Why You Should Look for Stocks with a Moat

When even Jamie Oliver can’t make an Italian restaurant work, it probably a sign you shouldn’t try either.

You might remember Jamie from his early days as the cheeky Naked Chef.

Since then he’s undertaken societal challenges, like battling teen unemployment and introducing healthy options to school canteens.

Along the way he’s opened his fair share of restaurants.

One in particular is Jamie’s Italian. You can find this chain of homey restaurants across Australia.

But this year, Oliver will have to close 13 Jamie’s Italians. 11 more had to renegotiate rental terms due to debt struggles.

Chalk it up to bad advice. Or an overextension of Jamie’s brand name, some say.

But the failure of 13 Jamie’s Italian had nothing to do with that.

Rather it was kryptonite that befalls thousands of restaurants and businesses globally every year.

Jamie simply didn’t spend enough time thinking about his moat.

What do you feel like eating, honey?

My fiancé and I don’t always have dinner out. Maybe once a week. And we usually go to different places each time.

Where we go might depend on what we feel like that night. Or we might want to try a new place to have a new experience.

I’m sure your dinner decisions are very similar.

So why is it that you don’t go back to the same place every time?

You might have a different answer, but for me, there isn’t anything compelling enough to bring me back to the same restaurant each and every time.

For example, there are a dozen Italian places to eat in Melbourne. All of them generally serve the same foods. If you think about it, there’s really no specific difference between them (other than price).

Giving people something no one else is offering is incredibly hard.

That’s not to say you can’t create a super successful restaurant. But being different from the crowd of other restaurants is maybe one of the hardest things to do.

And it’s why very few restaurants are extremely successful over time.

Even Jamie Oliver’s brand isn’t compelling enough to make customers come back time after time.

And it’s this problem many other businesses struggle with long-term. Their products or services aren’t all that different from the competition, so a price war ensues.

On a journey to the bottom price, hundreds of businesses end up going bust.

This is incredibly important to know as an investor. If you plan on holding investments for the long term, you want to be sure earnings will grow rather than erode over time.

So how can you find a business with loyal customers that keep coming back year after year? 

Every castle needs a moat

In yesterday’s Money Morning, I wrote about the greatest investment run of Warren Buffett’s career.

During that time, Buffett wasn’t investing in quality Blue Chips. He was buying heavily discounted companies worth maybe a few million.

Nobody wanted to touch these stocks, hence why they were so cheap. But Buffett happily bought them, knowing he would be rewarded in the long run.

It wasn’t until Charlie Munger convinced Warren to prize high returning businesses that Warren started buying companies like Apple Inc. [NASDAQ:AAPL] and The Coca Cola Company [NYSE:KO].

And it’s these companies that can flourish, even in the presence of competition.

Buffett often describes the situation with a medieval analogy.

When you have a wonderful business, it’s like having an economic castle. The nature of capitalism is that people want to come in and take your castle, which is perfectly understandable.

‘…If I have a restaurant here in Omaha, people are going to try and copy my menu and get more parking and take my chef and so on. Capitalism is all about somebody coming and trying to take the castle.

So what you need is a castle that has some durable competitive advantage, some castle that has a moat around it.

If we use the example of Apple, their castle is smartphones. It’s an incredibly lucrative business.

But what makes customers continue to buy Apple products is their brand power. Consumers like the aesthetics and simplicity that is Apple.

So every time they pump out a new iPhone model, hundreds of millions of loyal customers line up to buy one.

Brand power is just one kind of moat. There are, of course, dozens of others.

Being a low-cost producer is another type of moat. The company that immediately comes to mind is Amazon.com, Inc. [NASDAQ:AMZN].

Each time Amazon acquires a new business, the first thing they do is cut costs. Many online shoppers don’t even bother to check other sites. They just assume Amazon has the lowest price.

As you can imagine, it’s incredibly hard to exist next to Amazon, let alone compete with them.

A strong network is another type of moat. Think of Facebook Inc. [NASDAQ:FB]. Why do you have a Facebook account and not a Myspace account?

Because all your friends and family are on Facebook.

They’ve built an amazingly strong network that is now self-sufficient. You’d be hard pressed to find anyone leaving Facebook to join another, competing social network.

And because their platform draws so many eyes daily, digital advertisers pay through the nose to feature on Facebook newsfeeds.

These are the kinds of companies (businesses with moats) that you should be looking to buy if our market drops lower this year.

The chance that hardly comes along

The falls earlier this month definitely caught investors by surprise.

The All Ordinaries dropped almost 5% in a little over a week. Investors were shaken at first. But we’ve quickly climbed back above 6,000 points.

It’s as if nothing happened.

I don’t believe this will be the last scare we see on the Aussie share market in 2018.

You can read more about why in my recent Money Morning article here.

If the market does scream lower, there’s a chance for you to pick up multiple ‘castle’ stocks protected by deep wide moats at bargain prices.

When this will happen is anyone’s guess.

But now might be a good time to shore up some cash, ready to pump it back into beaten down stocks.

Just make sure you don’t make Jamie Oliver’s mistake. Look for moats, and stay out of trouble.

Kind regards,

Härje Ronngard,
Editor, Money Morning

Money Morning is Australia’s most outspoken financial news service. Your Money Morning editorial team are not afraid to tell it like it is. From calling out politicians to taking on the housing industry, our aim is to cut through the hype and BS to help you make sense of the stories that make a difference to your wealth. Whether you agree with us or not, you’ll find our common-sense, thought provoking arguments well worth a read.

Money Morning Australia is published by Fat Tail Investment Research, an independent financial publisher based in Melbourne, Australia. As an Australian financial services license holder we are subject to the regulations and laws of Corporations Act and Financial Services Act.

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