Decision Tree for Initial Business Evaluation

[Dexter]

Nice decision tree by Connor Leonard, Public Securities Manager at Investors Management Corporation.

https://twitter.com/Connor_Leonard/status/760824678734782465

The following articles by Connor explain the distinctions between Legacy Moats, Reinvestment Moats, and Capital Light Compounders.

http://basehitinvesting.com/importance-of-roic-reinvestment-vs-legacy-moats/
http://basehitinvesting.com/reinvestment-moat-follow-up-capital-light-compounders/

[Dexter]

Just a quick follow-up.  For anyone not familiar with the concept of an economic moat, Warren Buffett provided the following comments in a 2007 talk given at Florida University (https://www.youtube.com/watch?v=2MHIcabnjrA):

Buffett: I like businesses I can understand. We'll start with that. That narrows it down about 90% [laughter]...There's all kinds of things I don't understand, but fortunately there's enough I do understand. You got this big, wide world out there. Almost every company is publicly owned...You got all American business, practically, available to you. Now, to start with, it doesn't make sense to go with things you think you can['t] understand. But you can understand some things. I can understand this [Picks up can of Coca Cola]. I mean you can understand this. Anybody can understand this. I mean this is a product that basically hasn't been changed much...since 1886...and it's a simple business. It's not an easy business. I don't want a business that's easy for competitors. I want a business with a moat around it. I want a very valuable castle in the middle. And then I want...the Duke who's in charge of that castle to be honest and hard working and able. And then I want a big moat around the castle, and that moat can be various things.

The moat in a business like our auto insurance business at GEICO is low cost. I mean people have to buy auto insurance, so everybody's going to have one auto insurance policy per car basically, or per driver. And...I can't sell them twenty...but they have to buy one. What are they going to buy it on? They're going to buy it based on service and cost. Most people will assume the service is fairly identical among companies, or close enough, so they're going to do it on cost, so I gotta be the low cost producer. That's my moat. To the extent my costs get further lower than the other guy, I've thrown a couple of sharks into the moat.

Buffett: But all the time, if you've got a wonderful castle, there are people out there who are going to try and attack it, and take it away from you. And I want a castle that I can understand, but I want a castle with a moat around it.

Buffett: Thirty years ago, Eastman Kodak's moat was just as wide as Coca Cola's moat. I mean if you were going to take a picture of your six month old baby, and you're going to want to look at that picture 20 years from now, and you're going to want to look at it 50 years from now. And you're never going to get a chance — I mean you're not a professional photographer — so that you can evaluate what's going to look good 20 or 50 years from now. What is in your mind about that...photography company is what counts because they are promising you that the picture you take today is going to be terrific to look at 20 or 30 or 50 years from now about something that's very important to you. Maybe your young child or whatever it may be. Well, Kodak had that in spades, 30 years ago, they owned that. They had what I call share of mind. Forget about share of market – share of mind. They had something in everybody's mind around the country, around the world – the little yellow box and everything – that said, "Kodak is the best." That's priceless.

Buffett: They've [Kodak] lost some of that. They haven't lost it all...but they let that moat narrow. They let Fuji come and start narrowing the moat in various ways. They let them get into the Olympics and take away that special aspect that only Kodak was fit to photograph the Olympics. So Fuji gets there and immediately in people's minds Fuji becomes more on a parity with Kodak. You haven't seen that with Coke. Coke's moat is wider now than it was 30 years ago. You can't see the moat day by day, but every time...the infrastructure gets built in some country that isn't yet profitable for Coke but will be 20 years from now, the moat is widening a little bit. Things are all the time changing that moat in one direction or another. Ten years from now you can see the difference. Our managers of the businesses we run, I've got one message to them, which is to widen the moat. And we want to throw crocodiles and sharks and everything else, gators, I guess, into the moat to keep away competitors. And that comes about through service, it comes about through quality of product, it comes about through cost, it comes about sometimes through patents, it comes about through real estate location.