Moat-one of the most important concepts in value investing. Every company has a value; but, the companies with big moats are generally less sensitive to outside forces which means you can invest with more confidence and comfort.
There are a million different types of moats. Some are economic; some are brand; some are position. Some are right in front of our faces; some require a bit of digging.
Still, when a business changes your native language, you’ve got moat. Want to look for something online? Google it. Want to listen to music? A few years ago, we had MP3 players. Today, the IPod. But not just Apple’s IPod, Microsoft has the Zune-you know, Microsoft’s IPod. (Microsoft’s Zune is losing to Apple’s IPod because of the “IPod Brand Moat”.) Need something-anything? WalMart’s got it. Even if they don’t, we’ll check there first.
Why was Buffett’s 1988 purchase of Coca-Cola a no brainer? Coke changed the English language. In 1988, if you wanted pop (soda), you asked for Coke.
Moat = increasing owner earnings. How long will that last? That’s the art of value investing. So long as the moat is strong, the business is strong.
Where do you find wonderful businesses? Everywhere. Start with the companies that have changed your life by changing your language.
P.S., Sorry for the late post!
Filed under: How to Search for Opportunities
Hi Sammy,
This post is part one of a series of posts on moat. It will become more clear as we go one. Still, to answer your question:
The size and value of the moat comes into play in two ways:
- It determines how large your margin of safety should be. The wider the moat, the less of a MOS you need. Though you should always have a MOS to protect your investment and enhance your returns, you could safely buy a wide moat business with a 25% or 30% MOS as opposed to buying a narrow or no moat business with a 50% or greater MOS.
An example of this is in this American Eagle analysis – very weak (or no) moat in AEO so you should be conservative with the future cash projections and demand a large MOS. AEO varies greatly from Buffett’s 1988 Coca-Cola purchase – massive moat, smaller MOS.
- The size of the moat helps in your calculation of value by giving an idea of how long we can expect owner earnings to continue growing rapidly and consistently. How long will Google be the search engine and capitalize on it? Three years? Six? With how rapidly technology changes, can you predict with confidence that Google will still be the search engine ten years from now? (Remember: Yahoo! was the search engine ten years ago.)
If Google has five years on its moat, then the value calculation should show five years of sustained, rapid growth, and then include slower rates for the next fifteen.
When analyzing moat to buy a company, think about how long it will last. Then, use that in your projections and in determining your MOS.
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In a lot of industries I have no idea how to tell if a company has a moat or not. Morningstar has a moat rating for a lot of stocks. Is it wise to rely on their assessment of moat? I know at least that their fair value estimate may not be so reliable based on other posts you’ve had.
Thanks, Howard
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You have two choices – dig deeper for a moat, or skip it and move on. For some companies and industries, you really have to dive in and find the moat. You have to ask questions (and then answer them – don’t worry, it doesn’t make you crazy). Moats can come in all shapes and sizes, and are not always easily identifiable.
If you can’t identify the moat or are unsure, skip it. You have literally thousands of potential investment options available. Don’t worry about missing this one boat.
Hope that helps!
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Over the weekend, I converted Joe’s JNJ worksheet to a program that would query web-available data from Morningstar and Yahoo and create a summary sheet for the stock symbols identified as possibilities. Given the problems associated with valuing financial stocks, the less than five-years of patent exclusivity that is now the norm for non-generic medications, and Buffet’s reasonable reluctance to consider high-tech stocks (where barriers to entry are fleeting and comparative product analysis is difficult, at best), I populated the Excel file with the remaining Fortune 500 stock symbols (325 of them). If memory serves, there were 82 that met the initial cut (i.e., discount rate > 15 percent). Apply Joe’s >13% threshold for CROIC and the remainder was roughly 30 stocks, without considering FCF variation and shareholder’s equity growth reliability. My list is now down to 15, and I’m working through analysis of the financials (common ratios) and a reading the 10Ks and 10Qs, which tend to cull the majority of the remaining. For the few that make the cut, sensitivity analysis will follow (looking at up-side versus down-side risks at various growth rates, based on past performance), and I’ll perform reconnaissance for a moat (an amorphous concept with tangible benefits). Interestingly, I did the same for international ADRs first, using the NYSE lists. Consequently, the 30 that met the initial S&P 500 cut support Joe’s contention that there are abundant stocks worth considering. Add the rest of the Russell 2000 and the international ADRs, and there are options aplenty.
There are three caveats worth mentioning. First, as Joe has mentioned repeatedly, this level of analysis (mine) seeks precision in an imprecise exercise (i.e., there is an element of art to this science, and beauty is defined by the beholder). Second, BH purchases are limited by the size of the target company, while mine are not (a function of my relative wealth … er, poverty). I could sell the house and invest the proceeds in a single company and not move the stock price. Third, Buffet likened stock selection to the perfect at-bat in baseball — where no balls or strikes are called and the batter is not compelled to swing at anything other than a juicy fat one that is ripe for the outfield bleachers. He has, therefore, indicated that he needs only one good idea each year to achieve success. I’m still looking for the one, but the year is young.
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Hi Robert,
Could you share the program you mention, would love to check it out 
You could mail me the details, my id is my last name at hotmail.com
Thanks in advance!
Regards,
Sanjay Shetty
I blog at: http://indiainvestor.wordpress.com/
P.s. my last name is “shetty”
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Robert,
I would be very interested in taking a look at the program you have made as well. If you don’t mind, could you send me the program or a link to the program? My email is WatsonR711@gmail.com. Thanks a lot.
-Ryan
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I would also like to run your program as well. It does take some time
to screen out undesirable stocks. My e-mail is myaddy111@hotmail.com.
Thanks,
Ron
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Sanjay, Ryan, and Ron,
I sent the spreadsheet to Joe a couple of days ago. After testing it, we talked on the phone today. I’m trying to make an explanatory video that is sufficiently small to download. With any luck, it will be ready in the next day or so — Joe’s schedule and my verbosity permitting.
Thanks,
Robert
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Check out Sanjay Shetty’s India Investor. He has some great spreadsheets that can be used as screeners.
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Very good article. I have always wondered how can you objectively define ‘moat’ which is frequently emphasized by Mr. Buffet. I am from Canada and Walmart is a household term as well as the Tim Horton (which is synonymous for coffee)
Thanks for the nice, brief and easy to get article.
Wasi Mohsin
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I think the concept of moat can be summarized in a simple question: What edge does this business have that virtually guarantees that it will be making the money (or more money) five and ten years from now?
There is no simple answer because it varies from business to business and industry to industry.
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How do we value the moat? For instance, AAPL’s intrinsic value is about $25/shr. Obviously, the franchise value is about $75 – $100 more per share. How do we value this ‘moat’?
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