Wide Moat Stocks

[Hawks]

Have been reading Morningstar's book "Why Moats Matter". For example they mention JNJ in the healthcare sector and Stericycle in the industrial sector.

 

So I would like to ask board members 2 questions:

1. which companies do you consider to have wide moats and why?

2.  are there new companies like spinoffs which may have the potential to be wide moat in the near future?

 

Looking forward to your comments.

[Guest Schwab711]

Have been reading Morningstar's book "Why Moats Matter". For example they mention JNJ in the healthcare sector and Stericycle in the industrial sector.

 

So I would like to ask board members 2 questions:

1. which companies do you consider to have wide moats and why?

2.  are there new companies like spinoffs which may have the potential to be wide moat in the near future?

 

Looking forward to your comments.

 

For #1, that is really the secret sauce. If you create an excel file to show stocks compounding at 6.7% (15x P/E) and 10% - 15% over a long period of time (10 - 20 years) you will see how quickly the high-growth stocks outperform. You will see that an investor confident in company's long-term prospects can pay 25x - 45x P/E and still get 10%+ compounded expected returns. ER = ((1 + ME) * (1 + OR)^N) - 1) where ME = Multiple Expansion. Investor on ME growth is risky and unpredictable in my opinion and will lead to lumpy yet low returns. In my opinion, most wide-moat stocks are extremely undervalued by the market (such as GOOD, JNJ, WDFC, MKC, ect) at 15x - 20x P/E based on the formula above.

 

As for #2, I wish I could find more companies with hidden catalysts such as wide-moats subs that could potentially be spun-off in the future. I know I sound like a broken-record but FICO has the Scores and Applications divisions. The Applications division is a predictive-analytics big-data software company that's growing revenue (although with lumpy results) at 10%+ and has a very long runway for future growth as more industries learn how to use all their data to make better corporate predictions. However the jewel of the company is the Credit Scores unit. Even though it is mature, it also has a long runway (arguably longer than the low market-share Applications unit) due to its high correlation to consumer debt levels. FICO Scores has very strong pricing-power (often mentioned in stock research but most companies can only raise prices when costs' increase and not due to out-sized demand) as the costs of providing FICO credit scores is a minimal % of even the smallest consumer loans. To show the true power of FICO's moat, during and after the crisis, no financial commentators that I know of placed any blame on the ratings firm but instead the push by banks and credit card companies now is to provide credit scores to all customers on a monthly basis (showing in my opinion, that FICO has the widest moat of any company I know of). FICO Scores is only increasing their pricing power and leverage with credit card partnerships by increasing revenue and moving away from the credit reporting middle-men (like Equifax).

[Hawks]

Schwabb711

Appreciate your comments and companies you mention. Will do some research on them. I may have  found a new company that might grow into wide moat status, but still too early to tell. It is PAH (Platform Specialty Products). They are a specialty chemical company, accumulating light assets in niche fields, and in multi-industries. Crude oil up or down really is no factor in their business as I understand it; therefore different that some "chemical" cos. Ackman is a main driver and owner getting this co going.

I have a small position and still evaluating and researching whether to accumulate more. If you know PAH or have any comments, would be interested in what you think.

[tede02]

Two businesses that I perceive with extremely wide moats are Broadridge Financial Solutions (BR) and Morningstar (MORN).  Broadridge essentially has a monopoly within investor communications for public companies such as sending regulatory information and administering proxy votes.  Morningstar simply has a very strong brand.  In my view, no company rivals the firm when it comes to rating mutual funds and ETFs.  The brand extends to investing platforms for financial advisers and the company even manages money using all of their data.  If I could turn the clock back, I would have loaded up on both in 2008-2009.  Both are pretty pricey today.

[Liberty]

Transdigm (TDG) has a wide moat. Sole source supplier of most of the relatively low-cost (compared to the price of a plane) but critical parts that they make, regulatory barriers and low absolute market per single part make it not worth even trying to compete, airframes stick around for decades and need aftermarket parts rain or shine (annuity-like characteristics), and they're supplying parts for pretty much everything that flies, civilian and military, so very well diversified.

 

Mastercard/Visa, for reasons that have been explained frequently.

[WideMoat]

MCO

GOOG

 

Two that Buffett has publicly named.

[west]

Have been reading Morningstar's book "Why Moats Matter". For example they mention JNJ in the healthcare sector and Stericycle in the industrial sector.

 

So I would like to ask board members 2 questions:

1. which companies do you consider to have wide moats and why?

2.  are there new companies like spinoffs which may have the potential to be wide moat in the near future?

