Putting numbers on Buffett's principles

[ratiman]

Buffett mentions moat, pricing power, and "circle of competence" or understandability of a business. Can we put numbers on these characeteristics of a good value investment?

 

 

First, moat.  A moat is a business in an industry where the market share changes very slowly. A number can be put on this, such as how much market share changes hands per year, for instance. There is a way to measure this such as the Herfindahl-Hirschman Index, which is easy to calculate. Of course a stagnant industry is not enough.

 

Next is pricing power. Pricing power can be measured by consistently increasing unit profitability. Sees has increased unit profits consistently while losing market share, so pricing power doesn’t necessarily rely upon a moat.

 

Next is the simplicity or understandability of the business. This could be measured by the Lindyness of the business: the longer the business has been around, the more it has demonstrated staying power, the more “understandable” the business is. 25 years ago, when Ebay was new, network effects were a relatively novel moat, but today it is understood that Ebay is a Lindy business.

 

A good Buffett investment would have low market share percentage changes, increasing unit profitability, and be a long-established business. All of these things can be measured.

Edited July 3, 2025 by ratiman

[LC]

A good way to gut check this would be to find failures which meet this criteria, and analyze why they failed.

 

Newspapers perhaps: disrupted by a structural technology change

 

[ratiman]

I should mention that the market share criteria was proposed by Bruce Greenwald.

 

Some failed Buffett investments are Kraft Heinz, Dexter Shoe, and IBM. Kraft Heinz he underestimated the pricing power of brands relative to retailers, although he probably also underestimated the shift away from processed food. Did Kraft or Heinz have increasing unit profitability and stable market share before Buffett bought it? I am going to guess no on that.

 

I think Buffett said that he bought IBM after talking to IT directors in his businesses who relied on IBM. Again I suppose it depends on how market share is defined. IBM probably has pricing power but has probably been losing market share for a long time.

 

I don't know what happened with Dexter Shoe. Like newspapers, Dexter was probably on the wrong end of a secular trend. In fact the same could probably be said of IBM and Kraft Heinz as well.

Edited July 3, 2025 by ratiman

[Hektor]

On 7/3/2025 at 2:31 PM, ratiman said:

I don't know what happened with Dexter Shoe

Competition from lower cost producers with Chinese operations, many be.

[ratiman]

But why couldn't Dexter move operations to China? I assume Fruit of the Loom is not made in the US.

 

Here is Greenwald on moats:

 

 

Greenwald: So it is really about, and Buffett’s word for this is moats, moats and franchises are identical, and it turns out moats are not that hard to calculate.

I think one of the things Buffett has been coy about is not letting people know how easy it is to calculate.

So if you think about the global automobile industry, it is so big that people can be viable with two percent market share, that people buy cars every seven to ten years so they don’t tend to be captive.

So a lot of market share changes hands, typically about one percent will change hands a year. Well to get to two percent, which is a viable level of entry, at one percent a year is a two-year moat, and that’s not going to stop anybody.

At the other extreme you’ve got Coca-Cola. In order to have the economies of scale necessary to distribute heavy product like soft drinks you typically have to have something like 25% local market share. That’s a situation where there’s tremendous consumer loyalty.

If you look at it in contested environments, two tenths of a share changes hands every year, so to get to 25% it’s going to take you at a fifth of a percent every year. It’s going to take you 125 years. That’s an enormous moat.

So the first element in this is what’s the minimum viable share somebody has to get to. For very big markets that’s going to be low. For small niche markets in geography or in product space that’s going to be large, and secondly what does customer captivity look like? And because the current technologies tend to be user oriented you have to learn how to use it so you have a lot of customer captivity.

And in services it’s face to face with high purchase frequency so again you’ve got a lot of customer connectivity but really what you’re looking for is minimum viable scale divided by annual market share change in a contested environment.

[Hektor]

2 hours ago, ratiman said:

But why couldn't Dexter move operations to China?

Good question. I had assumed that the cheaper competition eroded Dexter’s margin, making them less profitable. I asked ChatGPT and found this:

 

Dexter Shoe Company, once a well-known American footwear brand, faced a combination of factors that contributed to its decline. Here's a breakdown of the main reasons for its failure:

1. Shifting Market Trends

• Rise of Athletic Shoes: As consumer preferences shifted toward athletic shoes (e.g., Nike, Adidas, Reebok), brands like Dexter, which had been known for traditional dress shoes, were left behind. Dexter was slow to adapt to these changing trends.

