Is the need for an economic moat moot?

“The key to investing is . . . determining the competitive advantage of any given company and, above all, the durability of that advantage. The products or services that have wide, sustainable moats around them are the ones that deliver rewards to investors.” Reflecting on legendary investor Warren Buffett’s insight, Odlum Brown equity analysts Stephen Boland and Steven Zicherman report on their pilgrimage to Omaha.

Economic_MoatWe recently flew to Omaha, Nebraska for Berkshire Hathaway Inc.’s Annual Shareholder Meeting. The much-acclaimed Warren Buffett has been reading and thinking in Omaha for over 60 years. In his mid-20s, he worked in New York City, but returned home in 1956. He has since espoused the benefits of being away from Wall Street. Mr. Buffett once noted that every street corner in New York had someone whispering in his ear—all sharing their favourite investment idea or the latest Wall Street rumour. It’s easy to lose sight of the long-term, bigger picture under such circumstances.

We saw this recently with Apple Inc. (NASDAQ—AAPL). Prior to Apple’s latest earnings release, the investment community was tripping over itself to figure out how many iPhones were sold in the first quarter. Based on supplier feedback, concern spread that it was a weak quarter, and, consequently, Apple’s stock sold off.

Think long-term

We had been discussing the long-term merits of Apple for some time and were able to recommend the company during that period at a reduced price. Interestingly, Mr. Buffett announced that his company had bought another $12 billion worth of Apple stock.

When asked if he had worried about the quarterly results, he likened the scenario to BlackBerry Ltd. (TSX—BB; NYSE—BB). Ten years ago, investors were scrambling to figure out what BlackBerry’s next quarter would look like. They failed to consider the more important question: what would the company look like in 10 years? Unfortunately, the answer in that case was not so good.

We look at Apple through a long-term lens. How dependent are customers on Apple’s products? How effective is management at allocating capital? What are the company’s competitive advantages? These are the types of questions that truly matter in investing. More important than any one stock pick is the story Mr. Buffett shared at the annual meeting that speaks to market timing.

Go long—and stay invested

He asked the audience what $10,000 invested in 1942 would be worth today, assuming a market return and reinvested dividends? The answer: $51 million. In the end, betting on American business and having the stomach to stay invested through good times and bad would have worked out extremely well. Ignoring the noise is difficult. Twitter, television and countless other media outlets bombard us with information, most of which is a needless distraction.

Successful investing is not about trying to outguess the next person on how a stock will perform in the short term. Successful investing is about having a long-term plan and sticking to it regardless of the market chatter. We believe the best way to do this is by owning great businesses that are sensibly priced and run by good people. That’s what two wise men in Omaha have taught us, and it’s one of the things I thought about on my quiet flight back to Vancouver.

Moats still important in the ‘hi-tech’ age

Reflecting on this year’s pilgrimage to Omaha brings to mind one of the more intriguing topics covered—the changing nature of moats. In early May, Tesla Inc.’s (NASDAQ—TSLA) co-founder Elon Musk criticized Warren Buffett’s concept of moats, calling them “lame”.

During a Tesla conference call, Mr. Musk described moats as “nice in a sort of quaint, vestigial way. But if your only defence against invading armies is a moat, you will not last long. What matters is the pace of innovation. That is the fundamental determinant of competitiveness.”

When asked at Berkshire’s annual meeting to respond to Mr. Musk’s comments, Mr. Buffett acknowledged that businesses have become more susceptible to disruption due to technological innovations, but moats still matter and are critical to prospering long term.

Take the wholly-owned subsidiary of Berkshire Hathaway, GEICO Insurance, as an example; its low-cost model is a solid moat providing the company a competitive advantage over its higher-cost peers.

The discussion on moats continued the following day at Markel Corporation’s (NYSE—MKL) annual meeting. Tom Gayner, Markel’s Co-CEO and a long-time Buffett admirer, described learning about moats from a core Berkshire holding like The Coca-Cola Co. (NYSE—KO) and Jeff Bezos-controlled The Washington Post newspaper. Mr. Gayner asked his attending shareholders whether the moats around those two companies are growing or shrinking.

The conclusion was that the competitive advantages both once enjoyed have diminished significantly, if not eroded altogether. He noted that companies need to be flexible and nimble in today’s hyper-competitive world. Mr. Gayner went on to say that he expects to increase his ownership in certain technology stocks because of their moats, including an ability to adapt.

We agree. Companies like Amazon.com Inc. (NASDAQ—AMZN) and Alphabet Inc. (NASDAQ—GOOGL) are spectacular businesses, largely because of their employee cultures. They prioritize workplace creativity, fact-based risk-taking and experimentation to discover the moats of tomorrow.

As investors, we left Omaha reminded that we must always be on the lookout for companies with a weakening corporate culture. Typical red flags include increasing layers of bureaucracy and high employee turnover.

We must also search for opportunities to invest in under-appreciated companies that demonstrate an ability to think outside the box and adapt to fast-moving changes. Investors who take the time to understand the evolution of economic moats will likely continue to have an edge over those who don’t.

Stephen Boland and Steven Zicherman are equity analysts for Odlum Brown.

This is an edited version of an article that was originally published for subscribers in the June 22, 2018, issue of Investor’s Digest of Canada. You can profit from the award-winning advice subscribers receive regularly in Investor’s Digest of Canada.

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