Perfect Company

General
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In addition to Inderes’ analyses, we can leverage the power of the community to screen all companies in the world. On May 18, 2022, @Heikki_Keskivali presented 19 criteria for a perfect company in his blog post “Characteristics of a Perfect Company” (Täydellisen yhtiön ominaisuudet - Inderes).

The criteria are extensive, and finding perfect companies requires a lot of time and effort. This could be a suitable task to share on the Inderes forum. Together, we could analyze the companies in our portfolios. Any company is suitable for analysis. Each fulfilled criterion earns one point, meaning 19 is the maximum score.

I opened this thread to refine the idea. If the idea gains traction and we agree on the criteria, analyses can be added to this thread. :saluting_face:

Below are the criteria presented by Heikki Keskiväli. The margins for criterion 1 should be agreed upon. Criterion 15 is perhaps too subjective.

  1. A perfect company operates in an industry with high margins. It can withstand a couple of hits and still generate healthy profits after operating expenses and necessary investments. For example, Visa’s gross margin is 80%, operating margin is 70%, net margin is 50%, and free cash flow is as high as 60% of revenue.

  2. A perfect company is led by its founder. Studies show that they make bold investments, are more innovative, and produce better results – they have skin in the game and the company’s best interests at heart. For example, 38-year-old Mark Zuckerberg still has 58% majority voting control of Meta.

  3. A perfect company scales well. As it grows, its expenses barely budge, leading to consistently increasing profitability.

  4. Thanks to its excellent product, a perfect company enjoys a huge market share. For example, Google has over 90% market share of the global search engine market.

  5. A perfect company has a natural monopoly in an industry where overlapping operations are not very sensible. For example, railway companies such as Union Pacific and Kansas City Southern operate on railway networks that keep competition in check.

  6. A perfect company has honest and trustworthy management. They speak the truth, treat shareholders with respect, and educate them whenever necessary. This is how Berkshire Hathaway warned in 1996 about the potential overvaluation of its own shares.

  7. A perfect company focuses on long-term cash flows instead of short-term accounting quick wins. A living example of this principle is Amazon and its mindset from the very beginning. It is beautifully articulated in letters sent to shareholders, the first of which dates back to 1997.

  8. A perfect company has an ironclad balance sheet. Not even a complete economic shutdown, as in the Covid crisis in 2020, can shake the company’s financial position. Take Apple, for example, which had almost $100 billion in net cash in 2020 and generated an additional $70 billion in free cash flow during the year.

  9. A perfect company has network effects that are difficult to replicate overnight. Take Mastercard (MA), for example, which has a lasting relationship with its customers and merchants. Its cards or devices can be used at nearly 500,000 points of sale.

  10. A perfect company does not need much or any capital from its owners; its business model finances its operations. It can operate with low or even negative working capital, as Walmart (WMT) does. It receives money from its customers before it pays its suppliers.

  11. A perfect company can grow for a long time before it reaches market limits. In his blog, Bill Gurley estimated Uber’s total market value to be $450–1,300 billion. This provides ample opportunities to continue investing in new businesses.

  12. A perfect company’s business model has stickiness, and it is not easy to switch away from it. Voice control technology provider Cerence is deeply involved in automotive OEM (Original Equipment Manufacturer) manufacturing processes through long sales cycles and integration work. It is difficult for competitors to drive the company out of the market.

  13. A perfect company is unpopular or even disliked. It is no one’s friend and known by few. Low coverage offers investors attractive opportunities to find it before others. An example is XPEL, a company that manufactures coatings for cars, which offered investors an average annual return of over 100% for a decade.

  14. A perfect company has a strong patent portfolio that it can commercialize and prevent competitors from entering the market with the same technology. For example, Gentex, a manufacturer of auto-dimming rearview mirrors, had over 1,300 patents and an impressive 93% market share.

  15. A perfect company has products that I know or use myself. This way, I can follow product development and potential challenges well in advance of others. For example, I am exposed to Trimble’s design software at work, so I can assess its benefits for industry experts.

  16. A perfect company is chronically acceptably or attractively valued. This ensures that the investor or company has ample opportunities to buy shares from the bargain bin. Take AutoZone, for example, which bought back over 80% of its own shares between 2000 and 2018, most of which at an 8–12 EV/EBIT multiple.

  17. A perfect company has a vision that I can identify with. It is not against my values, and it is pleasant to own. For example, the Swedish company Mips has developed helmet technology. Who wouldn’t want to save lives by investing?

  18. A perfect company can reinvent itself product and service generation after generation. This sustains growth and keeps the company relevant. An example is McDonald’s…

    1968: Big Mac
    -73: McMuffin
    -79: Happy Meal
    -80: McNuggets
    -97: McFlurry
    2021: McPlant

  19. A perfect company sells business-critical products and services. For example, TransDigm, a supplier of highly demanding aircraft parts, is the sole supplier for approximately 80% of the company’s revenue. The company sells inexpensive parts with an average price of $1,000, and 90% of them cost less than $5,000.

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2

If one starts with these criteria, one will probably achieve a good outcome. Most of them are effective indicators of a company’s quality, and that quality can be interpreted quite broadly with their help. However, I don’t entirely agree with a couple of them:

#2) This could be expanded to include the founder or their family as the leader. Since everyone’s time on this planet is limited, it would be a bit unfair to dismiss many great companies just because the founder is no longer with us. Additionally, family-owned companies have their own good sides, including long-term development and lower debt levels (though there’s likely an overlap here with founder-led companies, I’d imagine).

#10) This doesn’t seem to be a completely unambiguous criterion, because sometimes capital intensity is a huge and long-lasting competitive advantage. Primarily, however, it holds true, so let’s leave it at that.

#13/15/16) These are either very subjective, mainly deal with stock valuation, or both. There was certainly a relevant idea behind each of them, but they don’t really fit into a checklist for evaluating a company’s quality. Perhaps something similar in spirit could be put in their place:

  • the company does not evoke exceptional emotions in either direction (e.g., Tesla - Meta)
  • the company’s products are easy to understand
  • the company’s management has proven its ability to allocate capital effectively (AutoZone is an almost perfect example)

It would be fun to see if anyone can even semi-realistically find a company that meets 19/19 criteria. From my own portfolio, Nelnet comes surprisingly close, but even with that, I have to use different subsidiaries/parts of the group for different criteria. A good challenge to throw out there… :grin:

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Many people have probably started from the garage phase, and not by merging with existing ones at the beginning. An excellent Finnish company, for example, is Planmeca, which started in a garage.

I’ve been wondering if a company’s management can be great, but its products don’t sell for one reason or another.

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I’m very interested if the company has a really big technical advantage, for example, if the water contains rare important minerals or something similar that has been shown to have some benefit compared to other waters.

That wasn’t really the case here, although someone seemed to fear that Lahti would run out of water due to high demand :slight_smile:

I’m not an oat milk expert, but the same seems to apply there; there might not be technical differences. Oat milk could succeed with “no brand - no marketing.”

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