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Collection: Mohnish Pabrai - #85 'How To Evaluate Economic Moats?'



You know, what are sort of the attribute of economic moats that you could value?

And there was a second part to that which is, do you think about those moats differently in a growing business versus a declining business? And a business that is sort of [Inaudible].


Okay, yeah that's a good question.

You know, the – I think the evaluation of moats is probably one of the most difficult things. You know, when I talked to Guy (Spier) and I remember recently we were talking about some companies, and you know, looked very compelling to me.

You know, I told him you know, how would you compare this to Nestlé for example. And his perspective was there's no comparison because Nestlé – Guy thinks Nestlé is bulletproof, you know, it's going to be there forever. And they gonna keep taking more and more shares in emerging markets and so on.

And then I ask him, you know, how is this compared to Weetabix which is a small UK company made cereal and such. And of course, he is very high on Weetabix.

And so moats are extremely important, I think the evaluation of moats is not the easiest thing. It takes time. And some you know, I would say latticework type thinking, thinking in many different ways to try to get to sense of – kind of what those moats are and how enduring they are and so on.

You know, so it's – I mean I think that the – you know, the expanding businesses or the shrinking businesses or the flat businesses. Well, you know, you have to look at it in the context of the actual business.

I would say this that other things being equal, you're better off investing in businesses with huge runways ahead of them. I think you're better off investing where you got – so again, this is a shift I'm going through and I've been going through for many year between buying assets cheap versus buying assets that are going to appreciate a lot in the future.

You're always better off buying assets that are gonna appreciate a lot in the future. And in Munger's words, paying up for that you'll end up better.

And you know to give you one example, and I think Tom Gayner use this example recently, he's from Markel. And you know, we talked about the Nifty Fifty in 1972 and we talked about how it got decimated.

So if you bought the Nifty Fifty – No, I'm sorry if you invested $50 in the S&P 500 on the day that Nifty Fifty peak in 1972. That $50 today is worth $2,800. Okay, it's gone up a lot. it's gone up – how much is it? It's almost like what 5,000-6,000 percent, a huge amount of gain in that period of time doing nothing just sitting on the S&P right?

Now, Tom Gaynor says that if you invested $3 in three of the Nifty Fifty, you know a dollar – He said let's say you put a dollar in each of the Nifty Fifty, and now you took just 3 out of those dollar which mean 3 of the companies out of the 50.

The 3 companies – the 3 dollar you invested – assume 47 went to zero. The 3 companies that were part of the Nifty Fifty today are worth more than $2,800. Okay, and this is worth more than $2,800 by buying it at the peak.

So you went through all the valleys, you went through the 90% decline, you went through all of that. And because you had a stomach of steel like Arvind, who eats his oats daily. You just with strong fortitude, you held on to those stocks through 1987, through 1973, through 1974, through all the crashes, through that dot com, through the 2008. You held it all with your steel stomach, you will have like $3,000, from the $3 became $3,000.

Now, I take a little – You know, I like Tom Gayner, but I take a little question with his analysis. And the little question I have is that there's a controversy whether Walmart was part of the Nifty Fifty or not? And one of the three that he included is Walmart, right?

And according to me, Walmart should not be in the Nifty Fifty because in 1972, it was not a Blue-Chip, it was a very small company. But Tom Gayner's point was that if one of those 50 companies was Walmart and you put a dollar into Walmart, you could had a 96% or 94% error rate means 94% of portfolio going to zero and still beat the S&P, okay?

And he makes another point, you know, we all know about the Salad Oil Crisis in the 1960s where Amex got hit a lot. And then Buffett bought Amex when it dropped a lot because of Salad Oil Crisis, and he puts 40% of his fund and he made a killing.

So Tom Gayner says, let's say you were the smug who bought Amex one day before the Salad Oil Crisis hit, okay? And you put money into Amex in 1962 or 1963 whenever that crisis hit or one day before, peak price. And next day it drops very heavily. And you held from that time in 1962 till today.

You did not touch Amex and of course, Amex you know now is at $70 a share. It went down to $10 a share in 2008. You know, it's – it loss lot of it's value in 2008 as well. But he says that if you held on and you compared it to Buffett buying it at 40% discount and assuming Buffett held till today.

And you compared the annualised return that you had versus the annualised return Buffett had, that two are going to look very similar. In fact, the more time that goes on, those returns are going to converge. Even though, there was a big difference in the buy price.

So the lesson in all of these is that if you bought great businesses and you know, this is why the Nifty Fifty and these bubbles get going because some pundit like me says you buy a great business and doesn't matter, right?

But that's not what I'm saying, so all I'm trying to say is that between buying a cheap business, you know, buying – between buying a fair business at a good price or a good business at a fair price.

You should always prefer the good business that are fair price. And so this is another lesson that I had been learning over the years where in 1999, Mohnish was a cheapskate investor and in 2015, I'm much more tuned to value management's can add, value that good moats can add, value that enduring moats can add.

And I think that the subject of figuring out moats, it's a really tough subject. I mean, we saw where the Nifty Fifty in 1972 that the Polaroid and Xerox and Kodak didn't make it. I mean Kodak was just – there was nothing visible at that time that would tell you that there was any chink in the armor, they had patent out the Ying-Yang, they controlled films, they're a monopoly in films, I mean pretty much they owned the whole market.

You know, so same with Xerox, you know literally they owned that market. And look where we are today.

So moats – the nature of capitalism is creative destruction. And that is the best part of our capitalism is creative destruction. So moats – it is very difficult to find moats that will not get destroyed over time.

It's an exception to find a moat that do not get destroyed. And so the quest is on for enduring moats at great prices where the rest of humanity doesn't understand that there's a moat.



[YAPSS Takeaway]

No businesses' moat can last forever due to creative destruction of capitalism.

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