Chit Chat Stocks - PAT DORSEY: Buy Wide Moat Stocks (Investing in Competitive Advantages)

Episode Date: September 25, 2024

On this episode of Chit Chat Stocks, we go through the work of Pat Dorsey, who focuses on analyzing moats and competitive advantages. We discuss: (11:02) Exploring Intangible Assets (24:32) The Importance of Switching Costs (33:53) Unpacking Network Effects (46:58) Economies of Scale and Cost Advantages (54:05) Analyzing Pat Dorsey's Portfolio (01:05:12) Key Takeaways from Pat Dorsey ***************************************************** Subscribe to our YouTube channel: https://www.youtube.com/@ChitChatStocks  Follow us on Twitter/X: ⁠https://twitter.com/chitchatstocks  Follow us on Substack: ⁠https://chitchatstocks.substack.com/  ********************************************************************* Sign-up for a bond account at Public.com/chitchatstocks  A Bond Account is a self-directed brokerage account with Public Investing, member FINRA/SIPC. Deposits into this account are used to purchase 10 investment-grade and high-yield bonds. The 6.9% yield is the average annualized yield to maturity (YTM) across all ten bonds in the Bond Account, before fees, as of 8/28/2024. A bond’s yield is a function of its market price, which can fluctuate; therefore a bond’s YTM is “locked in” when the bond is purchased. Your yield at time of purchase may be different from the yield shown here. The “locked in” YTM is not guaranteed; you may receive less than the YTM of the bonds in the Bond Account if you sell any of the bonds before maturity, or if the issuer calls or defaults on the bond. Public Investing charges a markup on each bond trade. See our Fee Schedule.  Bond Accounts are not recommendations of individual bonds or default allocations. The bonds in the Bond Account have not been selected based on your needs or risk profile. You should evaluate each bond before investing in a Bond Account.  The bonds in your Bond Account will not be rebalanced and allocations will not be updated, except for Corporate Actions. Fractional Bonds also carry additional risks including that they are only available on Public and cannot be transferred to other brokerages. Read more about the risks associated with fixed income and fractional bonds. See Bond Account Disclosures to learn more. ********************************************************************* FinChat.io is The Complete Stock Research Platform for fundamental investors. With its beautiful design and institutional-quality data, FinChat is incredibly powerful and easy to use. Use our LINK and get 15% off any premium plan: ⁠finchat.io/chitchat  ********************************************************************* Sign up for YellowBrick Investing to track the best investing pitches across the internet: joinyellowbrick.com/chitchat ********************************************************************* Disclosure: Chit Chat Stocks hosts and guests are not financial advisors, and nothing they say on this show is formal advice or a recommendation. Learn more about your ad choices. Visit megaphone.fm/adchoices

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The new bond account only at public.com forward slash chitchat stocks. Welcome to Chit Chat Stocks. On this show, hosts Ryan Henderson and Brett Schaefer analyze businesses and riff on the world of investing. As a quick reminder, Chit Chat Stocks is a CCM Media Group podcast. Anything discussed on Chit Chat Stocks by Ryan, Brett, or any other podcast guest is not formal advice or recommendation. Now, please enjoy this episode. the key to identifying wide economic moats can be found in the answer to a deceptively simple question how does a company manage to keep competitors at bay and earn consistently fat profits if you can answer this you found the source of the firm's economic moat welcome in

everyone. This is the Chit Chat Stocks Podcast. My name is Brett Schaefer and joined as always by Ryan Henderson. We hopefully have a fun episode for everyone this week, studying another investor, doing another investor profile on Pat Dorsey. We're going to go through his investment firm. We're going to go through his four moat categories in depth, which is the key to his investing style. We're going to go through his portfolio and what we learned from studying his book and his lectures that are posted online. In the past, we've studied investors such as Norbert Liu, who are undiscovered, to super famous ones such as Ray Dalio. And we got another one this month and we kind of do one perhaps every four weeks, perhaps every six weeks, but we try to

cover someone on a regular basis. Upcoming ones are going to be on David Gardner, perhaps Bill Ackman, although he, as we've been joking internally, he might not even be an investor anymore. But let's get back to this episode. We're starting with Pat Dorsey. Ryan, what have you learned from him and what's any tease you have as we are going into this episode? He reminds me a lot of Nick's sleep, actually. Just the focus on moats, the focus on getting to the source of competitive advantages. And he's given a lot of talks. He's given one of those famous google investor talks he's given um lots of keynote speeches and it's he's a very good communicator and he's very good at explaining what defines him like what really really drives it and

so it's fun to get into that um he's had the other part that's nice is he his record not his exact numbers but his investments are public so you know you can go through and you can find out uh companies that he's invested in in the past and see where he did really well and where he made mistakes. And we'll be going through both his old portfolio and his current portfolio. And Brett, you have undertaken the task of trying to calculate his returns a little bit. So we'll get to that as well. But do you want to talk about just who is Pat Dorsey for anyone that's never heard the name before? What's sort of his philosophy and why are we studying him today? Yeah, as a tease, I did a fun task of taking one of his old portfolios and trying to figure out what his returns would have been if he never sold. And his portfolio turnover is low. So he's actually valuable when looking at the 13F. But yeah, who is Pat Dorsey? He used to work at Morningstar, now runs Dorsey Asset Management. Looks like Dorsey Asset Management began in 2013. Although the information, since he's not a famous investor, I wouldn't say super famous, at least it's not exactly.

clear and they're not very public with their returns and any of their investor letters or stuff like that. So they don't give out performance or what their returns have been in the past. I think that's a sign that things maybe, well, it either means two things. One, you don't care about raising money or two, things aren't going extremely well because if returns are great and you want to raise money, well, you're going to put that out there. But estimates have been from third parties. And again, these are estimates, so they're not confirmed. The fund did well at the start with about 20% annual returns. But starting in 2018, they made some misguided picks that have led to some bad performance. We're going to get into that. And again, I should say these are not

confirmed returns. They're estimates from 13F filings, and sometimes those are flimsy. But he is a big buy and hold investor with less than 10% portfolio turnover. Luckily, from our friends at FinChat. They calculate that for us and have all the historical 13Fs for you, another bonus for that platform. So it's much more valuable than someone like Stan Druckenmiller, who might be buying in or out of positions, or someone like Michael Burry. Now, Dorsey has made a name for himself by focusing on competitive advantages. His talks, letters, books are all about competitive advantages and what allows a company to generate outsized cash flow, profit margins, and or ROIC, return on invested capital for an extended period of time. And the question is, and maybe after I

go through this part, I'll toss it over to Ryan for why we care about it as well. Why do we care about competitive advantages? Because they allow a company to raise prices. And raised prices mean the cash flow is higher. Higher cash flow means the stock is worth more. That's a very Neanderthal way to put it. But it's true. And what we're trying to focus on the outcome is raised prices or the ability to raise prices higher than your competitors. But the inputs are the competitive advantages and dynamics versus all your competitors that allow you to do that. Ryan, any thoughts and why this is important for investors? I know we talked, I guess one more thing. I know we talk about this ad nauseum. And some investors understand this, but there is still so much,

