Warren Buffett, the leader of Berkshire Hathaway and one of the most successful investors ever, has a few adages for his form of value investing.
While Buffett has been a wellspring of investing insights, one of the most integral parts of Buffett’s outlook on investing has a bit of a medieval flair to it — moats.
While this idea isn’t new, Buffett has been espousing this idea for years and we’ve highlighted the idea indirectly before, a note from CLSA’s Damian Kestel on Friday included one of the most relevant pieces of Buffett’s investing strategy we’ve seen.
Here’s the bit, from Berkshire’s 2000 annual meeting:
So we think in terms of that moat and the ability to keep its width and its impossibility of being crossed as the primary criterion of a great business. And we tell our managers we want the moat widened every year. That doesn’t necessarily mean the profit will be more this year than it was last year because it won’t be sometimes. However, if the moat is widened every year, the business will do very well. When we see a moat that’s tenuous in any way-it’s just too risky. We don’t know how to evaluate that. And, therefore, we leave it alone. We think that all of our businesses-or virtually all of our businesses-have pretty darned good moats.
Essentially what Buffett is talking about is the competitive advantage that a business has over others. Some sort of unique aspect to the good it offers, or way it offers it that is difficult for other actors to replicate.
The quote also emphasises another huge part of Buffett’s thinking. Basically, even with a substantial moat there are hundreds of external things that could go wrong for a business. This doesn’t mean the moat has disappeared, it just means that you need to be patient.
As we’ve noted before, having a longer time horizon on investments helps to smooth out the bumps along the way, and if you stick around long enough you’re more likely to have strong returns.
Now it’s not all peaches and cream from Buffett, who also highlighted the dangers for businesses, moat or not.
“It gets extra tough when a fanatical small competitor-like a Rose Blumkin, or a Les Schwab, or a Sam Walton sets their sights on your particular marketplace,” Buffett said.
“How do you compete against a true fanatic? You can only try to build the best possible moat and continuously attempt to widen it.”
The three names are disruptors that built a huge furniture, a massive tire retailer, and Walmart. Buffett is pointing out that you can’t predict the kind of disruptions that are coming for the industry, but making the moat as wide as possible will make this disruption more difficult.
This is especially important considering the constant discussion over disruption in today’s economy. Companies such as Uber, Netflix, and even fintech are challenging old ways of business, even to the detriment of Buffett’s own portfolio.
This means identifying legitimate moats could be a big challenge, and opportunity, for investors going forward.
Now there is no set way to find “moats”, Kestel suggest measuring profits against cost of capital and making sure this maintained over time, but finding a way to identify them could be the most important thing for investors to do.