March 2018

Thought For The Month

A wet Easter weekend provided a perfect time for a spring clean in the Mundy household. As this was apparently a game in which the whole of the family was expected to participate, I quickly went to hide in the cupboard in which we keep our sports equipment. Before long I was knee deep in tennis racquets, table tennis bats, running gear, golf balls (despite having no golfers in the family) and a plethora of trainers. It quickly became clear that the Mundys are at ‘peak sports equipment’. ‘Peak’ is apparently affecting a number of areas at the moment: restaurants, craftbeers, pound shops and artisan popcorn immediately come to mind. I also wonder if the concept of moats in the world of fund management may too have peaked.

Warren Buffett coined the term ‘economic moat’ referring to the sustainable advantages that protect a company against competitors and the concept obviously turbo-charged the second phase of his investment career (post his deep value beginnings). Not surprisingly, his success created a number of copycats and also provided the source for a number of books on the subject. Pat Dorsey’s, The Little

Book That Builds Wealth is one of those and probably one of the best.

Dorsey takes care to elaborate the difference between real and ‘mistaken’ moats. He highlights the mistaken moats as "great products, strong market share, great execution, and great management" arguing that the first three characteristics are insufficient to ward off competitors and that great management, whilst useful, is much easier to pick after the event than before. Investors are probably susceptible to watching a company – and its share price – perform well over a number of years and attributing the success to a combination of the four factors Dorsey highlights and extrapolating such success over the longer term. More often than not, history informs us the powers of mean reversion kick in.

Dorsey believes some characteristics are much harder to replicate and therefore far more durable: intangible assets (such as brands or patents), high switching costs deterring customers from moving to a competitors’ products, good networking economics (the value of the company’s product or service increasing with the number of users) and cost advantages, driven by better locations or unique resources.

Dorsey’s characteristics makes identification of a moat much tougher and encourages us to think about those companies temporarily in a sweet spot and those with long-term competitive advantages. With a number of companies currently priced at very punchy valuations his thoughts may be very relevant.