I think, misguided notions out there about how people should invest. I'm not sure if it was a bot, but there was a lot of comments on Dorsey's talk at Google where he goes an hour through some of the best businesses in the world. And one of the top comments says, hey, you know, during this economic crisis, we need to be prepping and buying gold, silver and crypto. So even like not even the people that are watching those videos are, I think, focused on the right thing. So talking about moats, I think we can't talk about them enough. Yeah, that might have been a bot. But the other thing about why I guess you and I, and I think why investors in general should care about competitive advantages is because the way I think about it is competitive advantages provide some

margin of safety. So I kind of think there's two margin of safeties. There's margin of safety in the stock price and the valuation, and there's margin of safety in the business model. Competitive advantages give you margin of safety in the business model, and it gives you a better chance of your investment having a good return because it's harder to compete against. So we're going to go through how companies develop competitive advantages. Dorsey does an awesome job of that i guess before we get to each segment what are your overall thoughts on we now having studied dorsey what did you like about him did anything surprise you in the research i don't think anything surprised me but i had watched that google talk before so i was aware

of his four moat categories i do like the categorization into moats and talking about how there are... It's not enough that you have, say, a moat, and then every company's tossed in this basket, and they all have competitive advantages. There's rankings, and some are much stronger than others. And I also like the fact that he talks about... And we'll get to this later. I kind of think he underplays the role of management, because that's where some of his losing bets may have occurred. But management is important, but the quality of the business... and he used Steve Ballmer as an example at his talk because that was right after his reign had ended

and the stock hadn't done very well. I will say there's a lot of multiple compression there, but there's also probably some mistakes. Management, if they're bad and the moat is extremely wide, it takes a long, long time to destroy the business quality. While if you have a, say, average business and then a bad manager comes in

after a really good manager, it might take three, four, five years for that business to deteriorate. For example, the classic industry that people talk about is an airline. I think if Ryan O'Leary at Ryanair leaves, and then you get a bad manager that comes in, they could destroy that business model within a couple of years. Yeah, 100% management. It's discussed a little bit in his book as well. And we should mention a couple of great resources if you want to get up to speed on Pat Dorsey. Dorsey Asset Management, And their website has some good presentation material, conferences that he's given, Google, that conversation is on YouTube.

And then his book, I believe the title is The Five Rules for Successful Stock Investing, goes into a lot of what you should look for. And I would even say, if you were recommending a book for a beginner, that might be the kind of book I'd recommend. I thought it does a really good job laying out a great way to invest for individuals. Yeah, probably not worth it if you know the terms, you know what a basic competitive advantage is, you know what income statements are and how all that stuff connects together. But for a beginner, I think it's a great book. We're going to get into all the separate categories here. First, let's just say a note. So when watching or re-watching Dorsey's video at Google from nine years ago, it is clear that some of the moats do deteriorate, even if the consensus is

that they have a wide moat at the time. So some of our takes today will age poorly. uh don't think we're idiots because of that i hope some of them age well but we give that examples clearly some of them are going to be wrong that just happens yeah it is funny it makes me realize if i ever write a book don't put any don't put any forward-looking takes out there because they might not age so well the companies that get bought out yeah where the story's over let's go through the first uh moat category which is intangible assets you want to take us through this one? Yeah. So an intangible asset is a broader category for the most, one of the foremost categories that he lays out. And it is one that is generally created in

people's minds. So this can be brand value. It can be regulatory licensing where, you know, group of people, government, or someone else gives some sort of license to a company or patents and patents. Again, it's just when people grant, you know, a monopoly to someone for a short time period. Patents, you know, they're straightforward, boring. I don't really want to talk about them, But I want to talk about brands. Brand value is the most exciting. And I think can, well, not think, they can drive tremendous value over the long haul for stockholders. You have Apple, Nike, Coca-Cola, PepsiCo, et cetera. A brand is a promise to a customer that is delivered repeatedly and to satisfaction. So Coca-Cola has the same recipe. They have the same type

of products. And you go to the store, you might see it's 20, 30% more expensive than the store Coca-Cola brand you've never heard of, but, or excuse me, the store soda brand you've never heard of, but you're going to go to Coca-Cola because you trust them. They've delivered what they say they're going to do time and time again, and you're not going to haggle and take a risk to go to another product that you might not like. Now, the brand promise builds trust, which then allows the company to deliver price increases without losing customers. I'd say one of our favorite examples is Hermes. Hermes is perhaps the best luxury company in the world. Who knows, that might age poorly over the next five to 10 years. I don't know. They have close to two

centuries of a brand promise to customers that has been repeatedly delivered. And on top of this, they have built over two centuries an aura of exclusivity due to, well, the fact that the stuff is exclusive and it's very hard to get. The high price of an Hermes bag does not make it a luxury product, the luxury stuff and the brand inputs that have been the heritage over the last two centuries allows it to raise prices. And that's why customers come back time and time again, and we'll buy a $20,000 bag from them versus $1,000 or even $100 at a target. Brands are important. And I'll let Ryan butt in here right after this. But I think perhaps more money has been lost in them than made betting on stocks because of brand value. Because most

Brands, I think, and Dorsey talks about this, are weak due to the ability of management to screw things up so easily. They also trade at high valuations often because people know about them. Ryan, do you agree or disagree that brands are dangerous as a moat? Investing because of a brand's moat is dangerous. Yeah, I would say this is probably one of the weakest forms of a moat, which is there's kind of two groups here in terms of brand. There's truly superior products and there's perceived superior products due to the brand. So one of the ones that comes to mind for me, I'd say Lululemon.

