The Little Book That Builds Wealth (The Knockout Formula for Finding Great Investments) by Pat Dorsey

The larger the economic moat, the more attractive the stock is. Look out for high return on capital, structural competitive advantages and economic moats. Even if you identify companies with wide moats, do not overpay for them. Think long term and look for durable companies. Focus on the type of business rather than the management. Identify the growth industries. Patents are a form of competitive advantage. The real moats are the following: 1) Intangible assets; 2) High customer switching costs; 3) Network economics; 4) Cost advantages. Some of the ways to get an economic advantage are having patents, accreditation. Regulation can also protect a certain industry from excessive competition. Good brands are able to command a premium as well. High switching costs are a form of competitive advantage. For examples, these are firms like asset management firms, manufacturing of laboratory equipment etc. In general, customer oriented firms have low switching costs. Businesses that are based on information and knowledge transfer, like Microsoft, Facebook, rely a lot on their networks. This means that the value of your products rises if more people start using them. One needs a closed network. A few more nodes equals a lot more connections. Third party logistics also have huge moats. Not all cost advantages are durable in nature. Cost advantages come from 4 sources: cheaper processes, better location, unique assets and greater scale. There are two types of size advantages. They are broken down into 3 categories: (1) Distribution; (2) Manufacturing; (3) Niche Markets.

Technology disruption can signal the loss of an economic moat. Look out for consolidation of once-fragmented groups of customers. Look out for an irrational competitor in the industry. Do not pursue growth in areas with no moat. Do not invest in an area where you do not have a competitive advantage. There are moats around the following industries: auto, asset management, software companies, telecom companies, bio-tech companies. B2B companies tend to have large moats as well. Pipelines are surprisingly good in the energy sector. Management has limited ability to survive in a sun-set industry. Bet on the horse, not on the jockey. Even if the company has a moat, do not overpay for it. Look out for FCFF levels etc.



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