One of the defining characteristics of Capitalism is competition.  Indeed competition in capitalist countries such as the U.S. is so fierce that thousands of companies go out of business every year since they can’t compete effectively.However it should be noted that “real” competition does not exist in all industries with some dominated by oligopolies or even monopolies. In industries where competition does exist, winners and losers are sorted out by the market.

Firms that have a competitive edge over their rivals thrive in the marketplace and can exist for a very long time. Public companies that fall into this category can produce substantial returns for investors as they are able to capitalize on their competitive advantage. If one or more competitors can copy their ideas or make better products then then the company that had the competitive edge loses that advantage quickly. For example, in the cell phone manufacturing industry, US-based Apple Inc(AAPL) was on top of the world last year due to the explosive popularity of its iPhones and other products. Investors couldn’t get enough of Apple’s stock pushing it well over $700 per share late last year. However mesmerized by the media and hyped by Wall Street they failed to realize that Apple’s competitive advantage is not permanent. Indeed their main advantage was not in the making of the iPhone (hardware) but the software that went into it that made operating the device incredibly easy for a kid, grandma or an adult. Other players in the industry were not going to sit around and let Apple dominate the industry far too long. Companies such as South Korea’s Samsung Electronics went on the offensive by offering cheaper and even better versions of mobile phones taking a sizable chunk of Apple’s market share in a short period of time. Accordingly Apple’s stock price has returned to earth and closed at $449.73 yesterday.

Companies that have multiple and sustainable competitive advantages can offer great returns to shareholders. This includes holding onto to a competitive idea or an advantage over a long time and not lose it like Apple. I recently came across a fascinating article by Ruan Stander, a quantitative and equity analyst and portfolio manager of Allan Gray Proprietary Limited of South Africa.

From the article:

Evidence for sustainable advantages requires a company that has:

1. Been around for a long time.
2. Outperformed the average company consistently.
3. Not changed a lot over time to distort the analysis.

One company that fits the profile is Coca-Cola. The company has been around for 126 years and has faced capitalism’s creative destruction for long enough to be counted as a fair example. Table 1 on page 7 illustrates how Coca-Cola has been able to generate value for shareholders over the short, medium and long term beyond the market average. If an investment in the market in 1919 was worth R1m today, an equal investment in Coca-Cola would be worth R37m.

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Note: The investment return amounts noted are in South African Rand (R).

He discussed three competitive advantages that companies such as Coca-Cola hold:

1. Significant benefits to scale (an industry in which being bigger helps to keep costs low).
2. A leading market share (capturing the benefits of [1]).
3. A supply chain that is superior and hard to copy for existing competitors.

A supply chain that is superior and hard to copy for competitors with a reasonable market share

The third point is important since it is the ‘moat’ that turns 1) and 2) into a money-making machine for shareholders. For Coca-Cola the advantages are a bottling and distribution system that is hard to replicate and a recipe that is widely regarded as one of the best kept secrets in business.

Source: Buy OUTsurance, Quarterly Commentary, March 2013, Allan Gray

Nine other U.S. companies that have sustainable competitive advantages are listed below for further research:

I believe most of these companies hold all the three sustainable advantages discussed by Ruan above using Coca-Cola as an example. However I have not validated them. But they satisfy at least the criteria that they have been around for a long time.

1.Company:Colgate-Palmolive Co. (CL)
Current Dividend Yield: 2.22%
Sector:Household Products

In business since 1806, the company owns globally popular brands such as Colgate toothpaste, toothbrushes, Palmolive dishwashing liquid and many others in the household products category. In the time period from 12/31/2092 to 3/31/13, the company’s stock yielded a total return of 1169% compared to just 437% for the S&P 500 and 765% for the peer group which includes The Clorox Company (CLX), Avon products (AVP), Kimberly-Clark (KMB), Procter & Gamble (PG), Unilever NV and plc (UN, UL) and Reckitt Benckiser Group plc(RBGLY).

2.Company:Procter & Gamble Co. (PG)
Current Dividend Yield: 2.94%
Sector:Household Products

P&G  gets 62% of its sales from emerging markets. Some of the company’s products include items such as toothbrush, toothpaste, paper towels. etc. P&G hasn’t changed much from manufacturing and selling these and other household products  since 1837.

3.Company:International Business Machines Corporation (IBM)
Current Dividend Yield: 1.85%
Sector:IT Services

Founded in 1911, IBM is now more of a IT contract services provider than an innovator of new technologies. Capitalizing on its coveted patents and core competencies the company continues to thrive and earned $104.5 billion in revenues last year.