I don't think – maybe the products are that much better. Maybe the shirts, the pants, whatever, they are superior products. But it's more so the perception of it. It's very easy, I think, from a competitive standpoint to attack that than it is to attack someone with significant scale or a huge network effect or anything of that sort. So yes, it feels like in terms of the moat categories that are most susceptible to deterioration, I would say brand driven is probably number one. yeah i think dorsey discusses a lot that brand durability matters like prior durability where it's been around for 40 50 60 years and has built that trust like a coca-cola an american express a nike an apple it has built that trust and delivered that promise to consumers over and over and over again while someone like lululemon yeah they've been you know they're getting up there. And they've been around for maybe 15, 20 years, at least as a major player. But he talks

about in his book, I think the example is Abercrombie & Fitch. He goes, well, they're doing well right now. We'll see what happens. And what's funny is that they actually did extremely poorly for about 15 years. But the last couple of years, they've actually returned to greatness. And I don't think anyone could have predicted that. Yeah, I think the brands that end up doing really well are the ones that pair the perceived product superiority with true product superiority so like ferrari for example those cars are probably superior to your maybe typical luxury vehicle or even your typical you know vehicle that you drive on a daily basis that's not just perceived brand value that is people feel the product superiority you could probably make the same case for apple

um people feel like that product is superior uh maybe they haven't tried an android out in a while or something like that but there's some elements of the business some elements of that product that make it feel better it's not just this blatant perception now here's a quote from his book and i think it highlights how dangerous it is to invest in brands especially when you know hey they mean they've been on fire you know who cares if they're 30 40 times earnings they've been doing so well. I mean, how many people would have piled into Coca-Cola in 1998 after Buffett made a fortune in the stock 10x? Here's an example from the book. Quote, take Coke, for example. There's no question that Coke has a solid competitive position in the late

90s, and you can make a strong argument that it still does. As a note, this was written in 2004. But folks who paid 50 times earnings for Coke shares have had a tough time seeing a decent return on their investment because they ignored a critical part of the stock picking process, having a margin of safety i think the struggle with the brands is that when they're doing so well everyone knows about it and then the stocks trade at 50 times earnings well that's tough yeah once the cat's out of the bag on you know what this kind of applies to a lot of the other other categories as well when it feels like the moat is so clear i think it gets priced in a lot faster. Oh, yeah. Sherwin-Williams, Costco, Chipotle. Although I don't know if that's

wide mode. It's more of a reinvestment runway. But yeah, we're not going to dive too much into valuation today. But just again, we can't talk enough. As a reminder, as stocks are hitting all-time highs, as the S&P 500 keeps marching higher and stocks like NVIDIA can't lose, valuation matters, price matters, it always will. Now, more importantly, I think this is much more fascinating. Less sexy than brands, but perhaps I think more value are regulatory modes. These are licensing agreements that need to be obtained, usually from various levels of the government in order to operate your business. Landfills and garbage companies fit this bill. You can't have 100 waste companies competing in a neighborhood. It's not going to work. Landfills need regulations

in order to operate because you can't have that in the middle of a neighborhood. And unless it's going to get put in some part of the town, but getting it voted to put there is tough. There's just kind of the, you know, no one wants a landfill in their backyard. Regulatory advantages, and sometimes known as the regulatory capture, which I'll say, thank you, the lobbyists for your hard work to capture that. They can drive outside profits and squeeze out any competition. For example, when the tobacco companies went through their master settlement agreement in the 1990s, it was agreed that there would be no more marketing for cigarettes. Well, that made it impossible for new brands to pop up. So the existing brands

maintain market share and raise prices above the inflation rate every year. Beautiful. And why Philip Morris is, I would say, undisputably the greatest driver of value creation in the history of capitalism, probably over the last 125 years. I think if you bought one share and reinvested the dividends, which is not realistic, you would own the entire company today. So that's obviously not realistic but like if you did the theoretical exercise like that's how much profits they've generated for shareholders and most of it's been distributed out through dividends which is why the market cap is not that high so yes regulatory capture can work we bring back to uh bring it back to kind of the broader intangible asset stuff they're not allowed to advertise and you also

need fda approval for cigarette brands so no one competes and they also have that brand value too when you look at a store, you're at a gas station, there's 50 different things up there. You go with what you know. You're going to pay for something that's slightly higher than the other one? Eh, I don't know. It's six bucks versus seven. Who cares? Any thoughts on that, Ryan? Any

companies come to mind before I give maybe the most fun example? The National Football League. Yeah, I'd say weapons manufacturers, anyone that has contracts with the government, that kind of stuff where it requires that prior clearance. Being a

long-term partner of the government, assuming that it's a government that's going to last, is a great intangible asset. That's like one of the most clear ones you could think of. You know, that relationship is super valuable. It might not be a tangible asset that you can mark on the balance sheet, but it's obviously valuable. Yeah, I agree. Let's go through another example, the National Football League. And this is a great example of licensing, creating a monopoly, and therefore pricing power. So here's a quote. In 1961, Congress approved legislation that allowed professional football teams to pool together when negotiating radio and television broadcast rights.

The law was the first action for the federal government that would spur the growth of a multibillion-dollar enterprise. CBS paid $2 million for the rights to broadcast the NFL's championship game in 1966, the year Congress approved the NFL merger with the AFL and expanded the combined league's antitrust exemption. The idea was to distort the fledgling sports league. Today, however, the NFL makes an estimated $7 billion in revenues just from the television deals. Hands down, NFL games are the most popular television programming, and last fall, 34 of the 35 most watched TV shows were NFL games. I think this was written back in 2014 or 2016, but But, you know, the numbers might be a little higher today, but either way, it's similar.

You have that monopoly in, you know, there's only one league. No one's negotiating separately. Everyone's together, as opposed to, say, professional baseball, where there's a lot of local stuff. And I think the pricing power probably isn't there as much. Yeah, wow. And no one can compete. I don't think anyone, like, I don't think any leagues or other leagues are allowed to exist. So, you know, you got a pricing power there.

New leagues have tried XFL and they just, it doesn't really seem to, it seems very, very difficult to compete with. What about this discussion question? What companies for you come to mind with the most durable intangible assets in the world? So we've talked luxury already and say that's definitely a category. We studied them a lot last year and go back and listen to those if you want. I think, and they're declining in usage, but the cigarette companies, again, make a lot of sense because you have the combination of brand value and regulatory capture that I don't think is going away.

