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Moats are not forever.


PlanMaestro
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^ Yeah health-driven shifts are a big reason why Coke could see its moat diminish. I'm not that bullish on Coke.

 

Furthermore, you have to remember that Coke is so dominant in soft drinks, that national governments could start taking steps to dismantle its monopoly. Can't rule that out.

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I agree.  This is why I sold all of my KO in 2010.  I know Coke makes other products besides soda, and the stock is up since I sold, but sugary soda (and even worse the diet crap) is its bread and butter.  I just didn't feel comfortable owning it any longer.  I've sold most of my BRK as well.    I think when the public opinion on sugar turns sour, it will happen quickly and KO will be one of the largest casualties.  KO won't go out of business or go bankrupt or anything, but its stock will tank.  Might be a good buy when that happens.

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I generally consider myself to be too dumb and inexperienced to try to pick out moats, and I'm not convinced that you need to be able to.  But how about colgate palmolive?  That is one stock that I never see anyone mention on here.  They earn ridiculously high returns on capital.

 

One stock I was looking into recently was de master blenders.  They have the pilao coffee brand which is the top selling brand in brazil if I remember right.  If the middle class in Brazil grows at a good rate it could mean a lot more customers for that brand.  They also have brands that are #1 or close to it in several european countries.

 

I've never looked into it but if I had to bet I'd say coke will probably earn high returns for quite a while even if consumption declines some.  I think you'd have to do the math on how much unit sales are likely to decline vs. how much they can get away with in the way of price increases.  Look at the returns cigarette companies are still making after all their problems.

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People still do unhealthy things even when they know they are unhealthy (drink alcohol, smoke, eat junk food, etc.)

I agree... it's so hard for human beings to fight this.  Obesity has steadily been rising.  Scientific studies on weight loss show that people lose weight initially but gain it all back in the long run because it's so hard for them to stick to their diets.  A few people do lose weight and keep it off but they are in the minority.

 

I think that Coke has a strong moat as it has been around for a very long time and is practically a dinosaur.

 

Tobacco companies apparently have good moats since smokers usually don't switch brands.  Buffett passed on Lorillard for ethical reasons.

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I think this is an area (moats) that can be affected by pereception as much as reality.  Take local TV and radio firms as an example.  The perception is that the moats are going away or gone the reality in many cases is the moat is still there but may go away if action is not taken.  The longer the firms have to react the more likely the moat will remain.  Cellular phones provides an example of an industry where moats were not damaged and incumbants were able to react and preserve their moats.

 

The way I measure the depth moats is return on tangible assets versus WACC.  Given the prcing of some of these firms the market expected duraion of these moats can range from less than a year to slightly more than 5 years.  One thing I can say is the moats will last longer than 3 years and most likely longer than 5.

 

Packer

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When you dive a little deeper moats are the product of good management.  Coke was in a weakened state when Buffett started buying.  Prior to Goizueta they had been hemoraging sales worldwide to Pepsi.  After Goizueta died Buffett and the other well known director whose name escapes me had to force retire one of the CEOs because management was damaging the company. 

 

When you look at many moats you see good management at the top, powerful advertising, cost control, focus, etc.  Take Tim Hortons in Canada.  A coffee and donut chain turned multi fresh fast food company.  They have advertised extremely well for two decades inventing whole new concepts such as roll up the rim to win.  They have sponsored childrens camps, entire hockey and soccer leagues for kids.  Due to their skill they hold some 75% of the Canadian coffee market, and over 50% in the fast food category.  No one else need apply, not Subway, Mcdonalds, Starbucks. 

 

Starbucks is another example.  I am sorry I sold the SBux stock I bought in April 2009, under $10.00.  I have sat in Jpjam packed Starbucks in Madrid and Paris, and yet I still sold the stock.

 

Amex, Visa, MC, have another moat, but it is also the result of expensive marketing by each company. 

 

Pipelines are an awesome moat, based only on the product.  Especially pipes that are already built.  Railroads are another product moat.  With current costs, and environmental hurdles will anyone ever be able to build continent spanning railways again. 

 

Big O&G cos are another product moat.  They can so easily move their cash into renewables if they also have good management.  It would take Exxon a couple of weeks of cash to buy all existing solar capacity in NA. 

