#-ad_banner-#I’m fortunate to live in a city with generally strong economic activity and new business development. Still, even in the shadow of new construction, there are businesses dying off. 

A few days ago I stopped in for lunch at a local place, only to see an “Out of Business” sign on the door. A few miles away, a well-known chain restaurant finally threw in the towel and moved out of its location as well. I also noticed across the street, yet another chain-restaurant location is now vacant. 

Still, we have an abundance of casual dining options in my city. And just like in nature, the cruel reality is that some businesses will feast while others starve. The weakest must find a way to differentiate themselves and attract customers — or risk extinction. 

That’s true everywhere — and it’s especially important to keep in mind when investing.

I’ve been thinking about this a great deal lately as I re-read the profound insights of Michael Porter, the legendary business school professor at Harvard. He is a leading authority on competitive strategies and when he’s not teaching classes or writing books, he mentors newly-appointed CEOs at large corporations.

Frankly, the key messages Porter imparts to those new CEOs are the same messages that every investor should heed. And those messages center around competition.
I’ll explain his key message, which Porter calls the “five forces,” in today’s essay. 

Porter’s five forces can be neatly summarized in this graphic.

Think about all of those five forces for a moment. There are deeply embedded factors that make each industry unique. Some fortunate businesses are endowed with financial strength and ability; they can thrive without even breaking a sweat. Then there are other groups that must struggle to eke out the thinnest profit. 

Understanding the structural difference between the two is what the “Five Forces” model is all about. This qualitative framework is the best way I know of to measure the relative attractiveness of an industry. 

Let me give you a simple example. 

Think about a small city with a few dozen pizzerias…
 
A novice investor might read that a pizza chain’s earnings fell 5% last quarter and make decisions based on that number alone. A better investor will compare that to prior quarters to determine a trend (maybe earnings fell 15% the prior period and are starting to stabilize). But the best investors will dig beneath the surface and examine the contributing factors to draw conclusions about next quarter.

Has recent promotional activity led to increased store traffic? What if a new pizzeria opens up across the street? What is the potential impact of something like rising dairy prices? 

If you were to look at any company’s financial statements, you may not get much of a sense of these competitive dynamics. The numbers by themselves don’t really tell you what is happening in an industry. Instead, you need to learn what is actually influencing those financial results. This is the surest way for investors to spot fundamental changes underway (both positive and negative) before the crowd.

Michael Porter’s “five forces” model gets at the heart at this type of analysis, because it examines the roots from which all sustainable profits grow. 

That word “sustainable” is key, especially for income investors. 

You see, a flash-in-the-pan stock rally can come from anywhere. But virtually all long-term wealth creation can be traced back to an economic moat. That moat is formed by durable competitive advantages — the kind Porter’s “five forces” are talking about — that allow a company to generate superior returns on capital for stockholders. Yet the moat surrounding the business is only half the story. You also want to look for a moat that encircles an entire industry.
 
Back in school, we all learned the term “oligopoly,” which is characterized by an industry that has just a few key players. That certainly can’t be said about the pizzeria business I mentioned earlier. But it can be said about the bond ratings industry, for example. Just a few companies, including Moody’s Corp. (NYSE: MCO) and McGraw Hill Financial, Inc. (NYSE: MHFI), control almost all of the bond rating business. 

Moody’s, which is more of a pure play on bond ratings, has the financials you’ll often see in an oligopolistic firm: In 2014, the company generated 46% operating margins and 30% net profit margins. That’s about as good as it gets for any company in the S&P 500. 

Porter also suggests focusing on an industry’s ability to stave off new entrants. If you have taken a cruise in the past few years, chances are it was on a ship operated by Carnival Corp. (NYSE: CCL) or Royal Caribbean (NYSE: RCL). Those two firms control roughly 64% of the entire industry’s capacity. 

New competition in this industry is quite unlikely. It takes hundreds of millions of dollars to build just one new ship, let alone a fleet of ships that are needed to take meaningful market share. The net result of limited competition: Carnival has generated an average of $2 billion in operating profits over the past decade. 

Action To Take –> Once you fully absorb the importance of Porter’s Five Forces, you’ll never look at a company — or an industry — the same way again. And it’s the firms with wide moats built around these five forces that tend to offer some of the most reliable and robust dividends on the market. 

In the last month’s issue of my premium advisory, High-Yield Investing, I looked more closely at Michael Porter’s forces and discussed how we’ve used them in the past to find some of the best dividend paying securities the market has to offer. 

Using this analysis recently helped me find a collection of stocks so impressive that I think every investor should consider adding them to their portfolio today. Together the companies I found boast an average yield of 7.4%… have returned nearly three times more than the S&P 500 over the past decade… and offer less risk than the broader market as well. 

With performances that great, I’ve dubbed them my “High-Yield Hall of Fame” stocks. And if you’d like to see my full research and insights on each of these eight must-own investments, then I invite you to visit this link.