The true meaning of a moat is a deep and wide ditch surrounding a castle or fort, filled with water as a barrier for protection. This is a wonderful analogy for economic theory as a means to understand what protects a business from being attacked. As a long-term investor we need to determine the viability of the product or service the company has to offer its customers for the next decade, not just over the next year. Wall Street might even think in terms of quarters.
The future is hard to predict, but, some investors can find signals both quantitatively and qualitatively pushing the odds in their favor. These signals might allow us to form an opinion over a longer time horizon, providing an edge.
Capitalism, by nature, is what works against us on seeing a clear picture of the future. Excessive economic profits shouldn't exist in a perfect capitalistic world. Within such a vicious economic environment forecasting growth and operating margins is difficult. Even so, we've seen time and time again companies overcoming these dynamics through some sort of structural advantage. These advantages have allowed continued growth and high returns on invested capital. If an investor is able to identify these advantages along with a fair valuation, the long-term capabilities of the company can be prosperous to the investor.
A Tectonic Shift In The Business Environment
Software/internet is truly eating the world. It’s changing the environment on how consumers behave and corporate business models are developed. French philosopher Michel Foucault was fascinated with disciplinary relationships. This theory has correlation with economic moats. Disciplinary moats are based on repetition within a closed system. Before the internet, think of how consumers purchased products. They went to one or two of their favorite stores weekly and bought groceries and other household items that were needed. The closed system developed consumer habits for specific brands as they owned the shelf space. The company’s ability to control the environment and create continued repetition was the source of their moat.
This relationship even extends to the stores themselves. The internet has now changed this environmental control for companies like Walmart (WMT). In a non-internet world, it was easy to control consumer behavior as Walmart's goal was to put a store as close as possible to the customer. The problem now is consumers don't even have to leave their house. Walmart's moat has slowly decreased in width and depth over the last decade.
On the other hand there is a different emerging moat source. Nassim Taleb coined this concept of Anti-fragile. Taleb says, " Anti-fragile is beyond resilience or robustness. The resilient resists shocks and stays the same; the anti-fragile gets better." A business that is anti-fragile gets stronger or stays the same in a changing or volatile environment unlike disciplinary companies.
A Short Company Specific Moat Analysis
Let’s use Berkshire Hathaway (BRK.A) (BRK.B) under these lenses for a second. The company has connected many castles under one roof. From services such as auto insurance, railroads, to energy, all of them having their own unique structural advantages. With the ability to link up castles, scale advantages can bring synergies and optimal capital allocation. I would argue at the subsidiary level disciplinary moats still persist as controlling environmental variability is difficult. There are some subs that are more likely in the middle of disciplinary and anti-fragile pendulum.
Take for instance GEICO. They have been able to control consumer behavior by being one of the lowest priced auto insurers. I suspect this will not change from a behavioral perspective. The real risk for GEICO is 10-15 years from now with autonomous vehicles. The auto insurance landscape will have a drastic change as to what and who will be liable. In addition, the data set GEICO has been building for decades on age, geography, and claim history for optimal pricing will be obsolete. If perfect or near perfect autonomous driving is possible, age and claim history won't matter anymore. In fact, in an instant, GEICO's competitive edge could be gone. These are future risks, and they might sound silly now, but as a long-term investor we need to take them into consideration.
Where I think Berkshire Hathaway is anti-fragile is at the holding company level. As industries change causing pressure on subsidiary earnings, Berkshire can adapt easier by being a diversified holding company. This allows for optimal allocation of capital. If the environmental factors for one subsidiary are negative, additional resources can be adjusted to favorable industries. From a total holding company point of view, this provides a higher probability of sustained profitability. For instance, Buffett bought a textile business in the 60s. The industry started to shift to cheaper labor by moving plants and demand was declining. Eventually, Buffett closed down the textile mills as they weren't returning their cost of capital and rerouted the additional capital to favorable industries. The company today has been keeping around $100 billion in cash and short term investments and is where the anti-fragile moat lies.
Disciplinary moats create a loop on behavior, and companies will continue to protect this loop with everything they have. By trying to protect the castle as much as possible, it can leave blind spots. Environmental changes can move swiftly, think 2008. Being anti-fragile has specific characteristics like adaptability, excepting errors, and strong balance sheets to name a few. These all create shock resistors making anti-fragile companies more attractive.
By compounding our knowledge on moats investors can construct a portfolio of businesses that have wonderful attributes. These moats allow businesses to thrive in any environment and over long periods of time like Berkshire. Riding the wave of a moat that gets wider every year can be a wonderful thing and Buffett has been doing this for decades.
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Disclosure: I am/we are long BRK.B.
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.
Additional disclosure: The information contained on this article is not and should not be construed as investment advice, and does not purport to be and does not express any opinion as to the price at which the securities of any company may trade at any time. The information and opinions provided herein should not be taken as specific advice on the merits of any investment decision. Investors should make their own decisions regarding the prospects of any company discussed herein based on such investors’ own review of publicly available information and should not rely on the information contained herein.