 

Looking forward to your comments.

 

For #1, that is really the secret sauce. If you create an excel file to show stocks compounding at 6.7% (15x P/E) and 10% - 15% over a long period of time (10 - 20 years) you will see how quickly the high-growth stocks outperform. You will see that an investor confident in company's long-term prospects can pay 25x - 45x P/E and still get 10%+ compounded expected returns. ER = ((1 + ME) * (1 + OR)^N) - 1) where ME = Multiple Expansion. Investor on ME growth is risky and unpredictable in my opinion and will lead to lumpy yet low returns. In my opinion, most wide-moat stocks are extremely undervalued by the market (such as GOOD, JNJ, WDFC, MKC, ect) at 15x - 20x P/E based on the formula above.

 

My quant sense is tingling.  Do they discuss quantitative ways of assessing a company's moat in this book?  I know that you can look at the persistence of historic ROIC, but if the book discusses more things to look at, I definitely want to read about them.

[Jurgis]

10% - 15% over a long period of time (10 - 20 years)

<snip>

. In my opinion, most wide-moat stocks are extremely undervalued by the market (such as GOOD, JNJ, WDFC, MKC, ect) at 15x - 20x P/E based on the formula above.

 

None of the stocks above have a chance in heck to compound sales/earnings at 10-15% for 10-20 years.

 

GOOGL might have the highest growth rate in next few years, but they also have the highest risk of growth falloff. And their market cap with such growth would cross 1T really fast.

 

This is the biggest issue with wide moat high growth investing. Unless you get in early, no trees grow to the sky and the 25 -40 PE is not really undervalued.

 

In case people doubt this, please look at KO and the financial shenanigans it had to resort to to maintain the illusion of wide moat high growth.

 

Buffett has realized this long time ago. That's why cash flow from See's is not invested in See's. Unfortunately, for most companies the money is either invested in diworsefication or in overpriced share buybacks.

 

So, yes, buy wide moats when they are cheap. But don't expect great returns by buying them at inflated multiples.

[Patmo]

10% - 15% over a long period of time (10 - 20 years)

<snip>

. In my opinion, most wide-moat stocks are extremely undervalued by the market (such as GOOD, JNJ, WDFC, MKC, ect) at 15x - 20x P/E based on the formula above.

 

None of the stocks above have a chance in heck to compound sales/earnings at 10-15% for 10-20 years.

 

GOOGL might have the highest growth rate in next few years, but they also have the highest risk of growth falloff. And their market cap with such growth would cross 1T really fast.

 

This is the biggest issue with wide moat high growth investing. Unless you get in early, no trees grow to the sky and the 25 -40 PE is not really undervalued.

 

In case people doubt this, please look at KO and the financial shenanigans it had to resort to to maintain the illusion of wide moat high growth.

 

Buffett has realized this long time ago. That's why cash flow from See's is not invested in See's. Unfortunately, for most companies the money is either invested in diworsefication or in overpriced share buybacks.

 

So, yes, buy wide moats when they are cheap. But don't expect great returns by buying them at inflated multiples.

 

Nevermind that it's also way easier to spot an average business that's selling for cheap vs. a company that has a sustainable competitive advantage...

[Guest Schwab711]

10% - 15% over a long period of time (10 - 20 years)

<snip>

. In my opinion, most wide-moat stocks are extremely undervalued by the market (such as GOOD, JNJ, WDFC, MKC, ect) at 15x - 20x P/E based on the formula above.

 

None of the stocks above have a chance in heck to compound sales/earnings at 10-15% for 10-20 years.

 

GOOGL might have the highest growth rate in next few years, but they also have the highest risk of growth falloff. And their market cap with such growth would cross 1T really fast.

 

This is the biggest issue with wide moat high growth investing. Unless you get in early, no trees grow to the sky and the 25 -40 PE is not really undervalued.

 

In case people doubt this, please look at KO and the financial shenanigans it had to resort to to maintain the illusion of wide moat high growth.

 

Buffett has realized this long time ago. That's why cash flow from See's is not invested in See's. Unfortunately, for most companies the money is either invested in diworsefication or in overpriced share buybacks.

 

So, yes, buy wide moats when they are cheap. But don't expect great returns by buying them at inflated multiples.