 

In every case you pay up for the moat, except in dire circumstances.  Buffett has a knack for having cash around when the prices get reasonable.

 

in summary, a product may be good and necessary but you still need good management, or the promise of good management coming in to a company via shareholder revolt (thinking Bill Ackman and CP). 

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Amex, Visa, MC, have another moat, but it is also the result of expensive marketing by each company. 

I think some of their moat may have to do with fraud (as in, they know how not to get killed by fraud).  That's what I learned from Paypal... almost all of Paypal's competitors have been killed by fraud.  Paypal figured out how to keep fraud at a minimal level while maintaining convenience for Paypal users.  It has algorithms that spot patterns of likely fraud and automatically shut it down.

 

And if you look at Amazon dropping Paypal as a payment option, that might also suggest some things about the moat that Visa and Mastercard enjoy.

 

Personally I don't think that advertising affects people's decisions to choose Visa over Mastercard or cash or debit.  There are huge amounts of marketing aiming to sign people up for credit cards (each signup is worth $15-40+... check affiliate marketing networks for better information).  But I don't think that their brands are valuable.

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Fannie Mae and Freddie Mac might be examples of stocks with a durable moat.  The implicit government guarantee on their debt means that they have a cost advantage that nobody else can duplicate.  This moat will last as long as market participants believe in that implicit guarantee.

 

Unfortunately, management at these companies ran it into the ground.  Fortunately for Buffett he got out before that happened.

 

Moody's is another example of a stock that I would think that Buffett thought had a moat.  He has said that Berkshire would still hire Moody's for bond ratings if they doubled their prices.  This may be less true today now that Moody's credibility was damaged in the subprime crisis.

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Amex, Visa, MC, have another moat, but it is also the result of expensive marketing by each company. 

I think some of their moat may have to do with fraud (as in, they know how not to get killed by fraud).  That's what I learned from Paypal... almost all of Paypal's competitors have been killed by fraud.  Paypal figured out how to keep fraud at a minimal level while maintaining convenience for Paypal users.  It has algorithms that spot patterns of likely fraud and automatically shut it down.

 

And if you look at Amazon dropping Paypal as a payment option, that might also suggest some things about the moat that Visa and Mastercard enjoy.

 

Personally I don't think that advertising affects people's decisions to choose Visa over Mastercard or cash or debit.  There are huge amounts of marketing aiming to sign people up for credit cards (each signup is worth $15-40+... check affiliate marketing networks for better information).  But I don't think that their brands are valuable.

 

I don't think the moat would be in the brand name.  It's the switching costs and barriers to entry.  I would imagine it would be pretty difficult to launch a company that would compete with them.

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I agree with the PlanMaestro’s thesis that moats are not forever.

That’s why I invest in owner/operators, because their moats consist in the abilities of their founder/largest owner/manager. And, among owner/operators, I concentrate on the ones which are in the business of buying $1 bills for 50 cents. Because that is a business which will always be with us and will always be highly remunerative. Partnering with extremely successful capital allocators, when you understand what they do and agree with their strategy, is the safest way I know of for accumulating wealth. (Condition n.1: they must be still relatively young, so that they can go on compounding for a long time. Condition n.2: they must have permanent capital, BRK, FFH, etc.. Condition n.3: if they have float, BRK, FFH, etc., even better!).

 

giofranchi

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Mark Sellers had the best definition on quotes that I ever read:

 

"To my mind, there are really four different types of moats. The first is being the low-cost provider or company with economies of scale due to size. Wal-Mart is a perfect example of this. Second is having protected intellectual property, such as patents, copyrights, trademarks or FDA approvals. Here examples are drug companies, biotech and entertainment companies like Disney. Third is what tends to be the strongest, but also the rarest, of moats, which come from some sort of “network” effect. This happens for the company acting as the intermediary enabling communication or transactions between two or more parties. More volume begets more volume. This is what’s so powerful about the Chicago Mercantile Exchange, the New York Stock Exchange and eBay. The last kind of moat is when there are high customer-switching costs. You see this in consumer banking or in a payroll processor like Paychex.The most successful companies often have more than one type of moat. Microsoft has the network effect because of all the software created to work with its operating systems. It also has intellectual property rights and economies of scale."

