Thread by @retaox

In long term investing, moats are the most important qualitative factor an investor should look for. There are a lot of academic papers and books on moats. It's a subjective topic and these are the ones I look for.

1. Patents : A single patent does not protect the company. The company should have a track record of producing patents for this to be a wide enough moat. If competitors were able to copy the products, in spite of existing patents, then patents are just show pieces. Biotech/Pharma

2. Regulations : In general, regulations are good for existing players in the industry and bad for new entrants. It raises the barrier to entry. Regulations come with extra costs and head aches that deters new players to come in. Tobacco and Pipelines are prime examples.

3. High Barriers for Entry : Does the industry have barriers for entry for new players? If not, new players are going come in, one up and steal the customer. That's why retailers have low moats. Asset heavy industries like Railroads & Defense can't disrupted by an engineer in SFO

4. Premium Brand loyalty : Is the brand loyalty making the customers buy from the same company and deter them to go other companies. And are younger generations thinking the same way about the brand? Decades of brand loyalty is hard to disrupt. Apple/Ferrari/Coke

5. High Switching Costs : How easy is it for the customers to switch to a different company? Are there too much hurdles the customer has to cross to switch? Think banks, ADP, AWS, Oracle. Restaurants have literally no switching costs.

6. Recurring Revenue : Is the revenue recurring? Or each new sale has to be done with extra marketing costs? How many times do you think about your Spectrum/Netflix bill a year? This combined with high switching costs produces a wide moat.

7. Network Effects : The most famous moat. “The 10,000th customer on the platform improves the product for the 1,000th customer”. Master/Visa/Twitter would do just fine as long as they don't alienate their customers. Network effects work well with high switching costs.

8. Scale Cost Advantage : If the company is a low cost player, you have to ask 'What is stopping other companies to sell goods at same low cost'?

Some times the fixed costs are so high (UPS/Amazon), it would take more than 50% market share to break even.

9. Habit Forming : Is the business habit forming, making customer come back again and again out of muscle memory? Like MCD

Low frequency visits + High item price + Multiple people making purchase decision = Not a habit forming business. Fine dining is never habit forming.

10. Pricing Power : Can the company charge a premium for its brand and not loose customers? Increasing gross margin is a solid sign of this. Companies with the pricing power are the only ones that can withstand inflationary environment.

(Pricing Power continued) Does the company have higher gross margin relative to the closest identical competitor? Even better is the gross margin increasing? This is an indicator of widening moat.

11. Monopoly : Is the company monopoly in a niche industry? If so there is no incentive for new incumbents to enter the business. The lower the number of players in the industry, higher the profits. Duopoly in a secular growth industry? Buy both. Monopoly = Pricing power. FOX/MO

13. Disruption Resistant : Is it subject to frequent technological disruption or shifts in industry dynamics? Has the market share for big players in the industry remained stable in the past century? Severe change and exceptional returns don't mix in the long term. Think $SBUX

14. Product Differentiation : When the company sells a product that is very unique to itself, it has a moat. If the product is not a commodity, and the customers know that this is the only company they can buy this differentiated product, it is a moat. Think Apple.

15. Perpetual Innovator: Does the company have the history proactively disrupting it's own business and constantly innovating. When the barriers of entry is low (SaaS), the culture of perpetual innovation is a moat. Amazon/Netflix has the right attitude for software industry.

16. Fragmented Industry : This is not a moat, but means to growth. Is the industry fragmented? If so, are there benefits of scale, with consolidation? Like banks, cable, c-stores. Only works hand in hand with organic growth.

17. Multiyear Contracts : Does the company operate on long multi year contracts? This is very similar to recurring revenues. Think $HII / $ATCO. They operate with years of revenue already secured.

18. High Training Cost : Does the product involve significant learning curve and are the customers already well trained in it? When the training involves highly paid professional like Doctors and Software Engineers, you have an even stronger moat. Think $ISRG, AWS, Adobe.

20. Essential Nut: Is the product such that, the customer is indifferent to price increases? Like a low cost part in a plane, make/break ingredient in food. This is not a product people usually experiment with. They'd gladly pay up because it's so cheap in the grand scheme.

(Essential Nut continued) If you look at the value chain, this is where most margins lie. This only works when the product is differentiated to some level. Usually works better with other moats like Regulations. McCormick/Heico/ADP

21. Too Important to fail : If this company fails, will the government intervene to pull it back? Is this company's success directly tied to economy? Think Banks.

