Competitive Positioning Is Most Important

Future profits drive stock prices over the long term, so it makes sense to focus on how a business is going to generate those future earnings. Competitive positioning, or the ability of a business to keep competitors at bay, is the most important determining factor of future profits. Despite where the financial media may spend most of its energy, competitive positioning is more important than the economic outlook, more important than the near-term flow of news that jostles stock prices, and even more important than management quality at a company.

Compare investing to sailing on a ship

It may be helpful to think of the investing process as if you were planning a trip across the ocean. You cannot do anything about the current weather or the tides (the current economic conditions). You can try to wait out bad weather that might sink your ship, but then you are also giving up time. And as we've already covered, time is a precious resource in investing.

The main thing you can control is what ship to board. Think of the seaworthiness of a ship as the competitive positioning of a business, and the horsepower of the engine as its cash flow. Some ships have thick, reinforced metal hulls, while others have rotting wood. Clearly, you would pick the ships that are the most seaworthy (with the best competitive positioning) and have the most horsepower (cash flow).

Though the ship's captain (company management) certainly matters, the quality of the ship is more important. On a solid vessel, as long as the captain does not mess up, there is not much difference between a good and a great captain. Meanwhile, there is nothing the best skipper can do if the boat's engine is broken and the boat is constantly taking on water (poor business). To relate this to stocks, business economics trump management skill.

A better ship is always best

It's also worth noting that all ships will experience waves (volatility). And though it is true that a rising tide lifts all ships, the tides have nothing to do with the quality of the boats on the sea. All else equal, a better ship is still going to arrive faster, and a company with the best competitive positioning is going to create the most value for its shareholders.