Blue chips are supposed to be the best stocks you can possibly own — the crème de la crème of the stock market. These are pretty solid companies overall. They are supposed to be dependable stocks that will deliver steady returns year after year to investors. However, for investors who have lost dimes by the dozen in the recent crash by staking their hard-earned savings in those so-called blue chips, the losses have proved to be fatal.
Is there an alternative to blue-chip investing? The answer lies in investing in small companies that dominate a niche. These companies specialise in a product or service and control a small but very profitable niche . It is a fundamental tenet of prudent stock investing that market dominance is an important factor in picking companies. Companies, whose dominance in their niche segment appears to be sustainable. These companies target a particular market niche, perhaps that is not yet recognised by – or is too small to be of interest to larger companies.
By virtue of their dominance in the niche they operate in, these companies are able to retain their competitiveness and margins. In today’s cut-throat world, businesses that understand the power of specialisation are thriving. Small niche companies usually provide a product or service that large companies perceive as either beneath their need or non-core to their operations. Moreover, a substantial group of niche businesses are family-oriented or family run.
Look at some examples of successful niche players–some that have gone on to become household names. Others, not so popular but continue to achieve phenomenal success in their own niche.
Navneet Education has been a pioneer in educational publication content industry. Its Guides which makes education more simple and intelligible have strong brand recall. Over the years in the educational space, it has emerged as a preferred household brand.
Garware Wall-Ropes manufactures ropes and nets for fisheries, aquaculture, shipping and the sports industry. The company even supplies nets for the Wimbledon matches. It has further ventured into niche products like Landfill, Rockfall protection, Geosynthetic lining etc.
Control Print provides industrial grade coding and marking solutions. Once a machine is installed at a premise, the ink and other consumables have to be purchased from the same manufacturer or at least that is the preferred choice (because the machine is configured for the company’s consumables). Therefore, after a machine is installed, there is a regular source of revenue derived from supplying ink, various consumables and repair & maintenance. This makes it difficult to grab market share by competitors.
Indo Borax & Chemicals manufactures products which can be classified as boring, such as Boric Acid and Borax powder. The product finds application in Shampoos, Ointments, Mouthwash, Dishwashing products among others. Out of the three competitors in the field, it is the only profitable company in its space.
Several of the big fish in small pond companies are sole players in their small fields or are dominating their industry. These companies have created a moat around themselves, which is difficult to penetrate. Despite stiff competition, these companies enjoy very high operating margins. All niche players are into value-added products and services, not commodities. The very size of the niche they operate in, limits competition to these companies. It has been observed that successful niche businesses have responded to competition with innovation and higher-quality products, rather than cost-cutting measures.
There is a bright chance that some of the small companies operating and dominating in niche areas go on to become blue chips of tomorrow. An investor must keep a watchful eye on such opportunities.
(The author is founder of Prudent Equity)