The competitive advantage or moat of the company is one of the most important factors that determine whether a business will be able to generate a high rate of return. Competitive and pricing tests in the HexaShield framework are designed to test the impact on the business in extremely competitive situations. Companies that pass the stress test on this parameters are the one's which usually have a reasonably high pricing power due to the nature of goods and services that they produce. This pricing power usually comes from the fact that there is an intangible component in the products or services provided which makes it difficult for the business to be completely commoditised. It also is a function of whether a business is built on a business to consumer model or a business to business model. Business buyers employ staff whose sole raison d’être is to drive down the cost of purchase which significantly diminishes the ability of the business to protect margins and consequently a reasonable rate of return.

The competitive strength and ability to pass quality check is evaluated in a range:

Monopolistic Competitive & Pricing Strength: These businesses have extremely high competitive strength. They can protect margins and pass on all cost increases to customers without significant impact. Their competitive advantage is so strong that they emerge extremely resilient even if they are put through extreme competitive stress.

High Competitive & Pricing Strength: These businesses have high competitive strength. Their competitive advantage is reasonably strong and they operate businesses that are able to generate above average returns even as competitive intensity increases.

Reasonable Competitive & Pricing Strength: These businesses have reasonable competitive strength. Their competitive advantage is moderately strong and meet benchmark returns even if competitive intensity increases.

Low Competitive & Pricing Strength: These businesses are nearly commodity plays with minor differentiations. While they may survive in a competitive environment, they usually fail to build a sustainable compounding machine in a highly competitive environment.

No Competitive & Pricing Strength: These businesses are commodity players and usually price takers and usually fail to survive and also can't be sustainable compounding machines in a highly competitive environment.

Companies such as InfoEdge that operates Naukri.com and exchange platforms such as IEX or MCX typically have extremely strong competitive strength and pricing power. This usually is also a function of the two way network effects that have been built by these companies. Companies with reasonable pricing power are those where there is a lot of competitive intensity but an intangible moat such as brand recall, distribution network, etc allows them to charge a premium and protect margins in stress. Businesses like Dominos Pizza, Asian Paints, etc fall in this category. On the bottom end of the spectrum are pure commodity plays such as cement, steel or aluminium companies which are typically price takers of prevailing prices in global markets.

When the growth goes away, equities become bonds because when the growth is zero, the returns expected are merely the interest rates (earnings divided by market value) and not really the compounding. If growth goes away perpetually, then businesses cannot really quote higher than the net worth and when the outlook deteriorates further and turns negative, it will quote at a discount to the net worth. In other words, when the growth is away, the stocks become bonds. Growth is the key glue which allows the firm value to be much higher than the net worth or the value to have a power to reflect a strong multiple of the profits rather than being treated as a limited life concern. When growth is there, equities are treated as a going concern, and when the growth goes away, equities are treated as bonds or bond minus.

For creating outstanding value through investing, one of the most important foundations is earnings and its growth. It is narrated ad infinitum that price is nothing but a slave of earnings and its relentless growth over a period of time. If earnings are real and in cash and if they keep growing, then that will definitely reflect in the price and the sustainability of earnings growth into the market cap compounding. Re-investment and growth stress tests evaluate the impact of recession or depression on earnings and consequently the return on capital. They also stress test the impact on overall return on capital employed if incremental deployment of capital happens at lower rates which usually happens due to lack of market size or opportunity.

The outcome of reinvestment and growth tests are evaluated in a range

Exceptional: These businesses generate above average returns when put through stress of negative growth environments and have a huge size of opportunity to re-invest at an above average incremental return on capital.

Decent: These businesses generate above average returns when put through stress of negative growth environment however have a limited opportunity to re-invest capital and grow which reduces compounding capability.

Status Quo: These businesses generate average returns when put through stress of negative growth environment but have a little to no opportunity to re-invest capital and grow. This reduces them to bond like businesses.

Strained: These businesses struggle to consistently grow in normal situations and end up being value destroyers when put through stress tests.

Destructor: These are the worst quality businesses and end up being massive value destroyers across cycles.

Several companies operating in the consumer space such as Colgate, Castrol have high returns on capital but usually fail growth and re-investment stress tests. Companies that usually do well in these are ones that have a very large market opportunity (usually global) or are operating in a severely under penetrated category. Companies in the retail space such as Avenues Supermart or in retail financing space score well on growth stress tests due to the size of the opportunity. Companies that spend and money in R&D that usually end up creating new categories do very well. One such example is that of Microsoft which used cashflows from the Microsoft Office licensing business to build a very large cloud business. Similar was the case in Facebook which used cashflows from the facebook platform to acquire multiple businesses such as Instagram and WhatsApp to continue to expand its market opportunity.