year after year.
Now, you might be thinking, “That sounds great, but how can I spot the kind of brands that have long-term staying power?”
Here’s a simple shortcut…
Check which companies are consistently rising (or maintaining a high ranking) on one of the many lists of the world’s most valuable brands maintained by companies like Forbes and Kantar. The valuation methodology varies depending on the list, but all the rankings account for the company’s financial strength and the brand’s contribution to profits.
For the past three years, Apple (AAPL) has claimed the top spot on nearly every list. Apple’s brand is estimated to be worth $355 billion as of 2022.
Now, let’s look at the stock performance. As you can see below, Apple has quadrupled over the past five years. It’s up 318%… vs. a 75% total return for the S&P 500.
Given Apple’s No. 1 position on the list of the world’s top brands, it’s no surprise the stock is Buffett’s largest portfolio holding… by far.
Buffett started his Apple position in 2016. Today, Berkshire Hathaway owns nearly 6% of the entire company. Obviously, Buffett has a lot of confidence in Apple’s ability to generate market-beating returns for many years to come.
Another example of an exemplary franchise is PepsiCo (PEP).
According to Forbes’ most popular brand ranking, two of the world’s most valuable brands belong to Pepsi…
Pepsi—the soft drink brand—holds the No. 36 spot on the list. And Frito-Lay—the snack brand—comes in at No. 39.
Given Pepsi’s two strong brands, it’s no surprise the stock has nearly doubled (including dividends) over the past five years.
Just last week, Pepsi gave a strong sales and profit outlook as part of its second quarter (Q2) earnings announcement. The company expects 2023 full-year organic revenue growth of 10% (vs. a year ago)… and expects earnings per share (EPS) to jump 12%.
It’s worth noting that Pepsi’s growth is coming almost entirely from Frito-Lay—which grew both revenue and profit by 14% during the latest quarter… thanks to its ability to raise prices without losing customers (one of Buffett’s hallmarks of a strong franchise).
Conclusion
Franchises are the ultimate buy-and-hold stocks. Thanks to their focus on customer loyalty and brand-building, these companies are able to outperform their peers… while rewarding their shareholders year after year, across all economic conditions.