 

What you say with KO is pretty much what I'm saying. Companies with a moat are the ones who will compound earnings at 10%-15% in the future. MKC may not seem to have much growth but they are a lowest-cost producer in a growing industry while doing share buybacks. My picks certainly may end up being wrong, so lower P/E serves as MOS, based on UST rates, for the (1+ME) term (subsitute relevant metric). You should try writing out the comparison example in excel but MKC selling at 25x earnings will still outperform an average 15x P/E stock growing at 6% over the long-term (probably high but I don't know a better estimate than current earnings = 1/ P/E). Stock returns = ((1 + ME) * (1 + OR)^N) - 1). As you can see, the more reliable faster growth derives from (1 + OR)^N. ME depends on the P/E at sale price, which is out of an investor's control. If "cheap" is irrespective of quality of business for you then you'll always end up with the worst companies at each P/E multiple so you'll have to buy the cheaper and trade on ME.

 

The best metric as evidence of a moat is Retained Earnings/Additional Paid-In Capital (Whatever happened to Par...)

 

BR looks pretty good, never heard of it before. MCO is my biggest position. TDG is the company I don't own. I don't know how to define moats but I know it when I see it.

[Guest Schwab711]

10% - 15% over a long period of time (10 - 20 years)

<snip>

. In my opinion, most wide-moat stocks are extremely undervalued by the market (such as GOOD, JNJ, WDFC, MKC, ect) at 15x - 20x P/E based on the formula above.

 

None of the stocks above have a chance in heck to compound sales/earnings at 10-15% for 10-20 years.

 

GOOGL might have the highest growth rate in next few years, but they also have the highest risk of growth falloff. And their market cap with such growth would cross 1T really fast.

 

This is the biggest issue with wide moat high growth investing. Unless you get in early, no trees grow to the sky and the 25 -40 PE is not really undervalued.

 

In case people doubt this, please look at KO and the financial shenanigans it had to resort to to maintain the illusion of wide moat high growth.

 

Buffett has realized this long time ago. That's why cash flow from See's is not invested in See's. Unfortunately, for most companies the money is either invested in diworsefication or in overpriced share buybacks.

 

So, yes, buy wide moats when they are cheap. But don't expect great returns by buying them at inflated multiples.

 

Nevermind that it's also way easier to spot an average business that's selling for cheap vs. a company that has a sustainable competitive advantage...

 

+1

 

Which is why I see them as often undervalued and occasionally severely.

[tede02]

Here's a good quick read on Broadridge:

 

http://www.forbes.com/sites/steveschaefer/2013/10/30/the-broad-reach-of-broadridge-the-most-important-financial-firm-youve-never-heard-of/

[Hawks]

west

I would say that Morningstar's book is not overly heavy in statistical analysis (although the chapter on "The Importance of Valuation" does have that emphasis). I like how they identify the characteristics of moat status using different actual companies to illustrate their point. Also, they deal with different sectors (energy, consumer, financial, etc etc) re what makes a moat in that sector; I found that section particularly informative. I think you would enjoy it. I bought it on Amazon.

[west]

west

I would say that Morningstar's book is not overly heavy in statistical analysis (although the chapter on "The Importance of Valuation" does have that emphasis). I like how they identify the characteristics of moat status using different actual companies to illustrate their point. Also, they deal with different sectors (energy, consumer, financial, etc etc) re what makes a moat in that sector; I found that section particularly informative. I think you would enjoy it. I bought it on Amazon.

 

Thanks!

[The Falcon]

Coincidentally just ordered this book a couple of days ago, the concept certainly has appeal to a lazy investor such as myself, and who's frictional costs are not insignificant when investing in US equities. 8)

[Guest Schwab711]

POOL (Pool Corp) seems like a wide-moat stock. They are the only national distributor of swimming pool-related supplies and it is unlikely the market will ever be large enough to allow for 2 nation-wide distributors. They were even involved in the hallmark of a wide-moat business, they were accused of anti-trust behavior in 2012.

 

http://www.poolspanews.com/business/poolcorp-and--big-3--named-in-lawsuit.aspx

[rishig]

10% - 15% over a long period of time (10 - 20 years)

<snip>

. In my opinion, most wide-moat stocks are extremely undervalued by the market (such as GOOD, JNJ, WDFC, MKC, ect) at 15x - 20x P/E based on the formula above.

 

None of the stocks above have a chance in heck to compound sales/earnings at 10-15% for 10-20 years.

 

GOOGL might have the highest growth rate in next few years, but they also have the highest risk of growth falloff. And their market cap with such growth would cross 1T really fast.

 

This is the biggest issue with wide moat high growth investing. Unless you get in early, no trees grow to the sky and the 25 -40 PE is not really undervalued.

 

In case people doubt this, please look at KO and the financial shenanigans it had to resort to to maintain the illusion of wide moat high growth.

