The Value Of A Moat

August 7, 2007 by Joe Ponzio

If your business doesn’t have a moat, it is unpredictable at best. Can money be made in no-moat businesses? Absolutely-but it is a gamble at best. Ben Graham, Warren Buffett’s mentor and friend, stated:

An investment operation is one which, upon thorough analysis, promises safety of principal and a satisfactory return. Operations not meeting these requirements are speculative.

Though a small- or no-moat business may offer a “satisfactory” return, it does not promise safety of principal. So, we invest in wide, deep, shark-infested moat businesses. But, how do we put a value on that moat and factor it into our price?

We don’t.

The Price Of Moat

A moat is a durable, competitive advantage that protects your owner earnings for years to come. It provides stability, consistency, and confidence in your assessment. The moat is part of the art of investing-the intangible force shield that allows your business to sustain high owner earnings and returns on capital and allows you to estimate, with a degree of certainty and confidence, the value of your business.

The moat does not come with a price that should be added to your business’ value. Moat determines the value by allowing you to project owner earnings. Another way to say it: You shouldn’t pay a premium just because there is a moat.

How does moat factor in? Invest only in businesses with moats-big, fat moats. Skip everything else.

The Bigger The Moat…

Every company has a value, though some are more easily calculated. The moat affects the value only to the extent that it determines how long you can project high, sustained owner earnings. But, moat also affects the purchase price by determining your margin of safety.

The bigger the moat, the smaller your margin of safety needs to be because it protects you from slowed or erratic growth. Think about it-what were the obstacles to Coca-Cola’s growth in 1988? Certainly not fierce competition. Coke’s moat was huge which allowed investors to buy with a lower margin of safety because the future was so certain.

The Moat Durability

When valuing a business, you project the owner earnings and buy them at a discount today. But, it is not rational to think only in terms of 5- or 10-year timeframes. For example, how long will Google be the search engine? Three years? Seven? How long will Google have rapid, sustained owner earnings before a competitor comes in to steal market share?

If Google’s moat will last five years, your value calculation should show five years of high growth, followed by progressively lower growth for the following fifteen.

Oh, and if you’re not entirely sure-move on to the next company. Just because a company is growing doesn’t mean you have to buy it or justify buying it. There’s always another boat coming.

My Moat Problem

I’m right there with you, Sammy. I don’t know precisely how to value AAPL so I have to gamble or pass. I’ll pass. The same is true for Adobe-I know it will grow, I know it has a huge moat, but I can’t figure out a value yet. I want to own Adobe, but I refuse to overpay or throw money in blindly without knowing the value.

Of course, if I can figure it out, I’ll post it here.

A Note From Joe Ponzio

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