All About Moats – Book Notes of Pat Dorsey’s Two Books

If you haven’t heard of Pat Dorsey, here is a quick intro for you: He started his career at Morningstar as a sell side analyst, moved up to the head of the reach team in a few year and stayed there for about a decade. After leaving Morningstar, he started his own firm Dorsey Asset Management in 2014. Although his track record as a fund manager is yet to be tested, I found his books very insightful, especially for firm’s economic moat/competitiveness study.

 

Dorsey is the author of below two books:

Image result for The Five Rules for Successful Stock InvestingImage result for The Little Book that Builds Wealth

[The Five Rules for Successful Stock Investing] is a thorough book talking about the whole investing process (from having a philosophy, analyzing company to valuation), and the gem is the by-industry moat analysis frameworks the second half of the book was attributed to. [The Little Book that Builds Wealth] is a “the little book” series piece and essentially is a shortened and perfected version of the first half of the 2004 book, with heavy emphasis and elaboration on the economic moat analysis.

Based on his thinking process and writings, I think Dorsey is one of the greatest simplifier who can dumb down very intricate concepts to simple ideas and then generalize them delicately to make the underlying knowledge easily transferable. These two books are among the most practical ones I have ever read, and I highly recommend them for anyone interested in learning more about economic moat study. An imprecise comparison is that investing is like shooting, you have to practice constantly to get better in long run. Most of the books talk about the shooting technique (philosophy & process), Dorsey’s books also gave you a load of ammunition in addition to the technique.

 

Below are important thoughts/notes while I read through these two books, I document them here so I can refer back if needed in future:

  • Stock return = 1) Earning Power Growth + 2)Multiple Expansion/Collapse + 3)Dilution/Repurchase/Dividend; The first component is where value investors see as the most predictable ones among these three. Companies with wide moats will be able to grow the profit at a higher rate for longer time period than ones without. Thus intelligent investors should primarily focus on this part of this equation. The second component is basically the psychological part of the stock price, where Mr. Market controls thus much less predictable. The 3rd one is the additional term caused by distribution of profit or change of shares count.
  • 4 Moat Sources:
    • Intangible Assets (including Brands, Patents, Approval & Licenses)
    • Cost Advantages
    • Customer Switching Cost
    • Network Effects (including Process, Location, Unique Assets & Scale, also the most powerful type of moat)
  • Moats also affect the time horizon of company’s ability to earn excess return on capital

Moat.jpg

* Source: Morningstar

  • Runway/addressable markets are also important, because company like McCormick (the spice company) had wide moat, however has no room to grow. The excess profit earned by this type of company cannot be re-invested to earn high return on compounding basis.
  • Finding good companies is just the first step, the price you pay will determine largely the return you can earn in future. Valuation is still very important, so don’t over-pay. For example, Cisco was a good company, but if you paid its price in the tech bubble of 2000, you are still under water now (17 years later!)

 

Last, some more resources about Dorsey.

– A great presentation of his key ideas @ Talks at Google

– Recent podcast with Patrick O’Shaughnessy on 8/22/2017 (which covers extensively about his firm’s investment process, as well as his new tenet about identifying good capital allocators) : http://investorfieldguide.com/dorsey/

– Commentary/Publication per his firm’s site: https://dorseyasset.com/publications-commentary/

– Dorsey AM’s early days pitch deck (AUM back then was still $78M, now north of $200M), which has detailed investment process of the firm:  DorseyAM_PitchDeck

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