On You Tube you can find many videos – some are entertainment, some are educational and you can learn from them. One of the educational ones is Google Talks – people are invited to talk to the folks that work at google. One of the talks involved Pat Dorsey from Dorsey Asset Management in Chicago. Mr. Dorsey’s company examines moats of companies and tries to buy the ones that have them with the expectation holding these types of companies over the long term will give you a better return. In the Google Talk – he explains what Moats in the investment business are.
If you think about a Moat around a castle – it makes it harder for the opposition to cross and defeat the people inside, not many people can walk on water. Assuming the people inside the castle have enough provisions and assess to drinking water; they should be able to withstand any attacks.
In the investment world – there are some natural advantages companies have and if they have a moat or significant market share they have the ability to rise prices on a regular basis. As you examine moats ask can the company raise prices? If yes then it has a moat.
Mr. Dorsey has identified 4 types of Moats:
- Intagible Assets such as a) Premium Brands – customers are willing to pay extra for the brand, a good example is the automobile company Ferrari.b) Patents – a good example is drug companies. or c) License or Government Regulation – governments create scarcity or exclusivity – great examples are utility companies or oil and gas pipelines; casinos, landfills
- Switching costs – new software is invented which is better than existing, however in order to use it, the company has to remove the existing and install the new one. What is the cost to removal and switching?. Other examples are elevator companies once an elevator is in, it is very expensive to change companies and engine replacement parts where they are custom made
- Network effect – the idea is interactive one which adds value versus radical network but like a spoke on a wheel can be replaced.
- Cost Advantage – think how Wal-mart runs it business and the ability to compete against it. In the airline business Ryanair in Europe.
When a company has a great moat or is generating revenues – first it was a combination of luck and skill the moat exist, and Mr. Dorsey and his group try to determine what management does with the moat. Companies grow either organically or by buying another company. If the company buys another does that add to the moat or are they investing outside the moat? The best example of buying outside the moat and losing money or writing off investments is Microsoft which means it can and does happen to the best and brightest companies.
Linking to dividend paying stocks, companies with a moat or high barrier to competition are ideal dividend companies because every year they are profitable. The issue is when companies are profitable there are many trying to attack the moat. The key when you do your homework identify what makes the company different than the competition – why does it make money?
There are more questions than answers, till the next time – to raising questions.