What Is Best of Breed?
Best of breed refers to a stock that represents the most optimal investment choice for a specific sector or industry due to its high quality compared to its competitors. The term best of the breed is also used to refer to specific companies rather than the stock itself, generally focusing in on the management's track record in driving profits in all markets as the differentiating factor. This slang is derived from dog shows, where the highest quality dog for each breed wins an award and is given the "best of breed" title.
Understanding Best of Breed
Best of breed companies are usually identified through a consensus of analysts and high profile investors. The criteria for determining whether a stock is the "best of breed" is fairly basic. It usually involves looking at its revenue growth, market share, and corporate governance compared to its competition. The best of breed stocks are picked from this shortlist of companies that have shown strong growth over a period of time.
Challenges in Identifying Best of Breed Stocks
Not all analysts and investors will pick the same stock from the shortlist of best of breed stocks. As with any judging competition, personal biases play a role as some people value growth more than governance, and others care more about reinvestment in the business than dividends. Simply put, there are many personal opinions that go into anyone classifying a stock best of breed. More importantly, the time period being used can significantly influence the stocks that make the list. There are more stocks in the best of breed competition during a multi-year bull market, but the ones that stand out in a timeframe that includes a cyclical downturn may prove to be the higher quality investments.
There is also the issue of companies that span several sectors or industries due to horizontal or vertical integration. These stocks may be best of breed in one of the sectors they work in, but the investor is may actually be getting a company that only pulls a minority share of its revenue from that sector. This may not be a big issue as well-managed companies tend to do well in all their business lines, but the investor buying on a narrowly focused best of breed recommendation isn't getting the full picture of what they are buying.
On the whole, the best of breed distinction should be seen for what it is, an interesting way to refer to a strong stock pick. Reading up on an analyst's best of breed picks in biotech or oil services is fun, and it may actually identify some solid companies you've never heard. The next step is to do your own research into why that company is considered best of breed by that person or group. Blindly buying on a best of breed recommendation exposes you to the risk of ending up with a weak stock.