 

Buffett has realized this long time ago. That's why cash flow from See's is not invested in See's. Unfortunately, for most companies the money is either invested in diworsefication or in overpriced share buybacks.

 

So, yes, buy wide moats when they are cheap. But don't expect great returns by buying them at inflated multiples.

 

The reason to invest in wide moat stocks is not because they have the highest top or bottom line growth - it is because typically they have high sustainable ROIC for years to come with a reasonable growth rate. And that by itself can create more wealth for shareholders than a higher growth rate company with low ROIC or a unsustainable ROIC.

 

As an example, for the period from 1968 to 2007, net income at the phar­macy chain, Wal­greens, grew at 14% annually and it was among the fastest grow­ing com­pa­nies in the United States. Dur­ing this period, the aver­age annual share­holder return (includ­ing div­i­dends) was 16%. Now, con­trast this with per­for­mance at the chew­ing gum maker Wm. Wrigley Jr. Com­pany during the same period. Wrigley’s net income dur­ing the same period grew much slower at about 10% a year, but the aver­age annual share­holder return of 17% a year was higher than at Wal­greens. The rea­son Wrigley could cre­ate more value than Wal­greens despite 40% slower growth was that it earned a 28% ROIC, while the ROIC for Wal­greens was 14% (which is quite good for a retailer).

[Guest Schwab711]

10% - 15% over a long period of time (10 - 20 years)

<snip>

. In my opinion, most wide-moat stocks are extremely undervalued by the market (such as GOOD, JNJ, WDFC, MKC, ect) at 15x - 20x P/E based on the formula above.

 

None of the stocks above have a chance in heck to compound sales/earnings at 10-15% for 10-20 years.

 

GOOGL might have the highest growth rate in next few years, but they also have the highest risk of growth falloff. And their market cap with such growth would cross 1T really fast.

 

This is the biggest issue with wide moat high growth investing. Unless you get in early, no trees grow to the sky and the 25 -40 PE is not really undervalued.

 

In case people doubt this, please look at KO and the financial shenanigans it had to resort to to maintain the illusion of wide moat high growth.

 

Buffett has realized this long time ago. That's why cash flow from See's is not invested in See's. Unfortunately, for most companies the money is either invested in diworsefication or in overpriced share buybacks.

 

So, yes, buy wide moats when they are cheap. But don't expect great returns by buying them at inflated multiples.

 

The reason to invest in wide moat stocks is not because they have the highest top or bottom line growth - it is because typically they have high sustainable ROIC for years to come with a reasonable growth rate. And that by itself can create more wealth for shareholders than a higher growth rate company with low ROIC or a unsustainable ROIC.

 

As an example, for the period from 1968 to 2007, net income at the phar­macy chain, Wal­greens, grew at 14% annually and it was among the fastest grow­ing com­pa­nies in the United States. Dur­ing this period, the aver­age annual share­holder return (includ­ing div­i­dends) was 16%. Now, con­trast this with per­for­mance at the chew­ing gum maker Wm. Wrigley Jr. Com­pany during the same period. Wrigley’s net income dur­ing the same period grew much slower at about 10% a year, but the aver­age annual share­holder return of 17% a year was higher than at Wal­greens. The rea­son Wrigley could cre­ate more value than Wal­greens despite 40% slower growth was that it earned a 28% ROIC, while the ROIC for Wal­greens was 14% (which is quite good for a retailer).

 

Great example. It would be interesting to see the changes in shares outstanding and multiple expansion/contraction. Your example provides excellent evidence for the Buffett/Munger statements regarding long-term returns approximating LT ROIC.

 

Although it seems impossible for large companies to grow at 10%-15% indefinitely, an example of this is WFC. Since the S&L Crisis, WFC has consistently been a top-3 bank in the US (and currently #1). They have been able to average >15% ROE because they consistently buyback stock or raise their dividend. Just because a company is able to sustain 15% returns doesn't mean they must grow to the sky.

 

To go with your example, Wrigley was able to more closely approximate continuous compounding due to their capital light business model where as Walgreens returns were closer to simple interest. The business model, return of capital, and market potential are all important factors in determining whether a company is able to compound (compounder is as over-used as moat).

[BG2008]

There was no mention of price.  So, I would say that Vulcan Materials and Martin Marietta are wide moat companies.  Here's what Peter Lynch has to say.  I'd love to own one of these companies, but their prices isn't so attractive. 