4.Company: Lorillard Tobacco Company (LO)
Current Dividend Yield: 5.01%
Sector:Tobacco

According to the company website, Lorillard is the oldest publicly traded company listed on the New York Stock Exchange and one of the oldest continually operating companies in America. Lorillard celebrated its 250th Anniversary in 2010. Founded in 1760, it is the third largest cigarette maker in the U.S..

5.Company:Exxon Mobil Corporation (XOM)
Current Dividend Yield: 2.75%
Sector: Oil, Gas & Consumable Fuels

Originally founded in 1870, the company today is the world’s largest publicly traded oil and gas company.

6.Company:Johnson & Johnson (JNJ)
Current Dividend Yield: 3.04%
Sector:Pharmaceuticals

Founded in 1886, Johnson & Johnson went public in 1944. J&J has increased dividends for 51 consecutive years.

7.Company:Abbott Laboratories (ABT)
Current Dividend Yield: 1.48%
Sector:Pharmaceuticals

As a major drug company Abbott manufactures many products in the areas of diabetes care, cardiac and vascular diseases, eye care, nutrition solutions, etc. Companies in this sector naturally have an edge over competitors since they hold the patents for the drugs they invented.

8.Company: Lockheed Martin Corporation (LMT)
Current Dividend Yield: 4.30%
Sector:Aerospace & Defense

Lockheed Martin’s history dates back to 1909. The company is a world leader in the aerospace and defense sector with thousands of innovations that are patented.

9.Company:Norfolk Southern Corp (NSC)
Current Dividend Yield: 2.58%
Sector:Road & Rail

Dating back to 1883, Norfolk Southern hasn’t changed much in a very long time other than many mergers and acquisitions. Today it operates about 20,000 route miles in 22 states and DC serving every major container port in the eastern U.S.

Data Sources:

Public companies 100 years old or more, USA Today
Company Sites

Note: Dividend yields noted are as of May 31, 2013. Data is known to be accurate from sources used.Please use your own due diligence before making any investment decisions.

Disclosure: Long NSC, RBGLY

One of the dilemmas often faced by investors in dividend-paying stocks is if they should reinvest the dividends or not. Reinvesting dividends received from equity investments on a periodic basis such as monthly, quarterly, bi-annually or even annually can substantially boost the total returns earned, especially in the long-term due to the effect of compounding.

The following chart shows the performance of the FTSE All Index of UK with and without dividend reinvested over the past 10 years:

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Source:  Reinvesting dividends key for growth, says Franklin Templeton’s Morton. FE Trustnet

Note: The blue line shows the Total Return (TR). The returns shown are in British currency terms.

From the article:

Investors who had simply put their money in the FTSE All Share would have seen their money grow by 81 per cent over the last decade, according to data from FE Analytics, but those who had reinvested their dividends over that period would have made 156.15 per cent.

Reinvesting dividends in the FTSE All Share index almost doubled the return for the period noted.

The decision to reinvest dividends depends on many factors like the goal of investment, type of investor, market conditions and so forth. Like any other investment concept, dividend reinvestment also has both advantages and disadvantages.

Some of the pros of dividend reinvesting include:

• Dividend reinvesting takes the worry of trying to figure out where to invest the dividend amounts received every time.
• The automatic reinvestment of dividends option offered by most brokers can make the reinvestment process easy and systematic.
• Most brokers reinvest the dividends for free without any commissions thus helping an investor acquire new shares without costs.
• In declining and volatile markets, an investor can pick more shares cheaper by reinvesting dividends.
• Dividend-payers that consistently increase dividends can help to accumulate additional shares when held over many years thereby increasing the total returns.

Some of the cons of dividend reinvesting include:

• This strategy deprives an investor of the ability to invest in some other stock or asset which may higher potential for growth.
• Reinvesting dividends in low quality companies or some sectors may not yield the best result. For example, it is not a wise idea to reinvest dividends in tech stocks since not only are the yields low but companies in the sector can go out of favor or even out of business almost overnight due to changes in the unpredictable industry.
• Taxes have to be paid in the years when dividends are earned from stocks held in taxable accounts. If a crisis such as the global financial crisis erupts and the company’s stock becomes worthless, an investor not only lose the original investment but also all the dividends earned and the taxes paid.
• Dividend payments are discretionary and can be cut for any or no reason by a company. When this happens, investors are likely to dump the stock wiping out years of price growth. An investor who was loyal to the company and reinvested every cent of dividend for years will lose out on gains.Hence selecting high-quality well established companies is important.
• If a broker charges a commission to reinvest dividends then reinvesting dividends will not be highly beneficial.

