Friends,
I (Stoffel, here) have been running companies through my Antifragile Scoring System for nearly a decade. While the system is far from perfect, it has helped me identify some of my biggest winners ever, including:
- Buying Axon Enterprise at $22 in 2017.
- Investing in Shopify at $4.50 in 2017.
- Adding CrowdStrike for $15 per share during the COVID outbreak.
But recently, I made a pretty big change to how I evaluate a company's moat -- or sustainable competitive advantage.
Moats: The basics
If it's hard to wrap your head around what a "moat" is, consider this thought experiment:
You are given $100 billion and 10 years' time. You get to keep it -- and all of the success you generate -- so long as you build a company that dominates its industry after 10 years.
The big question is: which industries do you avoid altogether?
For instance, beverage companies have been trying to dethrone Coca-Cola for over a century. There's nothing particularly unique about combining sugar, water, and a few other ingredients. Give me $100 billion, and I could make a drink that matches Coke on a blind taste-test.
And yet...
Despite that, the Coca-Cola brand is so powerful that consumers will still choose it over rivals despite what any taste-test shows. THAT is a moat.
But brands aren't the only moat. They can come in several varieties:
- Network effects: Each additional user of a product/service makes that product/service more valuable. This is the key moat for social media companies.
- Switching costs: Once you start using a product, the stakes are too high (in terms of time, money, or risks) to switch. This has been the key moat for software companies over the past ten years.
- Low-Cost production: If a company can produce something for the same or lower cost than competitors, it will win business. Walmart's scale offers such a moat.
- Intangibles: This is where Coke's brand value lives. But it can also include things like patents or government licenses.
- Counter-Positioning: The most short-lived of the moats, this is what happens when a new business model undercuts those of industry titans. Netflix's no-late-free red envelopes did this to Blockbuster's late-fee-reliant business model.
When a company has a moat, it can keep the competition at bay for years. This allows profits to compound -- which is like magic for investors.
That's why whatever industry you avoid in the bet above is probably where you should be investing your money.
Moats: Width vs Direction
For most of the past 10 years, my only concern was how wide a company's moat was. If it was wide, that was good. If it was narrow, that was ok. If it was non-existent, I ignored it.
But the world is a dynamic place, and thinking of moats as fixed was an error in my thinking. Moats can get wider or narrower depending on how they respond to changing markets.
And when you think about it from an investor's standpoint, the direction of the moat matters as much -- if not more than -- the width of the moat.
The thinking behind this is simple. Investors aren't going to wait for proof that a moat is eroding to show up on the income statement. The income statement is backwards-looking; the stock market is forward-looking. If you wait until it shows up, the stock has already lost a huge chunk of its value.
Because of this change, I'm more likely to give credit to a narrow moat that's expanding than a wide one that's stable or narrowing.
It's a change that took me time to make. I don't like adjusting such tools willy-nilly. At the same time, investors either need to evolve or die. That's what I'm attempting to do.
Keeping your mind open to evolving is one of the most important traits for surviving -- and thriving -- over the long run.
Wishing you investing success,
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Brian Feroldi, Brian Stoffel, & Brian Withers
Long-Term Mindset
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