Another one that comes to mind would be Copart, which I believe, I'm not an expert on the company, but I believe they are not landfills, but maybe it's landfills, but I think it's car like land what is that called car car lots where people take you know a junkyard a junkyard car junkyard right yeah that's one that's not going to get replicated you can't just start one of those up randomly in your neighborhood there's a lot of regulatory stuff there and i think that's quite durable yeah i think there's a more friendly term for it than junkyard but i'm blanking on it something like i'm looking up copart online car auctions from salvage yards is salvage yards salvage yards something like that yeah anyways yeah the only other ones that come

to mind for me luxury brands for sure because it's one of those that they can always do things to make themselves feel more exclusive they can always limit more supply release a certain bag that's even a higher price ferrari seems like a very very durable brand even in a world where they switched to EVs. I think that brand translates. I'm trying to think of some others here. Cigarettes make a lot of sense, not necessarily in terms of the brand value, but I think that regulatory capture, I don't know. I'm sure there's some software businesses that have the regulatory relationships or the government relationships that are pretty insulated at this point, but I don't have any that come to mind.

all right let's move on to the next topic the second note category switching costs ryan let's kick things off yeah i think switching costs are maybe one of the more intuitive categories uh people probably understand it as soon as they hear it but i do like how pat dorsey explains him so he says switching costs are when it costs more for users to switch to a competitor than it does to remain with the incumbent. He also mentions that cost, in this case, can come in many forms, money, time, or risk. There are some obvious examples that come to mind here. Microsoft would be one where so many businesses are built on top of Microsoft applications like Excel that it would just be an awful time switching. Adobe, Autodesk are other ones that come to mind for me

where creative roles have spent years and years training on a certain software and it would simply take too long to retrain on something else and it's time wasted for most people and it's just when you're working a job you it's not if you run a business that's like a creative agency first or something like that podcast agency and you had to retrain everyone to use a different editing software for two months that is time you could be spending generating revenue elsewhere so which is really oftentimes not worth the time commitment. And he actually says this in his book. He says, remember, a switching cost does not have to be monetary.

In fact, it rarely is. Much more frequently, what deters customers from dropping a product or service in favor of a competing product or service is time. Often learning how to use a product or service can require significant investment of time, which means the benefits of a competing product have to be very large to induce a switch. I actually experienced this recently. And this was the software provider. I work at FinChat for anyone who doesn't know. They're one of our sponsors. Go ahead, check them out. It's our research terminal here. I was working with a software provider, I won't name them, who they were helping us manage affiliates. And for one reason or another, the software stopped working. We were forced to switch. And honestly, it was an awful process. It consumed a ton of my time. And all I could think was I do not want to go through this again. So you spend, I spent a ton of time looking for a reputable service because I don't want to end up switching providers again. And especially when it's something that's not – how should I say this?

It's a business process. It's something that is internal and it's not – maybe the revenue – it doesn't have a direct revenue correlation or something like that. You don't want to deal with it all the time. You don't want to spend a month or two switching when it just meets the needs, especially if they're keeping prices relatively consistent. there's just, it's really frustrating to have to switch. And I think that's kind of one of those examples. Dorsey offers another great example in his book, and this is probably one of the most powerful examples I can think of. He says, medical device firms such as Stryker or Zimmer are perfect examples of how firms can create high switching costs that help ensure customer

attention. Both of these firms manufacture artificial joints such as hips and knees, and surgeons have to be trained on how to implant their products. The training process is time consuming for surgeons, which means surgeons tend to develop preferences for a particular company's products and stick with them. Yeah. If you know how to implant a striker replacement hip, you're probably just going to stick with it as long as you're a surgeon. That's the kind of thing you don't want to mess with. Yeah, I agree. I'd say probably intuitive surgical goes into that as well. It's become the industry standard everyone's trained on and i'm sure that these type of products are used in

medical schools and it's probably similar to the adobe autodesk excel uh all the engineering software that gets taught at schools when you have a whole class dedicated to a software program that might be a switching cost when you move on to your job bloomberg bloomberg terminals as well although we will say FinChat makes it quite easy to switch. Yeah, this is a good, the resume moat is like, if people are putting it on their resume, it probably has high switching costs. Yeah, I agree.

I'm going to skip to your discussion and question what comes to mind for me. I'm going to give three different examples and maybe some of them may like indicate it. Yeah, there can be switching costs, but it doesn't necessarily mean that it's a great industry to invest in. First one would actually, and this might surprise people, I would say someone's grocery store.

You go there, you know where everything is, you're going to go to the one you go to, switching costs from a time, effort, and risks. Now, the money is not going to be that different because you know grocery stores are relatively the same cost, but you're taking a big risk switching from your, I won't call provider, but the one you go to. And why do you think people go to the same grocery store all the time from where they live in. It makes sense. Now, these aren't the best businesses because their input costs are hit so much by food and energy and commodity prices. But I still think that that's what makes these brands durable and grocery store brands have been quite durable for the last 50, 60 years. This episode is brought to you by our

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If you want to earn a 6.9% yield for the next four years or more, you need to check out the bond account at public.com. It's a new way to invest in a diversified portfolio of bonds and receive monthly interest payments. The best part, if you act now, you can potentially lock in a 6.9% yield until 2028. That's the new bond account at public.com forward slash chitchat stocks. Yeah, it's definitely not one that came to mind for me, but I could see how it makes sense. I was trying to give a fun example. It can pop up everywhere. I would say another one is Boeing and Airbus, where there's all these parts associated with them within their ecosystem of supply chain there's also the airports trained on them you literally have gates made for planes of

this size there's a reason that the size and kind of the general shape of a plane hasn't changed much because switching that for airports the airlines the maintenance people it'd be tough and it would take a lot of training to switch now again management comes to you know we're going to talk management how that matters uh for people that you know everyone knows the boring story now but that's a clear one and why those two companies have been so durable um from market share perspectives of the last 40, 50 years. Yeah. Here's another element of switching costs is the reputational risk involved in switching. Bloomberg's a great example. If you're a big investment bank or a big asset manager, switching to a lower cost provider might be the right

solution. There might be data providers that offer data parity and you're getting a lot of the same stuff or much cheaper. But when all of your largest competitors, especially investment banks in New York, which seem to all comp against each other, are all choosing Bloomberg, it's a big reputational risk if you're the software buyer to say, you know what? No, we're going to get the whole team to switch off of this and start using something else. There's some huge reputational risk. You go with the company, oftentimes the provider that's the safe pick. yep yep and that's why bloomberg has implemented absurd levels of pricing power and why the founder is one of the richest people in the world last one i'll give are payment processors for

merchants you have one that exists it works fine if you go to a new one you have to rip it out put a new one in and there's a risk that if it doesn't work like even 30 minutes of downtime for a large organization can screw a whole quarter. And it can ruin some reputation among the customers because if a customer is trying to check out at a store online and it can't happen, then they lose trust in that brand. So I think payment processors, point-of-sale terminals, those ones have switching costs.

Although I think there's some nuances to that industry that have been covered ad nauseum in the fintech world. And we've covered it a bit on this show that the terminals have turned into a bit of a commodity. and they're a little bit of a competitive industry just because it's so easy to make one, but it's everything that connects to it. Yeah, I agree.

All right, let's talk about this third moat category, which is maybe the most exciting here, network effects. Yeah, speaking of payments, Visa and MasterCard, best example. They're in vogue today, network effects are. I think they're being maybe a bit overused as a competitive term. I don't think if your product is going viral, that means you have a network effect, But it has become famous because of the likes of Facebook, Instagram, TikTok, YouTube, stuff like that.

