Stock Investing Lessons: The MOST IMPORTANT Business Trait
what is the most important attribute that a company can have for it to be a good investment is it high revenue growth a good management team great culture no we think the most important answer is a wide and enduring moat what does that mean stick around and we'll tell you my name is Brian Feroldi and my name is Brian Stoffel thanks to quarter for sponsoring today's video brian the word boat gets thrown around all the time in investing what does it mean well usually i think of the thing that's surrounding a castle like this but in reality this right here is not a moat a moat is a metaphor for a sustainable competitive advantage that a company can have over its competition sustainable is the key word there it's an attribute that a company has that allows it to compete at a effective level for a long period of time now why is emote important well let's say you and i develop a product or service and this is what we're seeing in our business profits are growing well if you live in a competitive marketplace you can be sure that people will take notice of that and they will want in on that and this is what will happen eventually competitors will come in they'll offer the same product or service perhaps at a lower price than you and you will be forced to lower prices in order to compete and your profits will decline but if you have a moat in place a moat acts as a balance to that competition and if it's strong and if it's growing it can help your profits to stay high for a far longer period of time than otherwise all right so the best way to talk about emote is a real life example where i had to learn this lesson the hard way i was a huge fan investor in whole foods markets and as you can see i wrote articles about the company where i said it is worth every penny for a long time i was right about that if we look at the stock chart we see that back in 2009 it was trading for about six dollars a share and by 2013 it was up to 55 a share all told that was a gain of about 950 clearly whole foods was on to something but then something happened over the next three years the stock fell from that high that i talked about before all the way down to thirty dollars a loss of roughly half of your investment now clearly it was still a good investment there was something going on here what was going on the company was losing its moat and here's how we know that from 1992 to 2012 whole foods degrade on a key metric for grocers it's called comps or comparable store sales it tells you how much a single location can increase its sales year by year in the grocery industry if you increase it by three percent per year where that red line is you're doing pretty well and as you can see from the point that it came public until this point in time it was well above that threshold the whole time with one exception of the great recession where everybody fell below that so that is what helps explain why whole foods was such a good investment however starting in 2012 we started to see something different happen what was that those comps went from being exceptional to pretty good to average to the point in 2016 where comps were actually negative existing stores were selling less collecting less from their customers than they did the year before well how did that happen well we can think of it like this for a long time whole foods was the only pure play on natural and organic foods in fact because of the great recession so many people got out of the market that whole foods was left to be the only one to play in this area which meant it was on top of the castle but if you look at this there was no unassailable moat there what does that mean it means that people saw how successful whole foods was doing people like krogers like walmart like safeway like costco like target and it might surprise you to know that these five companies today with their private label organic brands actually sell more organic goods every year than whole foods does because there's nothing to prevent any of these companies from selling organic goods there's no moat there i think this is a great example that you point out because the period where whole foods comps were declining it's not like the economy was doing poorly in fact the demand for organics was skyrocketing during this whole period if whole foods had a lasting and enduring mode it should have in theory been able to keep those comps high and it would have remained a fantastic investment so this is a great example to me of showcasing the importance of a moat now before we get into what is a moat we need to talk about what is not a moat there are examples of modes out there that are fake modes they're mirages one fake moat to be aware of is when a product is launched and it's just popular with consumers a few years ago a product called gopro was all the rage and sales of gopros were absolutely skyrocketing and taking it off if you look at that you'd be like wow gopro must have emote how popular its product is however if you study what happened to gopro you know that that popularity was about to wane and go in the opposite direction and that just shows that gopro didn't have a motion second is market share and our example of whole foods is a great way of talking about this whole foods own the market for natural and organic goods but as people saw how popular it was they got to move into that area and there's nothing stopping them from doing exactly what whole foods was doing so once it reached a certain level of popularity whole foods almost became a victim of their own success by attracting competition so market share alone is not an example of a moat three would just be boom times for a certain sector of the economy in the late 1990s the demand for tech stocks and internet stocks was sky high and everything was coming public however once the tide turned in the year 2000 a whole bunch of companies went out of business and only the companies that built a moat for themselves amazon priceline exist today all those fake companies that didn't have a moat were just benefiting from the boom times and that's why they're not around and the last fake mode is management and let's be clear