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Pat Dorsey: Using Moats to Improve Returns

 

Pat Dorsey, Sanibel Captiva Trust – Using Economic Moats to Improve Investment Returns
Pat is an author of The Five Rules for Successful Stock Investing, The Little Book That Builds Wealth and Vice Chairman, and Director of Research at Sanibel.

Sanibel has about $600M under management

• Capitalism works – High profit operations attract competition
o Most businesses see returns decline over time
o A moat is a structural business characteristic
o Smart mangers are not moats, but they can create moats
• Moats
o Intangibles
o Switching Costs
o Network effects
o Cost Advantages

Pat Dorsey: Using Moats to Improve Returns

• What are moats worth
o A lot if they can effectively reinvest returns to grow the business (Fastenal)
o Less if they cannot effectively reinvest (Microsoft)
• Management
o You’ve heard “Bet on the jockey, not the horse.”
o Still need a good horse!
o The management can only be a factor in the context of a business with a moat
• Dig fanatically – what drives a business’s moat
o Walmart – low price
o Amazon.com, Inc. (NASDAQ:AMZN)- Online shopping is not the same as offline shopping (there is a system of trust/no trust in the network) Pat mentioned that he was wrong about this early on.
o Louis Vuitton (LVMH) – Focus on scarcity and exclusivity
• Shoveling dirt into the moat… (investing outside the moat)
o Cintas – uniform business mature; tried fire safety and document management
o Pitney Bowes – moved into mail room outsourcing (really getting into staffing business)
o Cisco – trying consumer markets
o A business needs to consider fitting their strategy to the moat (it’s not a universal)
• Digging the moat – Intangible Assets
o Brands – consistency & ‘aspirational’ experience
o Consumer
o Luxury
o Patents
o Regulatory
• Digging the moat – Switching costs
o Integrate with the business process (payback in renewals of services)
o Ongoing services highly profitable (elevators, jet engines)
o Stickiness is higher when you address ‘pain points’ (Stericycle – waste disposal in a doctor’s office; ‘just take care of it’)
o High cost/benefit ratio (fasteners for construction availability, compressors for industrial processes availability) Important to , but small cost in the overall process
• Digging the moat – Network Effect
o This is one of the few ‘first mover’ advantages
o Scale quickly (eBay)
o Position between fragmented groups of suppliers and users (Fastenal)
• Digging the moat – Cost Advantages
o Process – temporary
o Scale – win through attrition of competitors (UPS & FEDEX vs. DHL)
o Niche – size brings competition (See’s candies)
• Digging the moat – Technology
o Be willing to kill your business because landscape changes
o Have moral authority to do
o Do not ignore the inevitable (Nokia, Garmin)
• Digging the moat – Industrials
o Built/Destroyed via acquisitions
o Big Fish in small pond can lead to success & wealth (Graco, Enerpac, Scotts Miracle Grow, Middlebury kitchens)
• Digging the moat – Banks
o Commodity – low cost producer critical (US Bank, M&T, Wells Fargo)
• Digging the moat – Consumer Brands
o Longer product cycles reduce ‘fashion risk’
• ‘Holy Grail’ is exclusivity + ability to generate volume (Polo, Tiffany, Coach)
o NEVER create an incentive to switch (Schlitz beer ‘bungle’ with changing formula)
• Acid test to ask managers – “What are you doing to build the moat?”

• Q&A
o Clarification of miners?
• Low cost raw material can be a moat
o Amazon – how could you have seen it ahead of time?
• Tough  to have known but he still believes it’s still cheap…

 

Value Investor Conference: Omaha, Nebraska –
Dustin Hunter, SunRift Capital Partners (www.sunriftcp.com)
(These notes are to the best of my recollection and trusty ink pen. Discrepancies are due to my error in understanding & transcribing.)

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