Question for the board

[JSArbitrage]

There are no small companies with a durable competitive advantage or wide moat. Small companies either don't have these traits or they are developing them. If they had them, they wouldn't be small. A more interesting question is what are the signs of a developing advantage.

 

I disagree.  Believe it or not, there are actually very high quality business that choose to remain small.  Two that immediately come to mind are In-And-Out Burger and Blue Bell Ice Cream (a brand in the South.) 

 

McDonalds: 32,000+ locations.

In-And-Out: 258.

 

 

[Myth465]

I see where you are coming from, but I also think its a waste of time. You realistically have only 4 real moats.

 

Patents

High Switching Costs

I am too lazy to name or find the other two.

 

Bruce had a book about this, and so did Pat Dorsey. I recommend buying either if you really want to know. Alternatively you can read this.

 

http://www.thesimpledollar.com/2008/03/21/review-the-little-book-that-builds-wealth/

 

 

 

I would instead focus on trying to kill a business and buying at a discount to IV. If there is a moat there just buy twice as much  ;D. ATSG doesnt have a moat, but its a small business that I like thats pretty tough to kill inmo, without investing loads of capital.

 

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Plan A is always to buy the Coke and Moody's of the world at 50% off. If you buy these type of businesses at that discount and it takes 2-3 years to trade at intrinsic value, you'll do very well. Intrinsic value will be much higher in 2 to 3 years. So 50 cents may be worth $1.30 or $1.40. This is always Plan A. But plan A is virtually impossible to execute across the entire portfolio because they are so very very rare. (Work Horse Positions)

 

When plan A fails, we go to plan B. Plan B is to buy at half off, regardless of business quality (as long as you're pretty sure intrinsic value is very unlikely to decline). Most of Pabrai Funds investments over the years have been Plan B.

 

 

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I find that most people perform Plan B, but lie to themselves and come up with some BS moat that isnt worth anything. I have done it in the past. Its a waste of time, if you do plan B, do so knowingly. Lets avoid the bed of procrustes.

 

Damn. I linked to that review and then decided to auctually read it. I havent read the book, but we pretty much agree. Also the 4 moats are listed here. I may have to pick this one up. Dont invent a moat for your write up. It will just cost you money. Trust me I am speaking form experience. This is what my typical write up looks like now with regard to the 4 filters.

 

Filter #2 – Does the business have a durable competitive advantage?

 

Not really. But its cheap, cheap enough to buy without a moat. Hopefully it works out...

 

Chapter Two – Mistaken Moats - From that explanation, it’s easy to visualize moats for almost any company. Any company with any size is doing something right, and it’s easy to confuse immediate success with competitive advantage. However, quick success usually has very little to do with true competitive advantage. Take Tommy Hilfiger, for example. Once, it seemed they were building a globally competitive brand – but now you can find Tommy clothes on discount racks. The dot-com busts like Pets.com are in the same boat – they seemed to have a competitive advantage because of the internet, but it was a mistaken advantage. There are really only four sources of true competitive advantage: intangible assets (like patents or licenses), customer switching costs (meaning it’s hard for a customer to give up that specific product – think Microsoft), network economics (like an ingrained shipping network), and cost advantages (control over some method of making the product cheaper than competitors are able to). A company with at least one of these and a nice return on capital is a good one to invest in.

[PlanMaestro]

I disagree.  Believe it or not, there are actually very high quality business that choose to remain small.  Two that immediately come to mind are In-And-Out Burger and Blue Bell Ice Cream (a brand in the South.) 

 

I am not American, and I know and love them both!  

[Guest VAL9000]

I see where you are coming from, but I also think its a waste of time. You realistically have only 4 real moats.

 

Patents

High Switching Costs

I am too lazy to name or find the other two.

 

The moat that I find most fascinating is brand.  In "Poor Charlie's Almanac", Munger gives a great description of how Coke's brand has been bootstrapped over the past 100+ years.  The short version is that Coke plows its earnings back into marketing, continuously rebuilding its lead in customer mind-share.  By always spending more than its competitors on marketing, Coke maintains its lead and makes better profits because of it.

 

Another good example of this is Tylenol.  It's so interesting that a product that has cheaper and equally effective competitors on the same shelves manages to own 35% of its market.  Unlike Coke, the recipe is public knowledge and can be readily produced.  And yet, people still prefer to pay the premium for pain relief.

 

[merkhet]

 

The moat that I find most fascinating is brand.  In "Poor Charlie's Almanac", Munger gives a great description of how Coke's brand has been bootstrapped over the past 100+ years.  The short version is that Coke plows its earnings back into marketing, continuously rebuilding its lead in customer mind-share.  By always spending more than its competitors on marketing, Coke maintains its lead and makes better profits because of it.