But they can be incredibly powerful in driving profit durability because if they run correctly, they can make it virtually impossible for competitors to step in with the exact same product. 10 you know the social network stuff is a classic example where tiktok uh run an extremely unprofitable hit the start financed by the chinese government uh or back not finance excuse me backed by the chinese government um basically they were forcing it to win by spending an absurd amount of ads on facebook and they came up with not the exact same business model they had to disrupt it with that short form video stuff that's the only way to try to kickstart it and it takes again a lot of work to make that happen and if you look at meta stock chart well they were able to you know they're at all-time highs right now so they're able to um which is the dorsey holding yeah it

is we'll get into it this is probably his biggest winner and generate the most returns for him so as a side note every time i cover network effects i feel like i should just own visa mastercard american express to go to the beach that probably will work out well uh especially with these in mastercard well i think they're kind of back up now but they haven't done too well over the last five years, but let's get into it. A network effect is when every successive customer or user for a company makes it that much more valuable for every other existing customer in the ecosystem. I know at first these are kind of tongue twisters and you go, wait, what is this? But just use the social network example. When you have Facebook with

one user doesn't doesn't have any value you're posting to yourself it's called all your friends what i said that's called the blog yeah yeah exactly but if you have every single one of your family and friends on there like they were back in the day it's very hard for someone to compete and you have to come at them through a different angle however not all network effects are equal and dorsey classifies two main categories within network effects first is a radial network effect, a network effect where one node is interacting with other nodes, but those other nodes are not interactive with each other. So think of it as a hub and spoke model where the more spokes you add to it, the more value is provided to everyone else, but it doesn't

necessarily have interactivity like the next one here. His example is Western Union. Western Union allows virtually anyone in the world to send money to any country, but most customers are sending money to a few spots such as the United States and really from a few countries such as Mexico and India. There was reasons that they got disrupted, which was basically mobile phones and the fact that you didn't need all these locations because everyone already had a location in their pocket. But I think that makes a lot of sense there. Any other radial network effects that come to mind? I'm going to talk about U-Haul here later. People talked about Carvana having one. I think that sort of makes sense although i don't know how profitable that business model is uh but

any any come to mind for you because it seems like it's kind of an under followed type of network effect i can't find one sorry i've got a uh oh you got a siren well maybe you want to meet yourself yeah good old seattle for the listeners there uh fast and all i think is used as an example where they have all these hubs and you need to get those parts to the manufacturing plants quickly I think I've heard that one before. Don't know. But the one that people know about is the interactive network effect. This is a network effect where every node is potentially interacting with every other node.

Therefore, the value is just that much more tightly wound. And I think you can think of a lot of network effects or interactive network effects as a marketplace with two distinct types of nodes. For Visa, MasterCard, American Express, there are cardholders who will pay for things at merchants that accept those brands, say Visa. Cardholders find value, the more merchants accept Visa and vice versa. The same can be said for the legacy Facebook, Twitter, and Instagram model. The more of my friends or people I care about that are on these places hosting things, the more potential value I have as a user.

I can keep up with everyone. These are two distinct types of nodes for these networks because even for social networking, you have. basically the people that are posting stuff and the people that are watching or the users. So that's two different types, but the value is still there where they can all like each type can connect with every other type. Like each user that isn't posting anything on Twitter is not finding value from someone else that doesn't post stuff. But the more people that are posting things within their stuff they follow or the niches they care about, the more value is

there. Now for a non-cliched example, because everyone's heard of Visa, Meta, Instagram, we can look at U-Haul. This is perhaps a cross between the radial and interactive models. There are a bunch of U-Haul stations or locations across the country. If you're going to move across the country from one city to another, say Los Angeles to Phoenix, you need to have a location in each city where you start and where you finish. And the denser the network of U-Haul stores, the more value it provides the customers and the more people who use U-Haul locations, the more value it provides to each of those locations. So I think that's one where the bigger it grows, the wider the moat can get.

I think that's a general example you can use when trying to identify whether the moat is an interactive network effect, where the bigger it gets is the moat getting wider. The more users, the more spend, the more people posting, does that make it more tightly wound or wider up from a competitive perspective? and I would also include the likes of Airbnb, Booking, Holdings, and Expedia as two other network effect businesses. You have the lodging people, then you have the people shopping for lodgings. The shoppers get more value, the more lodgings you have, simple, and then vice versa. Ryan, anything else here? Yeah, I think maybe one way to think about it is,

does there need to be a certain amount of supply for some of these marketplaces? If there needs to be a certain amount of supply i think it kind of fits into the more interactive network effect so for example uber you need a certain amount of like simultaneous supply on the platform in order to be able to get a ride at any certain point whereas if you're on maybe like a tutoring marketplace you can set a time you can find one tutor you know it doesn't need to be concurrent where some of these yeah yeah that i kind of think is more radial if i'm getting the definitions right yeah that would yeah i would say that's more radial because you have basically a aggregation of tutors and you just connect them to all the different

ones i think there is some cross-pollination between the two where i get confused myself well you know that's what i like to think like if each side of the marketplace gets bigger is there more value that's probably a network effect what are some examples of network effects gone wrong to who like society perspective or no no no network effects that lost their power lost their platform dominance you probably would have said american express 10 years ago but they've reinvigorated a bit ebay ebay i think he talks about that as an example in the book they i mean the fact that they're still around and that technology is so dated and people still use it is a testament to the moat but it's been

extremely maybe under invested because i i can literally not get the platform to work it's too frustrating yeah it has it's it's still around it's carved out a niche within certain markets like automotive parts and stuff like that so yeah it's still around the twitter maybe maybe we're on the way there twitter's holding up all right i think it's hard but i'm not sure about other stuff yeah i wonder if usage is still okay the um yeah it's it's hard to think of i mean myspace obviously remember the one that was like the flash in the pants social media success that hit during covid and then all the big social media providers that copied them um it was like the audio one oh what became twitter spaces yeah yeah uh i don't know i know what you're talking about the

four billion dollars from our four billion dollar valuation from andreessen horowitz yeah that one yeah that one i guess uh it's just used by uber drivers now it seems yeah that that's crazy that there was such a delusion among people that live audio chats were so important i guess it's not a thing it's not yeah just a covet thing can't really do that in public but let's bring it back in maybe for an example i know a lot of people follow us on financial Twitter and are probably, I think we'll even boast it on there this episode. Fintwit is an example of an incredible network effect. I think Substack may end up defeating them over the long term given Elon's kind of discretions, his distractions and how it's kind of angering

