The Dhandho Investor
Dhandho 202: Invest in Businesses with Durable Moats
In this chapter, the author suggests that because no moat can last forever, readers should invest in businesses with competitive advantages that last for many years. There is a vast list of businesses with durable moats like Coca-Cola, Chipotle, American Express, H&R Block, Harley-Davidson, Citigroup, BMW and WD-40.
There are also a few companies with no moat at all: Cooper Tires, Delta Airlines, General Motors, Encyclopedia Britannica and Gateway Computers.
At times the moat is not very clear. The instance of Tesoro Corporation, an oil refiner, is emphasized. Even though Tesoro has no control over the price of the crude oil supplies or the price of gasoline, its principal product, it does have an advantage over refineries on the west coast. Although the number of refineries has declined over the years, Tesoro holds an increasing advantage because of environmental regulations for gasoline products that are distinctive to the West Coast.
Even though a business' moat is usually hidden, whether a company has one is often clear from its financial statements. That is because good businesses produce high returns on invested capital. For instance, if starting a Chipotle store costs $700,000 while it generates $250,000 per year in free cash flow is an extremely good business according to the author.
While some moats are long-lasting than others (e.g. American Express was created 150 years ago but still has a strong moat.), it is important to notice that all moats erode over time. Even apparently unbeatable businesses today such as Google, eBay, Toyota, Microsoft and American Express will all ultimately decline and disappear.
The study of Arie de Geus showed that the average life of a Fortune 500 company is only 40 to 50 years, and it takes about 25 to 30 years from the origin for a particular company to get to the Fortune 500. This means the particular company doesn't exist after spending less than 20 years on the list. This implies that discounted cash flow measures into the future should be kept to rather short timeframes.