 

Another good example of this is Tylenol.  It's so interesting that a product that has cheaper and equally effective competitors on the same shelves manages to own 35% of its market.  Unlike Coke, the recipe is public knowledge and can be readily produced.  And yet, people still prefer to pay the premium for pain relief.

 

 

(1) I'd say that Coke doesn't just spend more than its competitors -- it's spends more intelligently.  (http://www.nytimes.com/1990/01/26/business/company-news-coke-disney-pact.html)  Children in the happiest place in the world think back and think of Coca-Cola.

 

(2) Tylenol's spending was arguably front-loaded while it was under patent and created a brand name effect.  In other words, it's sort of like the Tiffany's blue box effect.(http://www.neurosciencemarketing.com/blog/articles/is-branding-dead.htm)  People may perceive the brand to provide more pain relief specifically because of an association to the Tylenol brand name and not to, say, CVS or Walgreens brands.

[anders]

I dont think it is that easy..

 

I look for companies with a competitive advantage and believe that the durability of that advantage derives from the strength & growth of the moat... the building blocks of the moat/competitive advantage being porters five forces..

 

I believe that it wasnt until 'buying wonderful businesses at a fair price' that buffett increased his focus on the moat.. so for smaller companies it is much more difficult to find wonderful businesses with a moat since they really havent yet developed into one... One reason I believe buffett not invests in tech is because he can not determine the future of the moat.. e.i. low entry barrier into high-tech since thousands of students trying to make services better, faster and cheaper.. coca cola is so much easier, "give me 100B and tell me to compete against coke and I say it can not be done" - WB.. All porters forces in coke are so extremely high that no company would make the effort to compete (except giants like pepsi).. its throwing money away.. virgin coke anyone?

 

Charlie munger stated that google has the biggest moat he has ever seen.. b/c of mindshare which I believe is final destination for building a moat.. but mindshare still depends on the durability of the competitive advantages.. how did apple grow and fall then rise again..? The business must start out with certain characteristics that enables it to build strong barriers before competitors enters the arena.. I believe you can find these characteristics in all levels of market cap and in all levels of industry..

 

I recommend reading books about entrepreneurs..  e.i. Sam Walton.. He opened his first store in newport, arkansas.. I you can understand how he created the company coupled with the situation and place at that time, I believe you are on the right track for understanding how great moats are created.. how wonderful businesses are created..

 

Regards,

[oddballstocks]

I'm reading the book "Hidden Champions of the 21st Century" referenced above and the whole book basically answers the question you're asking.  I would highly recommend it, very easy read as well.

 

As a total aside one thing that I think makes the book great is the author's aim has nothing to do with investors it's about business and good business practices.  I've found some of the best "investment" books to have nothing to do with investment at all but are more how to run a good business.  An excellent book in that regard is "Billion Dollar Lessons", it identifies patterns that precede business failure.  Just something good to keep in the back of the mind when examining a company. 

[Shane]

I think a lot of small companies with moats are likely to be private.  American Panel is a company which makes walk in freezers that Berkshire Bought (I tried to sell them insurance last year and they told me, from the CFO).  They almost have a monopoly in the south as far as I can tell, and have no need to go public.  They never needed to raise capital so their only real incentive would be for the manager to sell their shares...

 

So I think most moat businesses will outgrow a small market cap or will be closely held.  If you can gain access to a wide moat business for cheap it would obviously be very smart to load up, and there are plenty of eyes out there trying to find them too so the odds are it will be fully priced.

[twacowfca]

 

The moat that I find most fascinating is brand.  In "Poor Charlie's Almanac", Munger gives a great description of how Coke's brand has been bootstrapped over the past 100+ years.  The short version is that Coke plows its earnings back into marketing, continuously rebuilding its lead in customer mind-share.  By always spending more than its competitors on marketing, Coke maintains its lead and makes better profits because of it.

 

Another good example of this is Tylenol.  It's so interesting that a product that has cheaper and equally effective competitors on the same shelves manages to own 35% of its market.  Unlike Coke, the recipe is public knowledge and can be readily produced.  And yet, people still prefer to pay the premium for pain relief.

 

 

(1) I'd say that Coke doesn't just spend more than its competitors -- it's spends more intelligently.  (http://www.nytimes.com/1990/01/26/business/company-news-coke-disney-pact.html)  Children in the happiest place in the world think back and think of Coca-Cola.

 

(2) Tylenol's spending was arguably front-loaded while it was under patent and created a brand name effect.  In other words, it's sort of like the Tiffany's blue box effect.(http://www.neurosciencemarketing.com/blog/articles/is-branding-dead.htm)  People may perceive the brand to provide more pain relief specifically because of an association to the Tylenol brand name and not to, say, CVS or Walgreens brands.

 

Expectations are half the battle with pain relief.  Real changes occur in the brain when a substance is taken with the anticipation that pain will be relieved, mood lifted, things go better with _____ (fill in the blank).  :)