What you’re up to in this post:
– Find out if a company with an average high ROE over the past years does have a moat
– Ask yourself the questions helping you to figure this out
So here you are.
You have been through the financial statements of the company you wished to study. And you gladly found out that it has been averaging a high ROE over the past decade.
Now, you know that this fact can be due to pure luck. Some people do have luck, right.
It also can be the consequence of the presence of a type of economic competitive advantage, called moats.
At this stage, what you need is to figure out which of the two it is: luck of the effective presence of a moat?
This post is about that step.
To figure it out, you need first of all to know what you’re looking for as a moat type.
To get deeper and make sure the high rewards to the shareholders you have emphasized over the past decade aren’t hazard, you can ask yourself some questions that lead to the presence or absence of an economic moat type.
To do such a thing, I base this writing upon a well-documented book called “Why Moats Matter”, from Heather Brilliant and Elizabeth Collins.
These two women from Morningstar follow up on Pat Dorsey’s recommendations, as he is himself a former Morningstar head of Research.
In this book, we are interested in the questions the authors suggest we answer in order to find out if there’s a type of moat or not.
But before showing it off, here’s a reminder of the different kinds of economic moats looked for by the Morningstar approach, explained by Heather Collins herself:
Now here are the questions.
1) What premium can the company charge relative to competitors?
2) Do higher costs offset this premium?
3) How do the company’s margins compare with competitors that have weak brands?
1) When do the company’s patent portfolio intend to expire?
2) How diverse is the company’s patent portfolio?
3) How do you judge the potential of patentable products in the market and what do you think the probability of their success is ?
4) Does it make it easy for competitors to enter the market once products come off patents?
5) Are there substitutes for the patented products?
6) Is the intellectual property protection strong in the considered market?
1) Does the favorable regulation come up with offsets such as price controls or service mandates?
2) Does the service in the industry considered have potential substitute?
3) What are the odds for adverse regulatory changes?
2) Does the company benefit from costs spread over types of products or quantity?
3) Does the company benefit from low transportation costs?
4) Does the company own or control geological deposits with advantageous characteristics and how rare are such deposits?
5) Does this company have a unique production process resulting in a cost advantage and can it be replicated?
6) Does this company have bargaining power with suppliers resulting in a cost advantage?
7) Does the company have advantaged access to raw material and why can’t competitors get access to these low-cost raw materials?
1) What are the costs and benefits of switching?
2) Do customers’ existing assets and processes depend on a particular provider’s offering?
1) How the value of the good or service increases as more customers and suppliers join the network?
2) How does the company make money with its network?
Answering those questions will give you a good idea of the presence of moat, and which type it might be.
I guess you have to do your homework to answer these for every company.
There will be some examples of application on the blog soon.
In the meantime, it is very important for you to:
1) Get familiar with the types of economic moats you can find in a business.
2) Understand the importance of the questions above, as only their answers will clearly inform you about the presence of an economic moat.
This second part concludes the ultimate guide to invest in economic moats stocks.
You will find here-under a chart summarizing all the steps to follow in order to find this amazing business to invest safely over the long term.
I wish you a great time looking for stocks and great returns.