people. But it is hard to beat that Twitter network effect for the investment community because every new investor on Twitter creates more value for the existing users. So the larger the community gets the harder it will be to replicate somewhere else simple there it is now dorsey seems to love facebook and meta it's his largest holding it's been in with him for a long time uh he describes it as uh i wrote radial here but i believe he said it was an interactive network effect in his presentation back at google nine years ago i think today that network effect maybe more radial because now the economies of scale from the ai stuff and the technology barrier to entry may be stronger but i think because there are fewer and fewer people posting

on these platforms and not necessarily caring about your friends and family which was the original network that makes it much more of a hub and spoke model where you have these famous people you have brands you have all whoever posting on these places and it's kind of the centralized slop as they say being fed to the users the short form video stuff where you don't even need to follow someone i think that's weaker still strong but i think it is weaker than the original model do you agree or disagree there i don't know i mean you can make the case that it's stronger because initially it was like you you just share with your friends right you're just sharing information with your friends that's

stronger because that's a pure interactive network effect what about when you can interact with anybody globally and see their content is that stronger yeah i i mean but you could interact with anyone globally beforehand but i think the fact that it doesn't necessarily matter who is on there where if you are someone that, say, signs up for TikTok, it doesn't matter if anyone else you know has signed up for TikTok. And it seems like a lot of them are just turning into video and picture platforms where I feel like that's more replicable because it's not necessarily your friend's family that are posting it, but it's a small, you know, the moat's still strong either way. Finchat.io is the complete stock research platform for fundamental investors.

They have all the standard financial data on more than 100,000 stocks globally. But beyond that, they have company-specific segment and KPI data on 1,800 stocks. Want to see NVIDIA's data set in revenue? FinChat's got it. Like to track Spotify's premium subscribers? They've got that too. And they just added ETFs to the platform as well. The breadth of FinChat's data is truly one of a kind.

We use FinChat every day, and I've personally been using the AI Copilot more and more to summarize earnings calls and conference transcripts. To get 15% off any paid plan, go to FinChat.io slash chitchat. That is FinChat.io slash chitchat to get 15% off any paid plan today. The link is in the show notes. All right, economies of scale, fourth category. Ryan, why don't you take the listeners through it? Yeah, economies of scale, or what he more specifically calls cost advantages, can be founded essentially three forms, according to Dorsey. First one is process, second one is scale, and the third one is niche.

So the first cost advantage, which he defines as process, is creating a cheaper way to deliver a product that can't be replicated easily. The example he uses here is Dell. He says Dell is the classic example of a firm with a process-based advantage. Building PCs only if they're ordered allows the firm to take advantage of the swift price erosion of PC components. Parts don't sit in inventory losing value while the firm waits for more orders to come in. That makes sense. I mean, that was written in, I think, 2003 is when the book came out initially. So I don't know if the take has necessarily aged that well.

I think Dell's stock's done fine, but that's more of a business model transition. So probably not the moat. the uh yeah maybe those are pretty weak in some cases the airlines he uses as an example with the low-cost ones like ryanair and stuff like that i would say even costco gets included in this even though it has that scale too because their process of basically what we do with our input costs and how we build our warehouses to maximize like just from the size of things to maximize and say the cost per ounce of everything allows them to have an advantage versus a niche retailer. I think that's process as well as the general just scale advantages when negotiating with suppliers.

Yeah, even just the membership model in general is definitely kind of a unique process. The other example that comes to mind for me is the home builder NVR, which they pioneered that land option model in the 90s. That's mostly been replicated at this point, But that process gave them a real cost advantage for a while, and now they have other elements of the process that are unique as well that kind of give them a cost advantage, like building out certain elements of the house, being sort of vertically integrated in some parts. But yeah, process is one way, and process and scale, there's definitely some elements of overlap here. But the second one, just mentioned it, is scale. This is probably the most common one, the easiest one to think of an example for.

He defines scale-based cost advantages as spreading fixed costs over a large base. Relative size matters more than absolute size. The obvious example here is Costco because their scale, they're a huge win for suppliers. So that means they're able to command lower prices from those suppliers and pass them through to customers. This story has been told a million times over, but it leads to customers coming back more and more because they get lower prices. And then they can earn margins on the membership. So that's kind of one that comes to mind. Any others for you that you think scale is the primary one?

First one that came to mind would be Taiwan Semiconductor. Makes a lot of sense. There's other things in there, including switching costs, but that's part of it. They can offer a reasonable price to everyone and they can become the most advanced because you need that investment. It's part of the equation there. I think is scale. These ones are tough, though, because a lot of the times the scale advantages are in like a cyclical industry that I don't necessarily like. You would say I think a lot of the oil and gas companies have scale economies. You have the mining companies that are operated

well. I know there's the lithium miner that seems to do well, but that's just not an industry I like. I would say some banks as well and financing companies and credit card companies, you have Capital One, American Express, J.P. Morgan, those companies, and I guess Chase within J.P. Morgan Chase, those companies can offer much better rewards to their members. All the other companies and the travel companies, the restaurant companies, the lounges, all the stuff that they offer they can get because they have that scale.

Yeah. Yeah, it makes sense. I also think AutoZone kind of applies here. a lot of those companies, which is kind of ironic because we're going to talk about his current portfolio. It is in there, spoiler alert. So that is maybe one of the ones where you can clearly see the moat category that he would lump it into. The other one, this is the last one we're going to talk about, and then we'll get into his portfolio. The last cost advantage is niche. So they dominate industries with high minimum efficient scale relative to the TAM. I know

that's kind of a word salad so i'm going to go into that a little bit he gave this talk at a conference and he said there are some markets that are so small niche markets that they'll only profitably support one or two players because it only profitably supports one or two players it deters new entrants to begin with like and no one wants to compete with x the pool for the prize really isn't that high so the one that comes to mind is vertical market software where Or if it's a super, super niche software solution, I'm trying to think of one, like Bowling Alley. What's that? Golf Courser, yeah, Bowling Alley, same thing.