management matters it still matters to have good management however if your investment thesis is based on a rockstar ceo or someone in the c-suite that alone is not a moat a good management team can build the moat but they aren't the moat itself great example lee iacocca chrysler rockstar ceo did a good job of helping the company out but if the company had a moat then when he left then they would still be on good standing that wasn't the case as we all know by now so management while important is not a moat in and of itself if a good manager is your moat well what happens when that manager leaves your moat walks out the door so that is not a moat that you can only know all right so let's get to the five categories of real modes if you're familiar with our channel you know that we talk about these all the time when we're analyzing a business the first is a network effect second are high switching costs the third mode category is low cost production the fourth are intangible assets and finally is counter positioning some people consider this to be a strategy we actually consider it to be a moat although of the five it's probably the weakest but we still think it's there and we're going to go into details on all these next so let's start out with the network effect if you're watching this you're familiar with what a network is but what is a network effect simply put a network effect is when a new user joins a network ends up creating value for some or all of the existing users so when somebody joins a network the entire network becomes more valuable for everybody else a great example of this is the telephone when the telephone was first invented how useful was it well you could call one other person however as more and more people got telephones the number of people that any one telephone could call grew exponentially so when there were a thousand people with telephones that was less valuable than when there was ten thousand or a hundred thousand or a million today there are more than seven billion people with telephones on the earth and you can use your phone to call anybody so as the number of people that had telephones grew the network became more valuable for all other users so let's talk about where this applies in the investing world today social networks are a great example of the network effect that's because as more users join the network the network itself gets better which only entices other people to join the network the examples are pretty easy to see their facebook linkedin and twitter all examples of benefit beneficiaries of the network effect yeah one important distinction there that's worth pointing out in theory it makes sense that more people the more people join facebook the better the network gets for everybody but you and i both know that on facebook how many people do we actually care about are on there maybe a few hundred so if another million users join in a different part of the world that i'm never going to interact with does that really benefit me the user not really so that's just one that's just one nuance to really think through when you're thinking about how a network effect grows all right the second category of network effects would be data and data aggregators and companies that are using machine learning take advantage of data in this case the more users that a company or product or service gets the more data that company gets the more data it has the better the product becomes and the better product becomes the more users it attracts we saw this 20 years ago in the search engine awards why did google win the search engine wars that's because its search engine was built on data and the more people that were searching on it the better the search results got and that in turn attracted more users more recently we see this effect happening with crowdstrike where the more people that join the network the better the network gets at protecting its users and we've also seen this recently with companies like upstart so this is also a prevalent trend when we look at marketplaces which should be no surprise because when there are more buyers that attracts more sellers and when there are more sellers with products we want that attracts more buyers so in the real world we can see that with etsy when the pandemic hit and people needed mass they went on etsy which only which only incentivized people who are making mass to join the platform as well or market access for bond sellers or airbnb if you're looking for a place to stay or you've got an extra room you know that you can go there to offer up your room or to get a room another category that we see the network effect take place would be in the transportation sector and this would be the more buyers and sellers that there are on a transportation network the better that network becomes and the better that network becomes the more buyers and sellers that transport network attracts examples of this would be doordash or uber why are you and i using uber the reason is it has the biggest network of cars on it so when we're looking for a car we want fast we're gonna go to uber if i tried to start a rival network to uber it would be a monumental challenge for me to get drivers to come to my platform same thing at big shipping companies such as fedex and ups or meal delivery companies like doordash the bigger the network becomes the more powerful it becomes the more it attracts new users so let's move on to the second type of mode which is switching costs what does that mean exactly it means that once you become a customer of a certain product or service it becomes painful for you to switch now it's important to talk about what painful means it might be financially painful but it can also be painful in terms of training and the time it takes to train your employees or the data that you have to give up to switch to a new provider so what are some examples of companies that have high switching costs lots of the as a service providers that we talk about on our channel have high switching costs for them so this would be software as a service infrastructure as a service platform as a service some great examples of this today would be companies like shopify once you go