• Casualization of Fashion: In the 1990s, dress shoes became less popular as the casual dress trend gained traction. Dexter was primarily known for its formal and semi-formal shoes, which became less desirable as casual footwear options took over.

2. Branding and Image Problems

• Outdated Brand Identity: Dexter's brand was associated with old-fashioned, conservative styles. As fashion trends changed, the brand struggled to reinvent itself and stay relevant to a younger audience.

• Failure to Innovate: Unlike competitors that embraced technology or style innovation (e.g., introducing new materials or unique designs), Dexter's shoes were seen as boring and lacking innovation, which hurt its appeal.

3. Manufacturing Issues

• Production Costs and Location: Dexter relied heavily on domestic production, which was more expensive compared to competitors who outsourced manufacturing to countries with lower labor costs. As cheaper foreign-made shoes flooded the market, Dexter's higher-priced products couldn't compete.

• Quality Control Issues: Some consumers reported quality inconsistencies with Dexter shoes, which undermined the brand's reputation for durability and craftsmanship.

4. Management Missteps

• Lack of Adaptation to Retail Changes: The retail landscape was evolving, with the rise of discount retailers and the growth of e-commerce. Dexter was slow to adjust its retail strategy, which hurt its ability to compete with companies that embraced new selling platforms and direct-to-consumer models.

• Acquisition by Brown Shoe Company: Dexter was acquired by Brown Shoe Company (now known as Caleres) in the late 1980s. While this allowed Dexter to continue operating for a while, the larger corporate structure may have hindered the agility needed to respond to changing market conditions.

5. Competition

• The Rise of Discount Retailers: Brands like Payless, Walmart, and other discount shoe retailers grew in popularity, offering lower-priced alternatives to traditional, higher-end brands like Dexter. Consumers increasingly gravitated toward affordable options, which further hurt Dexter’s market share.

• Globalization and Foreign Competitors: The globalized footwear market allowed international brands (like those from Asia) to produce shoes more affordably, intensifying competition for American manufacturers like Dexter.

6. Poor Response to Consumer Preferences

• Lack of Trend Awareness: Dexter failed to recognize the rising demand for trendy, fashionable shoes and continued focusing on conservative designs that lacked broad appeal, especially among younger consumers.

• Not Targeting Emerging Demographics: They didn't effectively target newer consumer demographics, such as millennials and Gen X, who were more interested in casual and versatile footwear rather than traditional dress shoes.

7. The End of the Brand

• In the early 2000s, after struggling with declining sales and relevance, Dexter's brand eventually faded from the mainstream footwear market. Some of its assets were acquired by other companies, and its name is not as prominent today as it once was.

[xboojum]

It's worth remembering that part of Dexter's secret sauce was the use of factory outlet stores, which is a model they invented; if they're moving a significant amount of their inventory via selling factory seconds (as they originally and perhaps always were were) or more cheaply made/finished models to compete with lower-cost models (which is what a lot of "factory outlet" stores sell; I don't know about Dexter specifically), and then there's no reason to go to a special store to buy the discounted ones because you can just go to Wal-Mart or Payless to buy a cheaper pair made in Vietnam, the whole model collapses. I don't think Dexter had any particular brand equity; they were just optimized to make and sell cheap shoes, and then one day shipping containers started delivering a better mousetrap.

[Hektor]

9 hours ago, xboojum said:

It's worth remembering that part of Dexter's secret sauce was the use of factory outlet stores, which is a model they invented; if they're moving a significant amount of their inventory via selling factory seconds (as they originally and perhaps always were were) or more cheaply made/finished models to compete with lower-cost models (which is what a lot of "factory outlet" stores sell; I don't know about Dexter specifically), and then there's no reason to go to a special store to buy the discounted ones because you can just go to Wal-Mart or Payless to buy a cheaper pair made in Vietnam, the whole model collapses. I don't think Dexter had any particular brand equity; they were just optimized to make and sell cheap shoes, and then one day shipping containers started delivering a better mousetrap.