Golf Courser, Bowling Alley Management for Payments and Bookings. Yeah, I mean, those ones are maybe even bigger than some of the other ones that are out there. But yeah, there's all these super niche softwares. There's not that much incentive to go out and compete with them, I would think, if there's already an incumbent there. because the pool just isn't really that large so um yeah or at least it reduces the total prize money if you want to call it that the ultimate returns that you can generate for both players and so yeah that's that's kind of the third one here i think the most common ones in this are really scale and process that differentiate them yeah i agree although niche maybe we're just

not looking at the right niches there's all those auto aircraft parts stuff that he talks about a lot um other things within there you know he mentioned lubrizol but i think buffett bought or berkshire bought there's got to be those ones i feel like are more of the okay and yeah there can be switching costs in there too where you're a small piece of the puzzle in a larger pie but you're a valuable one you have this niche there's only one or two competitors no big competitor has there's no reason for them to get into this but yeah i don't like this one as much as network effects i will say all right let's talk about his old portfolio and how it's maybe transitioned to today yeah i don't know about the screen here because it's pretty easy to understand but

does not have a high turnover portfolio so i think it's interesting to look back at what he's held in the past to identify hey what was he looking at then why do you think he had these you can get the historical 13 f's on finchat uh it goes back to 2016 must have been his first 13 f end of 2016 he had facebook simpris brookfield asset management roper technologies uh am i pronouncing this wrong, Descartes Systems Group. Yeah, it might be French-Canadian. And then Ansys. All over 10% of the positions. I'm not sure what his international exposure was, but I'm going to pretend that this was his portfolio, that there was zero cash. He has large positions. And Facebook, for example, 20%. Simpras, 19%. Ansys is the smallest at 13.4%. Let's say we go through for

some of these and see what some of the motus may be identifying at the end of 2016. First, we have Facebook. We all know Facebook, owner of Facebook, Instagram, and WhatsApp. I think he identified a runaway network effect that would be difficult to copy. The stock traded on EBITDA EBIT of 30 at the time, which is not crazy for a wide moat business you still think has a lot of runway to grow, which you could argue at the time if you were bullish on the monetization of Instagram and WhatsApp. Since the end of 2016, Facebook slash Meta, after the name change, has generated a 22% annual total return for investors. And it looks like Dorsey Asset Management has owned the stock since 2016. I'm not sure how much they have trimmed or added, but it's clearly been a huge

winner for them. Second one, Descartes Systems Group. You've probably never heard of them. I've not heard of them before. This show, maybe a few listeners have. Here is what it describes itself as on its website our logistics technology platform digitally combines the world's most expansive logistics network with the industry's broadest array of supply chain logistics management applications and most comprehensive global trade intelligence services it helps get inventory information assets and people where they're needed when they're needed safely and securely sounds to me like wide or high switching costs what do you think if you take this if you replace this company it's like oh wow does our whole supply chain get just get screwed over

yeah it's one i never really looked at the returns are phenomenal on this uh it's probably one you and i need to visit and take a look at yeah uh i wish we looked at it back in 2016 2017 but the stock has posted a 23 annual total return since the end of 2016 The last one here, I'll say, is Ansys. One we've covered, I don't know if everyone knows about this one, but it's an engineering software portfolio for advanced simulation tools. This is for various engineering specialties, such as mechanical, electrical, or aerospace workers and others,

and research scientists, things like that. I believe he thought the company had huge switching costs given the, quote, educational advantage we talked about above on the show. The fact it takes so long to get comfortable with the software makes it tough for a company to switch. Plus, it's so damn hard to create. They have generated a 17% annual total return since the end of 2017. And I'm going to go through the rest.

Simpras is down 9% cumulatively, so basically flat. Roper, 16% return. CAGR, Brookfield Asset Management, 16% since the end of 2016. I'm going to calculate, or I did calculate, what their returns would have been if they never transacted again. I put Brookfield at a 10% return because I'm not sure they've done some splits and stuff, and I don't really want to calculate what all that would mean. And the aggregators like a FinChat are going to get that wrong. They're probably the bane of your existence. The Brookfields, they're just annoying to deal with when they have all these different companies.

But assuming a Brookfield at a 10% annual return, the original Dorsey 13F would have returned 16% per year to investors. Not bad, and I think probably better than the fund actually did. Yeah, probably. Because if we look at the current portfolio now, I'll kind of move to that. Still the same largest holding, Meta, accounts for roughly 14% of the portfolio. But other than that, I think every single company is different. Yeah, it looks like they don't hold any of the same companies here. So I'll just go through them real quick, and then I'll ask you a question. Meta's number one, Smartsheet, which I have really never looked that closely at. Wix, that's kind of an old company that we used to dabble in. We loved playing with him, along with him on that one. Yeah. AutoZone, Google, Danaher, PayPal, Sprout Social. I'm blanking on this one. I think it's called Herk Holdings, Samrush, and Upwork. So I guess two questions. First of all, does anything stand out to you here? Well, he switched conglomerates to Danaher. Don't know what the thesis was there.

Don't keep up on any of those companies. I think the addition of Google, unsurprisingly for listeners, makes sense. Or Alphabet. If you're going to own Facebook, you might as well own Alphabet. Here's my thing. I like – go ahead. With Google, what category would you put them in for a moat? well it's got various business models but the what's interesting is ai might disrupt the old

network effect because i think originally there was a network effect where you needed to be like say the marketplace are is websites and any sort of even websites small to as large as booking holdings or airbnb and they need to be on google search results and they're going to advertise there and then you have the users on the other side but with ai am i does that change it a little bit i don't know i don't know but the other thing i noticed is network effects probably still number one for them would be my guess especially with youtube obviously yeah i would say that google has a strong brand as well same with me i mean people joke about or not joke people there's a lot of facebook haters out there but it still has the brand is still valuable same with

amazon amazon's honestly is probably even stronger than others because the trust needed for delivering and picking up packages but what i noticed here is again large position in wix and i think along with that a lot of emerging software like this isn't legacy old software stuff this is emerging software and i'm wondering where he thinks the moat is developing in some of these companies because wix it's a it's i think it's a solid moat but i think it could also be disrupted yeah i'd say there's switching costs with wix you know once you've set up a website but it's not impossible it's not the highest switching cost in the world i do like that maybe he's moving if you look at it today versus the portfolio in 2016 these definitely feel like more developing

moats as opposed to the moats that have already been proven out what's with the paypal network effect does it is there also on dba like three years ago something like that three years ago yeah maybe that worked they had they were kind of a deep value if i remember correctly i could be getting this wrong but i remember he also in disney and maybe it's just disney but paypal disney wix the management i think he's we're gonna get to the kind of conclusions from the episode management matters and yeah definitely i'll just say that all right let's go through were some other parts of his book that I thought were really good. So at one point, he lays out seven mistakes to avoid in investing. So I'm going to go through each of these. Number one,

swinging for the fences. Two, believing that it's different this time. Three, falling in love with products. Four, panicking when the market is down. Five, trying to time the market. Six, ignoring valuation. And seven, relying on earnings for the whole story. Eight, ignoring management. What's that? I said eight, ignoring management. That's what I would add. Which of these do you think you have the hardest time with?

