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1/ Moats are overrated
A thread...
A thread...
2/ Many investors claim they only invest in companies with "wide moats" and "defensible positions."
If this were true, the bar is so high they would make few, if any, investments.
If this were true, the bar is so high they would make few, if any, investments.
3/ Before we go any further, let's get our definitions straight:
What is a moat as opposed to a competitive advantage?
What is a moat as opposed to a competitive advantage?
4/ An economic moat, as the term is used by Buffett and Munger, is more than your run-of-the-mill competitive advantage. It's a competitive advantage on steroids, one that allows a company to earn above-average returns on capital.
5/ On the other hand, a plain-vanilla competitive advantage is anything that a company does better than the competition; it's the reason some customers choose that company over others but does not provide enough of an advantage to earn returns above the industry average.
6/ There can't be that many companies with moats. There can't be so many companies earning above-average returns for long periods.
It's not that moats are overrated. It's that investors see moats where there aren't any.
It's not that moats are overrated. It's that investors see moats where there aren't any.
7/ Investors tend to confuse a competitive advantage for a moat. And the companies that do, in fact, have a real moat, usually can't hold on to it forever. Moats tend to be finite and fixed. And fixed defenses can eventually be overcome.
8/ An obvious analogy is the Maginot Line, pre-WWII.
The French built a complex line of defenses along their border with Germany. These defenses were thought to be impenetrable.
The French felt very safe behind their moat.
The French built a complex line of defenses along their border with Germany. These defenses were thought to be impenetrable.
The French felt very safe behind their moat.
9/ On May 10, 1940, Nazi Germany invaded France. How? It began by going around the Maginot Line, through Belgium, Luxembourg and the Netherlands with highly mobile forces.
10/ The Germans surprised the French and Allied forces when it simultaneously assaulted the Low Countries and weakest section of Maginot Line that was directly opposite the Ardennes, a dense forest that French military planners assumed was too difficult to traverse with tanks.
11/ The lesson here is that moats, even when they are real, can be outflanked or made irrelevant.
12/ There are plenty of examples in the business world...
13/ In 2013, 3G Capital and Berkshire Hathaway acquired control of H.J. Heinz for $23 billion and then funded the acquisition of Kraft Foods, creating the behemoth now known as Kraft-Heinz, the fifth-largest food company in the world.
14/ 3G Capital had been spectacularly successful using a simple formula:
Acquire well-known consumer brands with wide moats, at a premium if necessary. Finance the acquisition with cheap debt and operate the business as efficiently as possible.
Acquire well-known consumer brands with wide moats, at a premium if necessary. Finance the acquisition with cheap debt and operate the business as efficiently as possible.
15/ But things didn't turn out as expected.
Sales quickly fell as consumer tastes shifted and new and nimbler brands appeared.
Sales quickly fell as consumer tastes shifted and new and nimbler brands appeared.
16/ Jorge Paulo Lemann, a co-founder of 3G and board member of Kraft-Heinz, addressed this issue head-on at a conference in 2018:
"I'm a terrified dinosaur," he said. "I've been living in this cozy world of old brands and big volumes."
"I'm a terrified dinosaur," he said. "I've been living in this cozy world of old brands and big volumes."
17/ "We bought brands that we thought could last forever." Lemann added: "You could just focus on being very efficient…".
But things turned out to be a little more complicated. "All of a sudden, we are being disrupted."
But things turned out to be a little more complicated. "All of a sudden, we are being disrupted."
18/ Kraft-Heinz may not go bankrupt, but it did take a $15.4 billion write-down on its acquisition of Kraft Foods and Oscar Mayer.
It cut its dividend by 36%.
And is being investigated by the SEC regarding its accounting practices.
It cut its dividend by 36%.
And is being investigated by the SEC regarding its accounting practices.
19/ 3G Capital and Berkshire Hathaway each took billion-dollar write-downs.
Was it worth paying a "moat premium"?
Was it worth paying a "moat premium"?
20/ Companies that do have an economic moat tend to sell for higher valuations, which reduces investor's margin of safety.
21/ Are moats overrated?
It's not that they are overrated but that they are "over-spotted."
Most investors pay for moats that aren't there because very few companies have real ones.
And the ones that do, only do so temporarily.
It's not that they are overrated but that they are "over-spotted."
Most investors pay for moats that aren't there because very few companies have real ones.
And the ones that do, only do so temporarily.
22/ Moats *are* overrated in the sense that they are not necessary to earn significant returns.
We have reviewed countless companies, both public and private, that thrive with no moat, only plain-vanilla competitive advantages.
We have reviewed countless companies, both public and private, that thrive with no moat, only plain-vanilla competitive advantages.
23/ The only *rea*l moat is culture
24/ A good culture allows companies to do the essential thing for survival: adapt.
Investors hate to talk about culture because it's a soft subject that is impossible to quantify.
Investors hate to talk about culture because it's a soft subject that is impossible to quantify.
25/ Price will always matter:
Moat or no moat; high growth or low growth.
Price is the only source of margin of safety we get as investors.
End/
Moat or no moat; high growth or low growth.
Price is the only source of margin of safety we get as investors.
End/