 

Value Investor Insight, June 2005

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I agree with the above.  The moats created by the group of Visa, MC, Amex, and I guess we can add Paypal, are only partly related to brand name.  Much of it rests in the infrastructure created, and the sales structure, rather than advertising.  Greater than half the marketing would involve getting merchants up to speed on their products and offerings.  What you see is the constant innovation and work required to keep an oligopoly.  The fraud prevention aspect noted is something I had not thought of but it is important.

 

I would offer well run banks as another moat.  Even badly run banks keep most of their customers.  We have seen this first hand through the financial crisis.  The worst run operators didn't die from losing deposit or mortgage customers, but rather by their own hand.  Fraud prevention and security are also important here.

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The subject of moats is extremely complicated in my opinion.  I think it's easy to kid yourself into thinking that a moat exists when in reality it doesn't, or it isn't wide.  Disruptive technologies can render once strong moats useless against attack from new forms of competition.  Even the use of the term "moat" is interesting -- the invention of the cannon and guns in the middle ages made the overlord's castle and moat a thing of the past.

 

Famously, Munger once thought GM had a bulletproof franchise.  Buffett thought at one stage that Eastman Kodak's moat was as wide as Coke's. 

 

So what am I saying?  Well just be careful.  Companies with moats or competitive barriers will tend to have high margins and returns and likely trade on high valuations.  So if you misdiagnose the moat the stock has a long way to fall.  I think true moats are quite rare and of these some likely own their position to large slices of luck along the way.

 

All that said, I'll tentatively share an example of a company with a strong moat: Sysco, the food distribution company.  By virtue of its size (it's twice the size of its nearest competitor), they've got a number of advantages over their peers -- buying power, better utilisation of its warehouses / trucks for example.  As a result it generates three times the margins of peers.  It has a very diverse customer and supplier base (the opposite can be risky) and customers purchase regularly from them.  While there are no technical barriers to entry, it would be extremely difficult and expensive for a new start up to profitably replicate their network of trucks and warehouses.  They're not dependent on favourable government regulation, nor I think will they be much affected by fads in diets.  Finally and crucially, I believe Sysco faces low obsolescence risk: what will replace delivering food to restaurants etc. in the future?  Will the stock shoot the lights out over a 10 or 20 year period?  Probably not, but the valuation is not high, it generates good returns and management thinks long term.  I hope to get rich slowly from Sysco.  But hey, if Buffett and Munger can get it wrong.....

 

Outside of moats and the pitfalls involved, I would side with giofranchi on getting into bed with smart capital allocators.  Though of course what you're doing is betting on your ability to judge the abilities of others.  For every Prem there's a BigLiar, eh?

 

A long response, but this is an area of huge interest for me.

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I agree with the PlanMaestro’s thesis that moats are not forever.

That’s why I invest in owner/operators, because their moats consist in the abilities of their founder/largest owner/manager. And, among owner/operators, I concentrate on the ones which are in the business of buying $1 bills for 50 cents. Because that is a business which will always be with us and will always be highly remunerative. Partnering with extremely successful capital allocators, when you understand what they do and agree with their strategy, is the safest way I know of for accumulating wealth. (Condition n.1: they must be still relatively young, so that they can go on compounding for a long time. Condition n.2: they must have permanent capital, BRK, FFH, etc.. Condition n.3: if they have float, BRK, FFH, etc., even better!).

 

giofranchi

Giofranchi, curious, do you tend to look\find the type you are looking for more in the US or Europe?

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I agree with the PlanMaestro’s thesis that moats are not forever.

That’s why I invest in owner/operators, because their moats consist in the abilities of their founder/largest owner/manager. And, among owner/operators, I concentrate on the ones which are in the business of buying $1 bills for 50 cents. Because that is a business which will always be with us and will always be highly remunerative. Partnering with extremely successful capital allocators, when you understand what they do and agree with their strategy, is the safest way I know of for accumulating wealth. (Condition n.1: they must be still relatively young, so that they can go on compounding for a long time. Condition n.2: they must have permanent capital, BRK, FFH, etc.. Condition n.3: if they have float, BRK, FFH, etc., even better!).

 

giofranchi

Giofranchi, curious, do you tend to look\find the type you are looking for more in the US or Europe?

