Business Moats:- The dhandho Investor Chapter 9

Hello friends, in today’s article, we see business moats from chapter 9 of the book the Dhandho Investor by author Mohnish Pabrai. In this chapter, we see investing in businesses with durable moats. By investing in this, you get a competitive advantage as compared to their competitor.

so let’s see how to find, that companies that have durable accounts.

Previous Chapter 8

Invest In Business with Durable Moats:-

In starting this chapter the author explains what is the moat, with his barbershop arbitrage

the author says, ” As we saw in the barbershop arbitrage example, our barber is initially the only game in town. he is thus able to charge significantly more than the barbers in the neighboring towns and make supernormal profits.

Capitalism is greed-driven, and as barbers in the other town, get word of the spectacular opportunities in town C, they rush to open up barbershops.

Over time, the price to get a trim in town C is no different from town A or Town B. Capitalists strive hard to capitalize on any opportunity to make outsize profits. the irony is that, in that pursuit, they usually destroy all outsized profits.

but every once in a while a business with a secret sauce for enduring outsize profits emerges.

take the example, of one of my favorite restaurants Chipotle. whenever I go there, there is usually a line all the way to the door. In spite of the fact that there is this long line and I live in southern California with a plethora of choices for Mexican food, I remain loyal to Chipotle. (Business Moat:- The dhandho Investor Chapter 9)

Why? Well partly it’s the fresh high-quality ingredients, partly it’s the tasty food, partly and ambiance, and partly the ability to precisely decide which ingredients I want and in what quantity.

All the other Mexican and fast-food restaurant owners in town are fully aware of the chipotle phenomenon. they hate it and want to do something about it, but they can’t – not easily anyway. It would be a significant uphill battle to replicate chipotle, I’m sure many will try, and eventually, a few might succeed but in the meanwhile chipotle is likely to continue to thrive for years on end.

when more players enter the market, they are likely to take customers away from other restaurants rather than chipotle.”

then author explains, the Chipotle business moat,

the author says, ” From a standing start just 13 years ago, Chipotle recently opened its 500th restaurant. it could easily grow 10 times or more.

Its present footprint, not to mention its enormous prospects overseas. Chipotle has a durable moat.

This moat allows chipotle to have the ability to earn supernormal profits. Best I can tell those profits are here to stay at least for the next decade or longer. (Business Moat:- The dhandho Investor Chapter 9)

There are businesses with deep moats all around US-American express. Coca-cola, H & R Block, Citigroup, BMW, Harley-Davidson, WD-40, Nabisco’s Oreo cookies- the list is endless.

There are businesses with shallow or nonexistent moats all around the US its well- Delta Airlines, General Motors, Cooper tires, encyclopedia Britannica, Gateway computers, and so on.”

then the author explains, how to find the moat, and most moats of companies are hidden

the author says, ” Sometimes the moat is hidden. take a look at Tesoro Corporation. It is in the Oil Refining business- which is a community. Tesoro has no control over the price of its principal finished good, gasoline, nonetheless, it has a fine Moat.

Tesoro’s Refineries are primarily on the west coast and in Hawaii. Refining on the west coast is a great business with a good moat.

There hasn’t been a refinery built in the United States for the past 20 years. Over that period. the number of refineries has gone down from 220 to 150, while oil demand has gone up about 2 percent a year. the average U.S. refinery is operating at well over 90 percent of capacity. (Business Moat:- The dhandho Investor Chapter 9)

anytime you have a surge in demand, refining margins Escalate because there is just not enough, Capacity. West Coast refiners also have a good moat because state EPA regulations in California and Hawaii are very stringent and require unique formulations.

Refining on the West Coast and Hawaii carries much higher margins than the rest of the country. A refiner in Texas can not easily serve the California market. the California refiner is the one that usually serves the California market, which means that when Tesoro has a refinery in California it has a very large captive market.”

then the author talks about how we know when a business has a hidden moat and what that moat is

the author says, ” In the overwhelming majority of businesses the various moats are mostly hidden or only in partial view. it takes some digging to get to the moat.

how do we know when a business has a hidden moat and what that moat is? the answer is, usually visible from looking at its financial statements. good businesses with good moats, like our barber, generate high returns on invested capital.

The balance sheet tells us the amount of capital deployed in the business, and the income and cash flow statements tell us how much they are earning off that capital. (Business Moat:- The dhandho Investor Chapter 9)

So If a chipotle, store costs $700,000 to open and it generates $250,000 a year in free cash flow, it’s a damn good business. Every three years it can take that cash flow and open another chipotle. when it starts franchising, the return on invested capital is exponentially higher.

throughout history, kings have caught to build heavily fortified castles with ever-widening and deeper moats. At the same time, the marauding invaders continued to attack unabated and endlessly improved the tools, techniques, and armies at their disposal to capture these prize castles, it is virtually a law of nature that no matter how well fortified and defended a castle is, no matter how wide or deep its moat, eventually it is going to full to the Marauding invaders.

Throughout history, every great civilization and kingdom have eventually declined.”

then the author talks about the narrow and nonexistent moats

the author says, ” The business mentioned earlier as having borrow, or nonexistent moats, Delta, Gateway, General Motors, all had pretty formidable moats at one time. (Business Moat:- The dhandho Investor Chapter 9)

they have all eroded over time, just like the moat well-defended castle eventually falls into the enemy’s hand. Here is Charlie Mungers on it:-

Of the fifty most important stocks on the NYSE in 1911, today only one, general electric remains in business…. that’s how powerful the forces of competitive destruction are. over the very long term, history shows that the chances of any business surviving in a manner agreeable to a company’s owner are slim at best.   – Charlie Munger

There are no such things as a permanent moat. even such invincible, businesses today like eBay, Google, Microsoft, Toyota, and American Express will all eventually decline and disappear.

Some moats are more durable than others. Wells Fargo and American Express were founded over 150 years ago, and amazingly both their moats are as robust as ever today. amazingly, as an aside, both American Express and Wells Fargo were founded by the same person, Henry Wells.

But here is the dilemma: if you were picking stocks a century ago, it would have been virtually impossible to pick these two out of the larger available universe, the odds are very high that even if the ones you picked were the bluest of the blue chips, they would eventually wither away. (Business Moat:- The dhandho Investor Chapter 9)

In 1977, Arie de Geus Wrote a Fascinating book called the Living company.

Geus studied the life expectancy of companies of all sizes and was very surprised to find that the average fortune 500 company had a life expectancy of just 40 to 50 years.

it takes about 25 to 30 years from Formation for a highly successful company to Earn a spot on the fortune 500.

Geus found that it typically takes many blue chips less than 20 years after they get on the list to cease to exist. the average fortune 500 business is already past its prime by the time it gets on the list.

Even businesses with durable moats, don’t last forever thus when using the John Burr Williams Intrinsic Value formula, We ought to limit the number of years, we expect the business to thrive. we are best off never calculating a discounted cash flow stream for longer than 10 years or expecting a sale in year 10 to be at anything greater than is times cash flows at that time ( plus any excess capital in the business.) (Business Moat:- The dhandho Investor Chapter 9)

so this is all about chapter 8 of the book the Dhandho Investor on Invest in business with durable advantages.

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