through the arduous process of getting set up on shopify's network and selling it becomes a huge hassle for you to switch away to a different provider same for atlassian's tools or intuits turbo tax product where once you start using its tax program to do your taxes it becomes a big pain to switch to somebody else that's the power of switching costs the second comes from services that provide a high value at a low cost now technically the switching costs aren't high but because the costs are so low and because this is being charged your credit card every month without you even thinking about it in reality the customers tend to be much stickier than you might imagine so when you think about netflix you might go a month or two without watching a netflix show but that doesn't mean you're going to take the time to cancel your 8.99 membership or i am a member of planet fitness sometimes i might go eight months without using it but i'm only paying 10 a month and i love knowing that it's there or spotify if you're a podcast listener or a music listener these are all examples of high value low cost products that might not technically have high switching costs but because the cost is so low the value that's being provided is so high that you just tend to stick around another category that i personally love would be the medical device industry big companies that are out there such as intuitive surgical abiomed or medtronic health care providers go through an arduous training program to get up and running on these companies products and once they get to know them and once they know that they can use them on their patients they are loathe to go with any competing product one particular thing that i love about the medical device industry is that the providers are the ones that are using the devices but they're not the ones that are paying the bills the patients or the health insurers are the ones that are paying the bills so the healthcare providers have no financial incentive to switch so for them to switch there better be a really good reason for do so otherwise they think the switching costs are just way too high this video is sponsored by quarter with quarter you get frictionless access to conference calls investor presentations transcripts and earnings reports from markets around the world straight to your pocket at no cost quarter's mission is to change the way that people look at investors relations and create a completely new bridge between companies and stakeholders the first step on this journey is to let you the user interact with the company's content while you're listening i love using quarter because it's free convenient way for me to listen to my favorite company's conference calls while i'm on the go it also lets me move forward and rewind with ease and new features are being launched all the time download a free copy of quarter today by visiting the app store of your choice and searching for quarter that's q-u-a-r thanks quarter for sponsoring today's video all right let's move on to the third mode here which is low-cost production and the key here is on that word production what this means is that a company can offer the same or a better product at a lower cost than the rivals now the key is that this lower cost might not be at a lower price it needs to mean that they are able to produce the good or service internally at a lower cost than the rivals can do so what are some examples of this today well a lot of companies gain uh low cost production through economies of scale which is just a fancy way of saying massive buying power so take a company like walmart it has the biggest distribution network globally and it can buy the most amount of product from a supplier for that reason it can demand the best pricing on all of the products and that allows it to sell those goods to its consumers at a lower cost than its rivals a lower cost is the key point walmart also goes with a low pricing strategy to get customers to come in and buy its products but it costs walmart less to get those products on the shelves than many of its headers same can be said of mcdonald's with its immense buying power it can spend less per pound on hamburger meat or buns or lettuce than its competitors another example would be ikea or costco so economies of scale is a key way that companies can get low cost production now a second way to get this low cost production is via physical locations why because there's a limited amount of space on the earth and sometimes we take that for granted so if one community chooses to use waste management to do their recycling and their garbage collection they're not going to choose another producer to do the other neighborhood also there's only so many landfills that are available for companies to use so once you get set up in a community you're likely there for the long haul the same can be said for amusement parks it would be silly for me to try and set up an amusement park where i am because there's a six flags about 60 miles from where i live even if i was successful in drawing people in all that would really do is bankrupt myself and six flags because we need a certain amount of customers or compass minerals they own the salt mines and they are the closest provider to the salt that can be used on roads than anyone else because they're so close they can get it from point a to point b for less than anyone else another category that we've seen prop up leasing would just be infrastructure so companies like amazon has the biggest network of fulfillment centers in the united states and they can get goods to you at a lower internal cost than their competitors we see the same thing in other geographies such as jd.com in china and kupang in south korea all right next we're going to talk about intangible assets and there's a number of different ways that this can crop up let's cover them so an intangible asset is a competitive advantage that you can't see or touch but it's there for example i've been an iphone user for years and what is the difference the real difference between an iphone and an android phone not much but i know and trust the brand name apple so i'm willing to pay a premium to stay on apple's products