 

In Europe just Lancashire and Third Point Offshore (which has recently sent my firm a very welcomed Xmas present, declaring a substantial special dividend! :) ). I looked at Pargesa SA, but wasn’t convinced... The rest of my firm’s investments are US or Canada based. I basically agree with Mr. Kyle Bass, when he says that investing in Europe now is like picking nickels in front of a bulldozer… But I don’t trade, I don’t jump from one undervalued security to another. I just buy owner/operators in the investment business (the best business, paraphrasing Mr. Buffett), when they are offered at good prices, and I stick with them. Always keeping a lot of powder dry to average down aggressively, if I get the chance. For anyone who trades, instead, Europe might certainly be fertile ground right now. It is just not a game I like to play.

 

giofranchi

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Outside of moats and the pitfalls involved, I would side with giofranchi on getting into bed with smart capital allocators.  Though of course what you're doing is betting on your ability to judge the abilities of others.  For every Prem there's a BigLiar, eh?

 

 

Well, I guess that’s right! But how could it be different? I run two businesses personally every day, and the most important thing I have to do is to judge correctly the behavior and the abilities of my associates. Every time I fail to do that, something bad, or just stupid, happens. And my firm loses money… Simply put, that’s the job of every entrepreneur!

Otherwise, as a “passive” investor, you could do like Mr. Murray Stahl suggests: “if you listed all the owner-operators in the world, of which there are more or less 100, they’re in different businesses, run by different people, in different companies, with different mindset. … Almost all trade at big discount to book value.”

If you don’t feel like choosing among them, just partner with 100 outstanding managers!

 

giofranchi

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Cognitive dissonance=  actions dont match up with goals and beliefs.

 

 

Knowing something intellectually doesnt mean anything  unless there is an emotional attachment to result in a change of behavior.  Most moats that have an emotional attachment with the public will endure for forever. The logic is human nature never changes.  Unless something takes the place of the emotional attachment creating a greater attachment. Everyone should know the playbook to achieve financial freedom.  Read richest man in bablyon thats it. Thats the ultimate playbook and the reason most people arent finanically free is due to cognitive dissonance. Most people in the world have cognitive dissonance and arent logical. Being logical is a huge competitive advantage in any aspect of life. 

 

The long term trend towards wellness is real ( i'm in the wellness field). The problem is most people arent logical and have cognitive dissonance. If doing "x" will result in "y". Where "y" is achieving long term health and wellness and practicing preventation in disease. Even though its logical to practice preventative care instead of reactive care some people wont do it. Its an combination of fear and not having the discipline to create change.  Bottom line is there is a HUGE difference between intellectually knowing something and actually practicing it by taking action.

 

Knowing that coginitive dissonance is real and will never change in a global way i see brands like ko and jnj will continue to dominate until something of greater emotional attachment takes over (probadly never).

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The moats of the future is a great question. I use groupon for my business and personally and its a great service. Its the only advertising that actually delivers a great ROI each time. Sure you loss money in the front end but, its all about making money in the back end and creating residual business. Thats what creates REAL equity in business.  I have no idea about the moat all i know is its a blessing for small business owners. Its just an amazing tool for bringing customers in the door. Turning the customers into clients is the job of business owner not groupon.

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For a moat to not be a moat something of greater emotional attachment will have to appear. Greatest moat has greatest emotional attachment.

 

Best current moats

 

starbucks

apple

whole foods

amazon

Ko

Jnj

chiptole

 

Up and coming moats

 

lululemon

groupon ( debatable)

 

My top two moats would currently  be starbucks and whole foods.

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This happens for the company acting as the intermediary enabling communication or transactions between two or more parties. More volume begets more volume. This is what’s so powerful about the Chicago Mercantile Exchange, the New York Stock Exchange and eBay.

This reminds me of ICQ and Myspace... it looked like they had really strong network effects until they didn't.

 

I believe the New York Stock exchange is seeing its volumes shrink as regulators open up the field to competition.  A retail order might get routed to any of 20+ different places (the official exchanges, companies like Knight, etc.).

CME has much more of a moat since their contracts can't be traded elsewhere.  If you look at quarter contracts versus full contracts, the full contracts have much more volume and many quarter contracts never reached the critical mass to be liquid.

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This reminds me of ICQ and Myspace... it looked like they had really strong network effects until they didn't.

 

 

ICQ, by the way, in China, adapted into Tencent QQ, arguably the only company with a realistic chance of competing with Bidu.

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