In one sentence: Phil and Danielle show that the six moat types apply even to a house (location is a brand moat), then use Morningstar's wide-moat list as a source of ideas, with the warning that return on equity can be inflated by debt and that historical numbers only look out of the back window.
Key ideas
- The same formula works for any asset. Buffett owns private companies, real estate and farms as well as stocks. Phil focuses on public companies because the information is online and you don't need a lawyer or accredited-investor status. [00:00–02:00]
- Real investing means buying when others are afraid. In 2009 houses that rented for $1,000 a month sold at the courthouse steps for about $50,000 because buyers were scared. You can only act against fear without gambling if you're very comfortable with long-term value. Fear is also information, so take another look. [03:00–06:00]
- Six moats, applied to a house. Brand, toll bridge, price, switching, secrets, and (Phil's addition) network effect. Location is the brand moat of real estate: the neighbourhood's quality should still be there in 10 to 15 years. [06:00–09:00]
- Morningstar's Wide Moat Focus index. Morningstar screens by computer for wide-moat companies and publishes a list (and an index) updated quarterly. Rule #1 teaches the subjective approach instead (which kind of moat is it?). Search with a month and year, since old lists turn up. [09:00–13:00]
- Check 1: high return on equity. About 10% or better, though a company can inflate ROE by borrowing, which is why Phil prefers ROIC (return on equity plus debt in the base). Phil calls ROIC Buffett's most important number, "because debt is deadly". [13:00–15:00]
- Check 2: free cash flow divided by revenue. This shows how much of each sales dollar is left for owners after cash costs and replacement capex. Railroads must keep replacing ties, whereas Coca-Cola's formula needs little new capital. (Phil's own version divides free cash flow by net earnings.) [15:00–17:00]
- Coca-Cola's moat is under attack. US soda sales are falling and three quarters of its sales come from abroad. A moat is never permanent. [17:00–19:00]
- Numbers look out of the back window. Morningstar's ideas are 20% to 30% below its own value, with high ROE and cash flow. You still need to know what produced those numbers and whether the moat will last 10 years, and why the shares are on sale (a harness maker in the age of the car?). Phil also notes that few gurus he follows were buying them. [19:00–25:00]
- Homework list (not advice). FOXA, Disney, Polaris, Tiffany, Wells Fargo, Mastercard, Emerson Electric, John Deere, Visa and Salesforce. Pick two or three and name the moat type and whether it lasts 10 years. Buffett had said on CNBC he was buying Deere because it would be worth more later. [20:00–26:00]
How it maps to RuleOne
- The screen's ROIC and cash-flow columns on /stocks/ play the role of Morningstar's computer check. They show whether the numbers are consistent with a moat, not which moat it is.
- Treat a published list (Morningstar, a guru's buys) as Radar input, like the cloning idea in 001, and then do your own work.
Buffett, Munger and Graham links
- Munger's second filter, "intrinsic characteristics that give a durable competitive advantage", is quoted in 001 and 084.
- Buffett's moat idea comes from his Berkshire letters from the 1980s and 1990s, where he writes about a "castle" and an "economic franchise". Check the exact wording in the letters rather than relying on this note.
Words to know
- Return on equity (ROE): earnings divided by equity. It can be inflated by debt.
- Return on invested capital (ROIC): earnings divided by equity plus debt, so borrowing can't flatter it.
- Free cash flow: cash left for owners after operating costs and capital spending.
- Toll bridge moat: a business that is very hard to duplicate, such as a regulated utility.
Try this
Open Morningstar's wide-moat list (or pick any company you know on /stocks/). Choose one company and write down its moat type, what evidence in the numbers supports it, and one way the moat could be breached in the next 10 years.
Check yourself
- Why does Phil prefer ROIC to ROE?
Answer
Companies can raise ROE just by borrowing. ROIC includes debt in the base, so it shows the return on all the capital in use. - What is the "back window" warning about moat screens?
Answer
Screen numbers are historical. You must understand what produced them and whether it will continue for the next 10 years. - What is the brand moat of a house?
Answer
Its location: confidence that the neighbourhood's quality will be the same or better in 10 to 15 years.
Short quotes
"You can't drive your car looking out the back window." (Phil, ~24:00, auto-transcribed, paraphrased)