Little Book that Builds Wealth.pptx
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The document discusses identifying economic moats in companies as a strategy for long-term investing. It defines an economic moat as a competitive advantage that allows a company to generate above-average returns. The four main types of moats are intangible assets, network effects, cost advantages, and efficient scale. The document provides examples of companies that have strong moats and cautions that moats can erode over time. It recommends evaluating long-term return on capital and pricing metrics like P/E and P/S ratios to identify attractively priced companies with durable moats.
Little Book that Builds Wealth.pptx
- 1. The Little Book That Builds Wealth By Pat Dorsey
- 2. The Game Plan 1.Identify Business (Generates above average profit for many years) 2.Business less than Intrinsic Value (Then BUY) 3. HOLD (In years) Shares till the Business Deteriorates or Share become Overvalued or Find better Investments 4.Repeat
- 3. Economic Moats Whats an Economic Moat, & How will it help you pick a great Stock? 1.Buying a Share of Stock 2.Value of Business 3.Business profitably generate cash 4.Return on Capital best way to judge profitability 5.Protection from Competition
- 4. Mistaken Moats Dont be fooled by these Illusory competitive Advantages Common Canard Bet on the Jokey, Not on the Horses 1.Moats are structured characteristics inherent to a business 2.Great products, great size, great execution & management do not create long-term competitive advantage 3.Four Structure of competitive advantage are Intangible Assets Hard to give up by customers, gives firm pricing power Network Economics 4.Cost Advantages Stemming from process location and scale or access to unique asset.
- 5. Intangible Assets Intangible assets are those that dont have physical form but do produce value. For example, a brand strong enough that people will pay a premium price for it. Tiffanys, Sony The company is consistently able to charge premium prices and customers are willing to pay it Patents and regulations are also good moats, but the most valuable ones are those that are composed of lots of small patents and regulations, not a few big ones
- 6. Switching Costs There is a large intangible switching cost for abandoning products and services, and I dislike to pay that cost Can charge a high Price Businesses have moats along these lines banks, software vendors, and so on.
- 7. The Network Effect Any company that has an already-running distribution network for their product, like Anheuser-Busch, has this type of moat Pre-existing distribution network can be a huge moat It is this reason why it is almost impossible for another large-scale beverage company to independently become as large as Coca-Cola or Pepsi they cant afford the costs of distribution. A similar logic occurs with internet companies they use the internet as their network and reduce brick and mortar costs that way.
- 8. Cost Advantages Cost advantages come in the form of better locations, better access to resources, and better processes These allow a company to cut costs in ways that their competitors cannot
- 9. The Size Advantage Larger companies simply have a natural advantage over smaller ones. They can execute their plans on scales much larger than the smaller companies and because of their size find efficiencies and discounts unavailable to smaller groups They can use their size as leverage, promising plenty of business to suppliers in exchange for exclusivity They can also find efficiencies in processes that smaller companies cant, like having a person devoted to one tiny nuance of the production while other companies must multitask their workers. Thus, large companies often have an inherent moat, albeit one that can be superceded by other companies over time
- 10. Eroding Moats Moats can erode over time One of the biggest factors in moat erosion is technological change. When a new technology arrives on the scene, particularly one that has the potential to change that market significantly, theres usually a big opportunity for a competitor to severely erode the moat of another company. Similarly, when a company with a moat begins to make bad decisions, they cause their own moat to erode
- 11. Finding Moats There is no true sure-fire way to find a moat. You have to investigate the business, see how they operate, and then see if they have anything that might be construed as a true moat. Some industries have many companies with moats; others have basically none. Your only true recipe for success is learning how a company really operates, and that takes some research.
- 12. The Big Boss Many investment strategies put a lot of importance on the leadership of a company. However, Dorsey makes it quite clear that moats and leadership have little to do with each other. A great leader is not a moat, and a truly great leader cannot usually create a moat, either. On the other hand, even a merely average CEO will not erode an existing moat. Thus, if youre looking at competitive advantage as a reason to invest, dont spend much time worrying about the CEO worry about the business itself.
- 13. Where the Rubber Meets the Road There is one strong way of finding companies that might potentially have a moat, although its not a sure indicator: long-term return on capital. Dig into online research tools like Yahoo! Finance and take a look at a companys return on capital, especially compared to competitors. Is it substantially higher than the competitors? If so, that company may in fact have a moat, and its worth your time to start digging into information about the company to see if you can identify their moat.
- 14. Whats a Moat Worth? This chapter is basically an argument for value investing. In other words, a company with a great moat can still be overvalued. Rather than offering an exact recipe for the value of a moat, Dorsey instead suggests looking for companies that are reasonable values to begin with (using factors like a low P/E ratio) and then identifying from among those which ones have moats.
- 15. Tools for Valuation Dorsey recommends looking at the price-to- sales ratio as well as the price-to-book ratio. The P/S is particularly useful for companies that are temporarily unprofitable, while P/B is great for companies that offer services, particularly financial service firms. P/E (price-to-earnings) is a good general indicator, but make sure that you study this one over the long term in order to minimize the fluctuations in the economy.
- 16. When to Sell ? Moat-based investing isnt for people who dont want to put in the time to do some homework Basically, if you buy a companys stock, you should have a specific reason for doing so When that reason changes or goes away, thats the time to sell Better yet, that specific reason should have nothing whatsoever to do with what other people are doing in terms of buying and selling if your reason for investing still exists, you shouldnt sell it just because the herd is panicking because of a down market.