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Justin Pope
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Graduate of University at Buffalo Class of 2012 with a degree in Business Administration - Concentration in Financial Analysis. Dividend Growth Investor Creature of habit, nerd at heart. Let's learn a thing or two along the way.
  • Using Moats To Protect Your Investment Kingdom - A Lesson From Kings & Queens Of Old 0 comments
    Jun 10, 2013 2:29 PM | about stocks: CVX, KO, PEP, T, VZ, WMT, XOM

    Warren Buffett once said - "In business, I look for economic castles protected by unbreachable moats".

    Companies that make good long term investments usually have a competitive advantage that protects their ability to grow earnings year after year. This is sometimes referred to as a "moat".

    The idea of a moat comes from medieval times when kings and queens would surround their castles and towns with deep, wide, water filled ditches to discourage invasion from outsiders.

    We can protect our portfolios by using the same concept these folks used!

    It can sometimes be hard to identify a company's competitive moat, as it isn't always obvious at first glance. For this reason, it is sometimes easier to think backwards. I ask myself - what barriers of entry do I face if I were a competitor to this business?

    Some companies can beat their competitors by offering their goods and services at a lower price than almost anybody else. Companies such as Walmart (NYSE:WMT) are constantly killing off local businesses wherever they come because their size, leverage with suppliers, and distribution network allow them to undercut all their competition with pricing. This advantage has helped Walmart grow their EPS to $5.02 from $1.49 in 2002. They have also raised their dividend 39 years in a row and counting. The pricing advantage Walmart enjoys against their competitors will likely keep their earnings growing for the foreseeable future. Having a price advantage is a very strong moat for a company to have. Especially in times of a slow economy such as this, companies such as Walmart can count on their price advantage to further aid their cause.

    Other Companies have built a moat from competition through years of advertising and establishing a brand name that consumers will pay a premium for. I will probably never by store brand soda for as long as I live. Even if they tasted exactly the same as Pepsi (NYSE:PEP) or Coca-Cola (NYSE:KO) (which they don't) - I would pay the extra $0.50 to get what I have been seeing on TV since I have been in diapers. Coincidentally, Pepsi and Coke have been able to raise their dividends for 41 and 51 years respectively. Pepsi has doubled it's free cash flow per share in the last ten years, Coke has been just shy of doubling theirs. These companies are booking money by the handful to grow and raise dividends, and their brand name value all but ensures that there will never be a competitor that comes in and significantly harms their earnings.

    Some industries such as telecom, and oil have such a high capital investment needed to enter the industry, that they face a low threat from future competition. The oil majors of today partially stem from the break up of Standard Oil in 1911. ExxonMobil (NYSE:XOM) and Chevron (NYSE:CVX) are direct successors of Standard Oil. While there are a handful of other oil major oil companies out there today, the barrier of entry is so high that the threat of the industry being over saturated remains very low. The costs of land and equipment for drilling of the required magnitude are in the billions. This has allowed Exxon and Chevron to grow earnings by selling perhaps the most valuable commodity in the world today uninterrupted by excess completion. In a business where commodity prices can drastically effect the financial results of their business model, Chevron and Exxon have managed to increase their dividend annually 26 and 31 years in a row.

    Telecom companies benefit from the same type of moat, but they also benefit from another. They are able to lock in their customers with high switching costs. In almost all cases, you can't buy a phone from AT&T (NYSE:T) or Verizon (NYSE:VZ) without being locked in with a 2 year agreement. It is a wonderfully effective way to protect your market share. I cannot speak for anyone but myself, but I am not paying several hundreds of dollars to break my carrier contract no matter how "displeased" I am with their service. Verizon has not been able to raise their dividend as consistently as AT&T, but they have almost doubled revenues in the past decade. AT&T has been able to raise their dividend 29 years running.

    The Bottom Line:

    There are various factors that go into an investment decision. The companies I mentioned here are not recommendations to buy, but rather an illustration of a factor I think goes forgotten sometimes among investors. Most of these companies have been consistently raising their dividend payouts for a long time. The common trait among them is they all have a competitive advantage, or moat - that allows them to grow their earnings without a lot of outside pressure from competitors. When looking for a company to invest your money in, be sure to identify the presence of a moat. If you do, your portfolio will be better protected from harm, and your prosperity will grow.

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

    Themes: dividend-ideas Stocks: CVX, KO, PEP, T, VZ, WMT, XOM
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