Okay, swinging for the fences, believing that's different this time. I would say believing it's different this time. I get caught up to that. I can read the story. Ooh, things have changed. Like, okay, management's saying some new things. Sometimes that can work really well, but you can also get into trouble. Yeah, I'd say probably falling in love with products.

it's so easy definitely you're successful a little bit to that yeah yeah maybe even valuing the customer experience too much um over the valuation uh okay the second one that i wanted to talk about is how dorsey screens financially for moat so most of determining a moat is qualitative and he goes we've been through that we've gone through that this whole episode but he also says in his book the first thing we need to do is look for hard evidence that a firm has an economic moat by examining its financial results. Here are the financial characteristics he looks for. Free cash flow margin above 5%, net income margin above 15%. Hold on. Return on equity above 15%, return on assets above 6%. What do you think of this, Screener?

Don't like it, to be honest. I like the thought of that the financial history matters. and it does like i think it's one of the things that he would overlap with david gardner where david gardner simplifies it for his subscribers where he or i guess he's not running the business anymore but the molly fool and that style simplifies it by saying look if the stock performance has been so strong in the past that's an indicator that the business is strong and for him he's saying if there's 30 years of indicate indication that are not indicate there's 30 years of results that this business has performed well and the profits are so strong well that's an indication there might be a moat there because during those 30 years, there's probably been a

lot of smart people trying to attack them. But I would use a higher free cash flow margin. I would probably use more of a free cash flow conversion. And then I would use return on invested capital in the right circumstances for a business where that matters. That's what I would do. Now, some companies, it doesn't matter because you're Capital Light, but yeah. but actually that reminds me capital light uh one of the modiest businesses in the world we just forgot about and didn't talk about this whole episode and is perennially under i guess discussed fico fair is it corporation the fico score that's one there would you call that regulatory capture i would call it regulatory capture

and brand and switching costs yeah for sure i think they got all i think they got three or four Okay. Closing takeaways from studying Pat Dorsey. You want to alternate here? Sure. Yeah. You've been going, so let me go first here. First one. We've talked about the things we can learn from him. I'm going to maybe learn from his portfolio first. And sorry, you're listening, Dorsey, but this is maybe even that criticism. I know you have a lot more experience than me, but this is how I look at it. Management matters perhaps more than he is focusing on. I see him making mistakes by investing in management teams that don't want to take care of the shareholder, Wix, Disney, PayPal, even though the business might have a strong

moat or a potentially emerging moat. That's my first one. It's funny. He held Disney for a little while, if you look through his recent 13 Fs. And obviously the business has changed a lot. But in his book, when he's talking about red flags that you can find in a proxy statement, he specifically pulls a quote from the Disney proxy. and it's like i know it's a different business a lot of the board has probably changed the ceo has certainly changed but i don't know there's probably a culture there that's still around um because i think they were like moving the financial goals so that the ceos could meet target hey let's talk about moving financial goals wix yeah hey pal like look at that all

right we're going long what are your closing takeaways get out there and talk to customers he values primary research a lot and there's an interview with him where he talks about going to a lot of conferences you might not have the budget to go to a ton of conferences but when you talk to real customers you get a much better understanding of what powers a company's moat he said he went to an advertising conference i believe in like 2015 2016 where someone was like someone basically said if god could build an advertising platform it would be facebook and he said that quote really resonated with him. He saw that everyone was spending money and trying to optimize for Facebook ads

and he instantly knew... Yeah, I would say Instagram would be my choice. Maybe not Facebook, but Instagram is literally the perfect advertising platform, but yeah. Yeah, it... Anyways, do primary research. Yeah, for individuals that

can't afford to attend a conference or don't have the time, I know Reddit can have some weird stuff on there and sometimes you go down some strange rabbit holes, but Reddit... If you look up specific forums, you can find detailed explanations from experts in an industry. And they'll give it away to you for free. All right, what's your second one?

Some moats are stronger than others. Dorsey highlights that it isn't just important to identify competitive advantage, but how wide and deep the moat has been dug. The perfect example is the interactive versus the hub and spoke network effect. Or the fact that a brand moat is a lot more flimsy than a durable regulatory moat. Like, here's a question I have for the listeners. And I know everyone loves brands and they invest in them and it can work out well. But I know you're all going to lose a lot of money investing in them at 50 times earnings. What are you more confident that's going to be around in 50 years?

Lululemon or the NFL? Yeah. The regulatory stuff can matter. Now, you can combine both together, like the tobacco companies, and that can be perfect, but I think that's – it's not just like, oh, they have a moat, perfect, I can buy them at 40 times earnings. No, no, no, let's – there's a lot of nuance to how strong or weak a moat is. Yeah, I agree. My second takeaway is kind of this – it's in the same vein, which is identifying a network effect can be difficult. I think it's easy to get, or not network effect, sorry, a moat.

Identifying a moat can be difficult and it's easy to get it wrong. It's easy to think there's a moat when there isn't. And especially with larger companies, you just think like, well, they got to this size somehow. It's got to fit into one of these groups. When in reality, maybe the business is at such a mature stage that it's either A, attracting a ton of competitors or B, running out of investment runway. That's important too.

It's not just about having the moat. How much can they reinvest and still generate good returns? I mean, Boeing. It's part of valuation. Boeing is a huge moat. It doesn't generate good returns on capital. Yeah, exactly. And I think it also plays into the earnings multiple you pay.

If it's a mature business that's not going to grow that much and you're paying 40 times earnings, it's a lot more dangerous than one that has a long runaway of reinvestment. Absolutely. All right. I think I'll leave it there. All right. I'm about to sneeze, so hopefully I'm not going to try to end this before we have to make an edit. For anyone watching, that's why I was kind of looking strange there. The other thing I would say, and if you want to sneeze, you can go ahead while I'm talking.

He doesn't necessarily talk about this that much, but I think there's a lot more value in targeting developing moats than targeting the mature ones. Right. More risk, more reward, though. Yeah. Yeah. You can be wrong either way. You can be wrong thinking there's a moat here like he was with Chegg, and you can be wrong also with Dollar General, where both of those, he thought they had a moat. They didn't work out. But you look at a developing moat like Meta in 2016 or Facebook in 2016, there's way more upside in that, and it can make up for a lot of the losers than the Visa, which also had a moat, but it generated worse returns than the S&P 500. Yep, I think that's where Buffett and Todd Combs take it to the next level where they say, and their criteria question is, will the moat be worse or better in five years? That's probably a good question to ask as well.

I think that's where we can leave things. Let's hit the disclosure. We are not financial advisors. Anything we say on the show is not formal advice or recommendation. Ryan, I, or any podcast guest may hold securities discussed in this podcast, may have held them in the past, and may buy, sell, or hold them in the future. Thank you, everyone, for tuning in. You can find these episodes on YouTube, Spotify, Apple Podcasts, or wherever you get your podcasts.

And we'll see you next time. We'll see you next time.