versus buy from the competition same goes for chipotle me and my family know and trust the chipotle brand's name and when we're choosing a mexican place to eat with especially on the go we want to go to chipotle because we know and trust the brand name finally is tiffany's what's the real difference between tiffany's jewelry and anybody else's jewelry if you ask me not much but boy do people really love the brand name tiffany's and they are willing to pay a big premium to get their hands on that the next form of intangible assets comes in the form of intellectual property or patents now these patents can be implied in just about any industry but drug companies serve as a great exemplar so we're going to call out the three companies that are helping us through this pandemic with their vaccines pfizer johnson and johnson moderna they all have patents on the vaccines that the world is taking right now now importantly in the drug industry those patents don't last forever drugs do go off patent and you need to know that if you're measuring the moat around a company like this however they're usually able to recover more than enough money from the time that the drugs are under patent to make up for the fact that they will eventually go off pat final category that we're going to call out is a government license sometimes governments actually provide moats for companies for example your local utility probably has a government sanctioned monopoly in your area for example i only have one choice in my electricity provider nextera energy is one of the biggest electricity providers in the united states and they have monopolies thanks to the government another would be gaming licenses where companies like season entertainment or mgm graham literally have a government license game to offer gaming services to consumers that provides a moat a final category that's worth calling out would be bond rating agencies you and i can't go out and start a competing bond rating company we need to be licensed by the government do so that provides companies like s p and moody's with a lasting competitive advantage all right now let's dig into the final mode that we're talking about which is somewhat more saleable but is still really important and that's counter positioning this is where your competition would have to give up sales if it wanted to adopt your business model this is less product innovation and more business model innovation and an important thing that you need to realize here is that business model innovation can be every bit as disruptive as product and technological innovations that's a hard thing to wrap your head around so let's go through an example well in recent years we saw exactly this thing happen between blockbuster and netflix when netflix was just doing dvds by mail what was the difference between the product that netflix offered and blockbuster offered nothing they were the exact same thing however netflix was deploying a completely differentiated business model than blockbuster blockbuster depended on physical retail stores and it actually made most of its profits off of late fees netflix by comparison decided to go with a monthly subscription charge and offer zero late fees to consumers now blockbuster could have adopted this business model instantly and wiped out netflix but to do so they would have had to give up a ton of revenue and profits in the short term to match netflix's business model they were loathed to do so for years and years and that provided netflix with the time that it needed to build out its own assailable moat and that's why today blockbuster video doesn't exist and netflix is the king of streaming another more recent example comes from tesla tesla is counter-positioned against legacy players like ford gm and toyota and here's how one they have gone without dealerships by cutting out dealerships by making it possible for you and i to buy a tesla by going straight to the company they have lowered their costs they've done so because the middlemen the dealerships are no longer taking some of that money that means that tesla can keep more of that money to reinvest in r d or it can offer that's products at a lower cost because it doesn't need to worry about paying all the dealers importantly these other companies also get a lot of their money from servicing and supply tesla has decided to give the servicing and supplies away at cost in order for a ford gm or toyota to do the same they'd have to give up an enormous profit driver and probably raise the prices on their cars something that they are loaded to do and that their investors and wall street would not be happy about to say nothing of the customers themselves the counter positioning is one of the many many reasons why the auto industry really hates tesla they are changing the game and doing things in such a differentiated way that is the power of counter positioning all right so let's do a quick review what are the five real modes that exist out there number one network effect number two high switching costs number three low cost production production not low cost pricing low cost production number four intangible assets like brands intellectual property patents and government license and then finally counter positioning or business model innovation and the reason that votes are so important is it helps turn this into this well we hope you enjoyed this video as you know both brian and i are real big believers in the power of moats and we've devoted a substantial amount of our time and research into finding out what moats companies have and what direction that they are heading in we hope that you can learn this lesson the easy way from videos like this instead of having to learn it the hard way about us about how important moats really are yeah motes is something that i've overlooked in the past and i've misjudged moats and every time i've done that i lost money well thank you for watching this video let us know in the comment section below what we got right or we got wrong my name is Brian Feroldi and my mission is to spread financial wellness my name is Brian Stoffel my mission is to publish the rules of finance for anyone to see brian's out
2021-10-05 15:15