22. Toll Bridge : If the company is a toll bridge either physically or metaphorically, then it's a moat. Think Airport Operators for flights, Google for ads money, Master card for money. Verisign for websites. Moody's/S&P for bonds.

24. Long History : Not a moat, but an indicator. How long has the company successfully held off competition? If they have done it for a while, then they are likely to do it for a while. Wide moats take time to build. Think Coke.

25. AntiFragile : If the industry is recently through a crisis? Has this environment left the industry with only stronger players? Are any regulations passed, that just makes the remaining players stronger? Banks became fundamentally stronger after 2009.

26. Holy Trinity : When you have recurring revenue, with high training costs and high switching costs for a product, the moat is an ocean. Think Oracle, AWS, SAP, Bloomberg. Software businesses should ideally have these moats to protect them.

27. Management Moat : If the management has demonstrated integrity, smarts & hard work and with enough skin in the game and are planning to run the company for a foreseeable future (30 years) then you have a moat here.

28. Location : If you have full control over a coveted location, then you have an absolute moat. No one one can steal your business just like that. Think Vail/MSGE.

29. Fortress Balance sheet : In a highly leveraged fragmented industry if one company has a balance sheet like a fortress, guess who will go on a buying spree when market tanks and capital dries up for normal operations?
$ATCO

30. Vertical Integration Advantage : When a company is vertically integrated, controlling from sourcing to retailing, and no other company in the industry has this, the company enjoys a small advantage. This can it a leg up in cornering the market with low prices. Think Carvana

31. Paid by Others :
If the product is used by one group, but it's paid by a different group, the customer feedback loop is broken and pricing power can go top gear with minimal repercussions.

Health Insurance paid by employer is a prime example.

32. Non revenue related products.

An incumbent selling enterprise products that doesn't necessarily result in increase in revenue for customers are harder to disrupt.

Management often is predisposed to look for ways to increase revenue than to cut costs.

https://twitter.com/Roadmap2Retire/status/1433875467615055873?s=19

(cont)
Whoever is owning the migration, gets kudos if it is successful, but risks his career if the migration fails.

But a revenue generating project, if successful puts the person's career on rocketship. If failed, they'd be lauded for experimenting and failing.

Think ADP, NOW

33. Long Switching Time :

There are businesses, when you get locked-in, no matter how much money you spend, it just takes long time to switch away.

This gives time to course correct if things are going south before customers leave in troves.

AWS $CERN

https://twitter.com/retaox/status/1425461426458697730?s=19

34. Customers Have No Choice :

This not a moat, but an indication.

When customers have no choice, but to buy from a single company, not just presently but for the foreseeable future --> durable profitability.

Choices & competition are good for consumer; bad for companies.

Preferably, this should be accomplished by creating so much value for the customer, it'd be stupid on customer's part to not use the companies products.

Think : $AMZN $GOOG $V

35. Big Fish in a Small Pond :

In business, it's better to be a big fish in a small pond, than a minnow in the ocean.

A vertically integrated monopoly in a small niche, gets to keep high % of revenue as profits and it deters new competition away.

Think $CSU.TO $TDG

36. Private Need-To-Have Network Effect :

Opting out of such network would become a significant impediment in daily life of a customer.

Think WhatsApp.

Compared to Public Nice-To-Have Networks that rely on community and social graph.

Think Facebook.

37. Other Network Effects Subtypes :

Examples are self explanatory.
* 2-sided platform : iOS, Android.
* 2-sided marketplace : eBay, Craigslist
* Data Network Effects : Waze, TikTok algorithm.
* Belief Network Effects : Bitcoin, Religion.

Refer : nfx.com/post/network-e…

(cont)
Network effects are vulnerable to multi-tenancy issue. A driver driving for both Uber and Lyft. Same applies to passenger.

The issue is exacerbated when there is low switching costs between networks.

Both drivers & passengers can switch networks at no cost.

(cont)
Watch out for networks, which only gain diminishing returns on addition of more nodes to the network.

1000th driver does not add as much value as the 100th driver in a city. Any consequent reduction in wait time < 5 minutes, is of little value to the customer and network.

38. Razor / Razor-Blade With A Twist :

One group decides the vendor for the Razor, but the other group is the one who is forced to pay for the Razor-Blade. (Printer/Cartridge example works too).

Issuer/Manufacturer chooses $V / $TDG, but acquirer/airlines pays in perpetuity.

(cont)
This allows the company to raise prices on Razor-Blade with minimal repercussions on the sale of Razor.

Works especially well when combined with Regulatory Capture or Network Effects.