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Why Should You Care About Moats

December 23, 2013 | About:
Abhishek Jain

Abhishek Jain

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I started reading about Buffett when I was in undergraduate days. I somehow got interested in him. I was curious to learn what makes him do what he does. My quest for knowing more about Buffett led me to more wonderful things in life other than investing wisdom. It also introduced me to greats like Ben Graham, Charlie Munger, Phillip Fischer, Peter Lynch and many more.

Warren Buffett is the world’s most successful practitioner of value investing. Ben Graham, who is Buffett’s guru, is the father of the practice. Buffett changed value investing from Ben Graham’s cigar butt to more of Charlie Munger’s paying for quality moat businesses. But over the years I have started to believe there exists no such term as value investing.

Nothing captures this more than Charlie Munger’s words:

 “All sensible investing is value investing.”

Equity markets give us an opportunity to investing in a multitude of businesses where the prices on offer keep on changing every day. Sometimes Mr. Market may throw bargains while there are times when it is quoting irrational prices. It gives investors an opportunity to choose when to invest. Investing in equity shares of a company is not buying pieces of paper; it's buying a share in a business. For a financial investor it’s about partnering with a promoter as he goes around building and running the franchise. For any business to deliver good results it needs time in the same way for it needs time to get reasonably good results from any investment in equity shares. In the long run equity returns are anything but a function of the performance of the underlying business. In the short run shares prices get influenced by a host of factors like market sentiments. etc. It is always that quality franchises with honest managers tend to command a premium in the market.

Real returns in the market can be made by maintaining a long-term horizon.

As Charlie Munger once said, “Money is not made by buying and selling… but in the waiting.”

 It is very important for an investor to let their money compound. Great businesses are also great compounding machines. Great businesses enjoy above returns, they have pricing power and tend to be market leaders in their respective arenas.   

But in a capitalist society above normal profits tend to attract more investments and thereby more competition, driving the returns to the long-run mean. So a franchise which might look very profitable today may not sustain it in the long run. The forces of market competition may chip away the factors which contribute to the above-average returns. Investing in such businesses even for a long-term horizon may not give above average returns. That is the reason we need to find businesses with enduring competitive advantage, or "moats." Businesses which have such enduring competitive advantages or moats can withstand competition and still enjoy above average returns.

Competitive advantages can be illusionary or temporary in nature. They may disappear as conditions enabling such temporary competitive advantage wither away. For example, businesses can earn above average returns due to favourabe business regulations like licences, etc., or due to scarcity, etc. It’s important to understand the nature and reason behind the competitive advantage of the business.

So the next time when you come across a nice business franchise which you think is selling for a decent price proposition ask yourself just one question: "What makes this business franchise such a good one, and can the reason can stay long enough for me as an investor to let the magic of compounding work for me?" Just ask, “Where’s the moat?” and, “Is it going to widen?”

Albert Einstein once said, “Compound interest is the eighth wonder of the world. He who understands it, earns it ... he who doesn't ... pays it.”

Moats enable you to exploit the power of compounding. 


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