 

I’d much rather own a local rock pit than own Twentieth Century-Fox, because a movie company competes with other movie companies, and the rock pit has a niche. Twentieth Century-Fox understood that when it bought up Pebble Beach, and the rock pit with it. 

Certainly, owning a rock pit is safer than owning a jewelry business.  If you’re in the jewelry business, you’re competing with other jewelers from across town, across the state, and even abroad, since vacationers can buy jewelery anywhere and bring it home. But if you’ve got the only gravel pit in Brooklyn,  you’ve got a virtual monopoly, plus the added protection of the unpopularity of rock pits. 

The insiders call this the “aggregate” business, but even the exalted name doesn’t alter the fact that rocks, sand, and gravel are as close to inherently worthless as you can get.  That’s the paradox: mixed together, the stuff probably ells for $3 a ton.  For the price of a glass of orange juice, you can purchase a half ton of aggregate, which, if you’ve got a truck, you can take home and dump on your lawn. 

What makes a rock pit valuable is that nobody else can compete with it.  The nearest rival owner from two towns over isn’t going to haul his rocks into your territory because the trucking bills would eat up all his profit.  No matter how good the rocks are in Chicago, no Chicago rock-pit owner can ever invade your territory in Brooklyn or Detroit.  Due to the weight of rocks, aggregates are exclusive franchise.  You don’t have to pay a dozen lawyers to protect it. 

To top it off, you get big tax breaks from depreciation your earth movers and rock crushers, plus you get a mineral depletion allowance, the same as Exxon and Atlantic Richfield get for their own oil and gas deposits.  I can’t imagine anyone’s going bankrupt over a rock pit.  So if you can’t run your own rock pit, the next best thing is buying shares in aggregate-producing companies such as Vulcan Materials, Calmat, Boston Sand & Gravel, Dravo, and Florida Rock.  When larger companies such as Martin-Marietta, General Dynamics, or Ashland sell off various parts of their businesses, they always keep the rock pits. 

 

[LC]

BG - true: competition is limited within the industry. the "competition" comes from the gov't imposing costly regulation every few years, usually to improve environmental effects. upgrading kilns can wipe out half a decade's profits in a year for some of the smaller players.

[BG2008]

BG - true: competition is limited within the industry. the "competition" comes from the gov't imposing costly regulation every few years, usually to improve environmental effects. upgrading kilns can wipe out half a decade's profits in a year for some of the smaller players.

 

LC,

 

Can you expand on the kilns upgrade? 

 

I find that NIMBYism is good moat characteristics for aggregate miners.  Most residents are not keen on having a giant rock mining operation near their houses.  Hence, it's very hard to get permitting to open up new rock pits.  If a community is so desperate that they don't mind of a rock pit, well, that's probably not a community that you want to sell rocks in anyway.  That desperate community 1,000 miles away just can't ship the aggregates to your market. 

 

 

[LC]

Miners I guess are different: I think it was Monarch Cement I was looking at where every quarter for a while they were just complaining about having to comply with tighter emission standards and having to upgrade their kilns. This was after being allowed to delay the upgrades for a few years.

 

I agree with the NIMBY rationale you suggest, that seems to make sense to me.

 

Also another exercise is to map out where the producers are in comparison to demand centers for cement (large cities etc.) to give an idea of relevance. One of the cement trade journals had a good map to use as a starting point with the major plants.

 

Found it here: http://www.globalcement.com/images/stories/documents/articles/eGCMay2012-32-33.pdf

 

 

[BG2008]

Miners I guess are different: I think it was Monarch Cement I was looking at where every quarter for a while they were just complaining about having to comply with tighter emission standards and having to upgrade their kilns. This was after being allowed to delay the upgrades for a few years.

 

I agree with the NIMBY rationale you suggest, that seems to make sense to me.

 

Also another exercise is to map out where the producers are in comparison to demand centers for cement (large cities etc.) to give an idea of relevance. One of the cement trade journals had a good map to use as a starting point with the major plants.

 

Found it here: http://www.globalcement.com/images/stories/documents/articles/eGCMay2012-32-33.pdf

 

Seems like the Kiln that you're referring to is more geared towards cement production rather than the really dirt cheap $10/ton aggregates that consist of crushed stone, sand, and gravel.  I think those materials have even smaller radius where they enjoy tremendous amount of pricing power.  Cement is higher up in the value chain and supply can come from further away. 

 

[LC]

Yes I was talking about cement kilns, but they exhibit the same characteristics of regional monopolies (which is what attracted me to them). I would suspect the aggregate miners are even lower margin than cement producers but without the added regulatory risk.