HOW TO INVEST: MOAT A DURABLE ADVANTAGE

Welcome to the introduction to Rule #1 course, I’m Phil Town and this is Tutorial 3: Moat (Part 1)- A Durable Advantage.

This is part 3 of a 9-part series on How to Invest using Rule #1 strategies
Part 1: Rule #1 Strategy- Overview of the Basics
Part 2: Meaning- The Three Circles
Part 3 [You are Here]: Moat- A Durable Advantage
Part 4: Moat- The Big Four
Part 5: Management- Owner Oriented
Part 6: Margin of Safety- The Growth Rate
Part 7: Margin of Safety- Sticker Price and MOS
Part 8: Margin of Safety- Payback Time
Part 9: Zombie Value- Tangible Book Value

 

Moat: What is it in Investing Terms?

A moat is obviously the water around a castle but in investing terms, a moat is the durable competitive advantage that a company has that protects it from being attacked by competitors.

A moat is what makes a company predictable and allows us to put a value on the business.  Charlie Munger said that, “Coca-Cola is the perfect business, because it has this gigantic durable competitive advantage, or moat, which gives it predictable cash flow.” This allows us to figure what the future cash flow will be and value the company today, so we know whether we can buy it on sale or not.

5 Kinds of Moats

There are five kinds of moats: brand, secret, toll or toll bridge, switching and price.

1) Brand Moat

An example of a brand moat is Harley-Davidson. A brand moat is a lifestyle moat. Lifestyle is a huge area for brand building and Harley is brilliant at it. They build a lifestyle around the Harley-Davidson culture.

2) Secrets Moat

The second of the five moats is a secrets moat. 3M is brilliant at creating products around adhesives that they then patent and turn into products.  They’re a gigantic secrets company.

Another secrets company is Pfizer. They make Lipitor and a lot of other drugs that they patent and have exclusive rights to for many years.

A company like Dow Chemical, which creates a lot of products using their technology and secrets in the lab, that they then also patent. A secrets company is a big moat company.

3) Toll Bridge Moat

The next type of moat is a toll bridge moat. A great example of that is Pacific Gas and Electric.  If you want to get power in California, then you pretty much have to go through PG&E.

Another toll bridge moat is the Chicago Mercantile Exchange. They’re the only place in America where you can trade commodities. Burlington Northern Santa Fe Railroad is another example of this type of moat because, pretty much all the railroads in America have some sort of a monopoly.

4) Switching Moat

The next moat is a switching moat. Switching is a cost of shifting from one supplier or product to another. Costs like redoing all of your software for example, that links your entire network together. Which is why it’s tough for companies to shift off of Microsoft, into say something like Apple.

Another company that has a nice switching moat is Intel. Once a company like Apple has built their computers on an Intel chip, it’s really hard for them to shift to some other competitor.

Another example is ADP Payroll Services. Once they get in your back office and start doing your payroll, they’re there forever. The cost to switch services is just too much.

5) Price Moat

The fifth moat is the price moat.  Walmart of course, is the king of price moats. That is a company that can create products, or sell products much, much lower than anybody else.

Costco also competes on that basis, as does JetBlue, for example.

Conclusion

You might notice that a lot of these companies have multiple moats. Certainly you can have multiple moats, the more the better.  But every good company has at least one of these kinds of moats: brand, secret, toll bridge, switching, or price.

Make sure that with any company that you are looking at buying, you can identify the moat. Your job is to look in industries you understand and find big moat companies.

Your homework for this tutorial is to take the company that you found in the last tutorial, and figure out what moat that company has. Is it a brand moat, secret, toll bridge, switching or price moat?  Now, go on to Tutorial 4: Moat (Part 2)- The Big Four Numbers.

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Phil Town is an investment advisor, hedge fund manager, two-time NY Times best-selling author, ex-Grand Canyon river guide and a former Lieutenant in the US Army Special Forces. He and his wife, Melissa, share a passion for horses, polo and eventing. Phil’s goal is to help you learn how to invest and achieve financial independence. You can follow him on google+, facebook, and twitter.
  • MAG DEE

    You put a lot of emphasis on the MOAT in your speech.

    And now I see why.

    At the beginning I was always attracted and going deeper in the numbers of a business I like before even looking if it actually has a MOAT.

    I liked what the business was providing or doing and that was it.

    Even if the business looks great on paper doesn’t mean that the future of the business will look like the past.

    With a strong MOAT I understand now that you can help your odds of xxxx times.

    At the beginning I was getting sometimes confused with which MOAT was stronger than the other; looking at a company I was thinking that BRAND or Switching was it to finally going deeper into the research that it was neither of them.

    It’s then important to read read and read about the one business you like and AFTER look at the numbers…

    When I started I cheated. Now no cheating.

    MAG

    • slick555

      so which MOAT is best?