The Most Important Stock Selection Criterion
For those of you that have been following me, you might have learnt recently about my tumultuous financial past. I was born into a wealthy family in Singapore, but through a series of financial missteps, my immediate family lost everything and I had to rebuild my finances from zero in my early 30s.
Although I lost everything, one advantage remained. Every Chinese New Year, I would visit a wealthy uncle who had scaled our extended family’s business from its founding all the way to IPO. These visits were informal, but they were effectively a masterclass in business fundamentals and competitive strategy.
On one such occasion many years ago, my uncle imparted a lesson that, unbeknownst to me at the time, would later become the single most important stock selection criterion in my investing framework.
Throughout this article, I will use “donuts” as a placeholder for the actual line of business, to avoid revealing sensitive details of my family background.
The Visit
During one Chinese New Year gathering, a group of cousins sat around the lunch table when my uncle, in typical concerned fashion, asked one cousin how business was going. This cousin had recently ventured out to start his own company in a similar industry to the family business.
The conversation went like this,
Rich Uncle: "How has business been?"
Cousin: "Very bad, the economy is bad, so sales can't keep up"
Rich Uncle: "Are you attempting to do anything different from competition?"
Cousin: "What do you mean? I give the best customer service and have good relationships with my customers, that's why they buy my donuts!"
Rich Uncle: "Every competitor sells the same donuts you do. They can all offer good service and build relationships. You need something only you have. A special product or offering that forces the market to come to you. Only then can you control your destiny and increase profits".
He went on to explain that in the family business, a particular series of donuts was exclusive to them. Competitors could not replicate it, and that exclusivity was what allowed the business to scale past others.
My cousin dismissed the advice and continued operating a largely commoditized business. Years later, his company still struggles, and profitability has deteriorated from bad to worse.
At the time of this gathering, I was merely an observer. I had not yet read a single investing book. Yet this conversation would later crystallize into the foundation of my investing philosophy.
Stock Criterion #1:
My first and most important stock selection criterion is what I call a true Unique Selling Proposition (USP).
Simply put,
A special product or way of doing business that is so unique in offering customers value, to the extent that it is extremely difficult or impossible for current and future competitors to copy
This definition is deliberately strict. Many companies are believed to possess a USP. Very few actually do.
Companies with a genuine USP tend to be superior investments for two reasons:
- Sustained long-term runway of free cash flow generation
- Potential Pricing power
The first point is straightforward. As long-term investors, the value of a company is the present value of its future free cash flows. A hard-to-replicate USP creates barriers to entry, reduces competitive erosion, and increases the probability that future cash flows persist for longer than the market expects.
The second point is more subtle. Offering something genuinely unique allows a company to raise prices at or above inflation over time. Notice I prefixed with the word 'Potential'. This does not mean management must exercise pricing power aggressively, only that they can if conditions require it. Pricing power is an option, not an obligation.
Years after that gathering, when I was exposed to Warren Buffett’s concept of economic moats, and Pat Dorsey’s five moat classifications (network effects, switching costs, intangible assets, cost advantage, and efficient scale), I realized something profound - A true USP underpins most of these frameworks!
The frameworks may differ in taxonomy, but they are describing the same underlying phenomenon: protection against competitive replication.
The Turtle Moats
Over time, I refined the idea of a USP with 2 broad types of competitive advantage:
- Steel Moats: “Hard Moats”
- Steel moats are structural, systemic, and slow to erode. They are usually capital-intensive, regulated, or embedded deeply into customer workflows.
- Examples include: Network effects, Switching Costs, Intellectual property (e.g. Patents, Extensive R&D), Cost advantage, Efficient Scale (e.g. Regulatory Credit Ratings, Exchanges, Railway Infra, etc.)
- Clay Moats: “Soft Moats”
- Real but fragile. They rely heavily on customer perception, culture, and consistent execution. Like Clay, they must be continually shaped and maintained.
- Examples include: Brand (First-mover advantage or long-term reputation), Company DNA/Culture, Exceptional Management ability, Consumer habits (with low-medium switching costs)
How I Use This Framework in Practice
My initial shortlisting process for high-quality companies is simple:
- Does the company possess a USP that current or future competitors cannot realistically replicate?
- Is that USP protected by a Steel moat and/or a Clay moat?
This classification directly informs my portfolio construction and valuation discipline.
- If Steel:
- Higher portfolio allocation
- Less stringent valuation requirements, lower margin of safety
- If Clay:
- Smaller portfolio allocation
- More demanding valuation, higher margin of safety
Sometimes, a company possesses both - These are my favorite investments.
For example, Axon exhibits a Steel moat through its patented Taser IP and Evidence.com network, alongside a Clay moat driven by Rick Smith’s leadership, culture, and long-term mission alignment (Read this article)
There are, of course, a lot more additional filters I apply before adding a company to my watchlist. However, the two-step USP and moat classification is the fastest method I use to make a first cut into the “For-Me” investing pile.
For premium subscribers, you will have access to my latest stock watchlist including valuation-based buy levels. I also provide a detailed breakdown of the USP and Turtle Moat classifications assigned to each company on my watchlist below:
USP & Moat Breakdowns with My Buy Levels:
🔒Unlock below watchlist breakdowns with premium tier: