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Resilient demand that doesn’t typically fluctuate much can make defensive stocks attractive investments. The trouble is, they don’t usually have the most exciting growth prospects.
A few companies, however, are able to expand by buying other businesses. And when this goes well, investors can benefit from long-term growth prospects as well as steady cash flows.
Compass Group
FTSE 100 catering firm Compass Group (LSE:CPG) is a good example. Everybody needs to eat and it seems unlikely that stadiums, offices, and hospitals are going to want to start bringing this in-house.
Catering is a labour-intensive industry. That means rising staff costs in the form of wage inflation are a risk the business has to either absorb at the cost of profit margins or try to pass on to customers.
Compass, however, has a big advantage when it comes to dealing with this. In terms of revenues, it’s about the size of its two nearest competitors combined.
The company’s scale allows it to buy ingredients in larger volumes (meaning lower prices) and share fixed costs across a larger operation (resulting in wider margins). And this helps offset rising costs.
Acquisitions have been key to the company’s success, both in terms of revenue growth and the scale of its operations. And it’s continuing to focus on expansion its presence in Europe with recent deals.
That’s been a winning formula for shareholders. Over the last five years, Compass shares are up 92%, compared with a gain of 86% for the S&P 500.
Brown & Brown
Another thing that people need whether the economy is expanding or contracting is insurance. And Brown & Brown (NYSE:BRO) is an insurance broker with operations in both the UK and the US.
As the firm grows, it also reinforces its competitive position. Attracting more customers gives it better negotiating power with providers, which it can use to offer more attractive terms to customers.
Over the last five years, the company has made a number of acquisitions in the UK, Europe, and the US. In doing so, it has both boosted its revenues and strengthened its market position.
As well as increased size, acquisitions help Brown & Brown benefit from local knowledge and expertise. This insight can be a big advantage when it comes to finding the right cover for customers.
Looking for a high volume of takeovers can be risky though. Integrating new businesses is a complicated process that can set a company back significantly if it goes wrong.
Yet over the last five years, Brown & Brown has been very successful in growing its business. And as a result, the share price has climbed 164%, leaving the S&P 500 in the dust.
Business models
Compass Group and Brown & Brown have a lot in common. Both operate in industries that benefit from steady demand and differentiate themselves with the advantages that come with size and scale.
I think that’s a powerful business model. And while past performance doesn’t guarantee future returns, there’s no arguing with the returns both companies have generated for shareholders.
In terms of valuation, neither stock is unusually cheap at the moment. But I think the strengths of the underlying business mean both are ones investors should keep a close eye on going forward.
