How to Choose Good Stocks: Look for a Company with Patents/Trade Secrets

Last Updated on March 7, 2022

A company with patents/trade secrets is well protected from competition

What if your company was the only one allowed to make a particular product? No other company could produce the same product. If someone did, it would be illegal! That is exactly the power a Patent confers.

A Patent gives an exclusive right to the inventor of a new, innovative and usable product or process to derive benefits from it for a limited period of time. It protects your business as competition cannot copy your product. With a patent, however, you have to disclose all the information related to your unique product. And the life of a patent is usually a maximum of 20 years, after which anyone can produce the product.

So, what do you do if you do not want to disclose the way you make your product? This is where a trade secret comes in. A Trade Secret can be a formula, recipe, or process for making a certain product or providing a particular service. Unlike a patent, however, it is not limited to a particular time. Its life depends on how long you can keep it a secret.

A famous example of this is Coca-Cola’s formula for the soft drink, which has been a closely guarded secret for 122 years. A trade secret confers a slightly different advantage to a company. In Coca-Cola’s case, it has given the company a significant business advantage in the ‘carbonated drink’ market, as there is no other cola that tastes the same.

If a product is patented or has a trade secret, the company becomes the only one that can produce it. No other company can compete with it. Consumers who develop a preference for the product continue to buy it because the alternatives are not good enough. This leads to higher sales and consequently higher profits.

So, which companies have this moat? Obviously, the first thought that comes to mind is Pharma companies. Pharma companies like Dr. Reddy’s Labs, Sun Pharma, Cipla, Ranbaxy, and Biocon have patents for the new chemical compounds or compositions that they discover.

FMCG companies manufacturing personal care products like Procter and Gamble, Colgate, and Hindustan Unilever will usually have trade secrets (and some patents) for their products. Through R&D, these companies develop technologies that they claim perform a function better than the rest, e.g. cleaning our teeth, our clothes, making our hair grow stronger. This is also true of companies producing food products, like Britannia and Nestle India.

There are numerous possibilities in the food business to acquire this moat, because it’s difficult to copy a taste that is successful, and consumers feel that nothing but their favorite will do. Usually, these companies also build the brand moat to go with it, making the ‘total’ moat even better.

These companies usually spend a lot on R&D, around 6% of their turnover. This indicates the focus of these companies: the development of new and innovative products, a must for remaining successful over the long term. However, as an investor, you need to check whether this expenditure has yielded growing profits. So, look at the six critical parameters to know the financial track record of these companies. These are the stocks you should consider buying; naturally, at the right price.

Do any of your investments have Patents/Trade Secrets as their moat? Find a few companies which have this moat, and add them to your Stock Watchlist.

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