Despite the cons noted above, dividend reinvestment can be an excellent tool to build long-term wealth. However instead of blindly plowing back the dividends into their current holdings, investors have to be selective in picking companies for dividend reinvestment.

Ten British stocks that investors can consider for long-term investment are listed below with their current dividend yields:

1.Company: Unilever PLC (UL)
Current Dividend Yield: 2.97%
Sector: Food Products

2.Company: British American Tobacco PLC (BTI)
Current Dividend Yield: 3.78%
Sector:Tobacco

3.Company: Vodafone Group PLC (VOD)
Current Dividend Yield: 5.19%
Sector: Telecom

4.Company: HSBC Holdings PLC (HBC)
Current Dividend Yield: 4.16%
Sector: Banking

5..Company: Imperial Tobacco Group PLC (ITYBY)
Current Dividend Yield: 4.60%
Sector: Tobacco

6.Company: AstraZeneca PLC (AZN)
Current Dividend Yield: 5.37%
Sector: Pharmaceuticals

7.Company: Legal & General Group PLC (LGGNY)
Current Dividend Yield: 3.80%
Sector: Financial Services

8.Company: Reed Elsevier PLC (RUK)
Current Dividend Yield: 2.08%
Sector: Media

9.Company: GlaxoSmithKline PLC (GSK)
Current Dividend Yield: 4.51%
Sector: Pharmaceuticals

10.Company: Diageo PLC (DEO)
Current Dividend Yield: 2.31%
Sector: Beverages

Note: Dividend yields noted are as of May 30, 2013. Data is known to be accurate from sources used.Please use your own due diligence before making any investment decisions.

Disclosure: Long LGGNY

Charts are great way to visually represent data. The widely popular phrase “A picture is worth a thousand words” is indeed true, in most scenarios. However sometimes one has to dig deeper into the data shown in the chart in order to get a better understanding the information being displayed.

From an article titled Real Estate: More Than Just a Home by David Lee, fund manager at T.Rowe Price:

Mention real estate, and many people think of the place they call home. In the investment world, however, the sector encompasses a broad array of commercial opportunities spanning the globe. And, as a sector, U.S. real estate has been among the top performers of the past decade.

The Wilshire U.S. Real Estate Securities Index outperformed the S&P 500 Index by a wide margin over the 10 years ended December 31, 2012, and turned in a stellar 17.55% return through the turmoil and uncertainties of the past year (see chart below). Global real estate did even better with the FTSE EPRA/NAREIT Developed Real Estate Index, returning 28.65% in 2012.

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Source: Real Estate: More Than Just a Home, T.Rowe Price

Though the chart looks pretty and shows real estate assets outperforming stocks, one can argue whether the actual return earned by an investor is higher with REITs as opposed to stocks, if the investor held these assets in a taxable account.

U.S. stocks as shown by the dark blue bar had a total return of 16.0% in 2012 and REITs as yielded a 17.6% total return. REITs therefore outperformed stocks by 1.6%. This can hardly be called “stellar” because dividends paid out REITs are taxed as ordinary income for tax purposes whereas dividends earned from stocks can be “Qualified Dividends” subject to a lower tax rate of just 15% even for investors in the top tax bracket. Though REITs may assign a portion of the dividends paid as qualified at the end of the year the majority of the dividends will still be “Unqualified Dividends”  that will incur a higher tax rate. Generally the ordinary income tax rate for most people will be around 28% to 33%. Hence though REITs had a slightly higher return than stocks last year, when taxes are considered the total return for stocks will be higher. So in reality an investor would have been better off investing in stocks in a taxable account instead of real estate securities. The same logic can be applied for the 10-year period as well.

For an investor with a tax-deferred account such as Traditional IRA, REITs would have been a better option since they had a higher return both in the 1-year and 10-year periods. A  Roth IRA would be even better since the original investment and earnings can be withdrawn without any tax consequences during retirement.

Investors should definitely allocate some of the assets in their portfolios to REITs for diversification purposes. However it is highly important to determine in which type of account one has to hold REITs in due to the tax issue discussed above.

Related ETFs:

• iShares Dow Jones U.S. Real Estate Index Fund (IYR)
• Vanguard REIT ETF (VNQ)
• SPDR Dow Jones International Real Estate Fund (RWX)
• SPDR S&P 500 ETF (SPY)

Disclosure: Long RWX