Thanks @xboojum

[xboojum]

13 hours ago, xboojum said:

It's worth remembering that part of Dexter's secret sauce was the use of factory outlet stores, which is a model they invented; if they're moving a significant amount of their inventory via selling factory seconds (as they originally and perhaps always were were) or more cheaply made/finished models to compete with lower-cost models (which is what a lot of "factory outlet" stores sell; I don't know about Dexter specifically)

FWIW I checked Wikipedia, and the volume they were putting through factory outlet stores was sufficient that they couldn't fill it solely through factory seconds and started using it as a way to clear shoes that weren't selling due to fashion issues, seasonality, etc.: Harold Alfond on Wikipedia

[gfp]

There was a lot that was going wrong at Dexter.  I heard factory workers in Maine say that orders were drying up to a trickle and Alfond would instruct them to keep production up, to the point where they literally had nowhere to store the accumulating inventory.  Buffett should have known better, Harry Bottle would have painted a line on the wall LOL...  But nobody would even bring up Dexter if Warren hadn't paid in shares.  Berkshire bought a ton of businesses that went to zero.  It was paying in stock that made it hurt.

[schin]

Relative to Brooks, HH Brown, Justin Brands (cowboy) boots, Berkshire has shoe brands that have survived.  It's just Dexter was mismanaged and like Berkshire Hathaway (the mills), there was no competitive moat.

[Hektor]

Thanks @xboojum @gfp @schin for the titbit about Dexter.

[Eldad]

On 7/6/2025 at 3:11 PM, ratiman said:

But why couldn't Dexter move operations to China? I assume Fruit of the Loom is not made in the US.

 

Here is Greenwald on moats:

 

 

Greenwald: So it is really about, and Buffett’s word for this is moats, moats and franchises are identical, and it turns out moats are not that hard to calculate.

I think one of the things Buffett has been coy about is not letting people know how easy it is to calculate.

So if you think about the global automobile industry, it is so big that people can be viable with two percent market share, that people buy cars every seven to ten years so they don’t tend to be captive.

So a lot of market share changes hands, typically about one percent will change hands a year. Well to get to two percent, which is a viable level of entry, at one percent a year is a two-year moat, and that’s not going to stop anybody.

At the other extreme you’ve got Coca-Cola. In order to have the economies of scale necessary to distribute heavy product like soft drinks you typically have to have something like 25% local market share. That’s a situation where there’s tremendous consumer loyalty.

If you look at it in contested environments, two tenths of a share changes hands every year, so to get to 25% it’s going to take you at a fifth of a percent every year. It’s going to take you 125 years. That’s an enormous moat.

So the first element in this is what’s the minimum viable share somebody has to get to. For very big markets that’s going to be low. For small niche markets in geography or in product space that’s going to be large, and secondly what does customer captivity look like? And because the current technologies tend to be user oriented you have to learn how to use it so you have a lot of customer captivity.

And in services it’s face to face with high purchase frequency so again you’ve got a lot of customer connectivity but really what you’re looking for is minimum viable scale divided by annual market share change in a contested environment.

Thank you. That is great. It is not often I find a totally new concept in investing anymore. 

[ratiman]

 

19 hours ago, Eldad said:

Thank you. That is great. It is not often I find a totally new concept in investing anymore. 

I found that at the Acquirers Multiple blog. I don't know how he calculates market share changes. 1% market share change in auto market seems very small. .2% in soda sounds ridiculous.

[Trophicdynamics]

I think there are distinct quantatiave and qualitative aspects to equity analysis. The moat, pricing power, circle of competence are qualitative points of analysis and most likely should be based on your understanding of the respective topic. There is alot of subjectivity and assumptions involved in this analysis. I would put predictive DCF modelling in this category, even though there is some math involved. 

 

Quantitative analysis should focus on real numbers. Numbers which are based on historical performance and are hopefully free from fraud.  

  

[ratiman]

If a business is 100 years old, is Buffett ever going to say he doesn't understand it and it's not in his circle of competence? Has Buffett ever said that a new industry is in his circle of competence? I think it's pretty obvious that "circle of competence" is really just a way of saying the business has been successful for a long time.