We Study Billionaires - The Investor’s Podcast Network - TIP524: Four Wide Moat Stocks for 2023

Starting point is 00:00:00 You're listening to TIP. Welcome to the Investors podcast. I'm your host, Clay Fink. On today's episode, I wanted to cover four wide moat companies I think are worth a consideration for stock investors in 2023. Given we're in a bare market and teetering on a recession, the prices of the majority of stocks are down giving us the opportunity to potentially add to wonderful companies at discounted prices.

Starting point is 00:00:27 If you've been following along with the show for quite some of the time, time, you know that Warren Buffett loves companies with wide moats. These are the companies that are most equipped to handle the constant disruption occurring in the capitalistic marketplace. However, even some of the widest moat and highest quality companies can be a poor investment if you pay too high of a price. So I also brought price into consideration when selecting these four companies. With that, let's dive right in. You are listening to The Investors Podcast, where we study the financial markets and read the books that influence self-made billionaires the most. We keep you informed and prepared for the unexpected.

Starting point is 00:01:19 Before we get into the companies I'll be covering today, let's make it clear what it really means for a company to have a wide moat and why it's important for a company to have it. As long-term investors, it is critical that the companies we invest in have a strong economic moat, which is simply a distinct competitive advantage that a company has. has over its competitors. We want to be certain that if you're going to own a company for the next 10 or 20 years, we're fairly certain that the company's products or services will still be desired because if a company ends up getting disrupted, then it's likely that the sock won't end up being a good investment. Warren Buffett says that a good business is like a strong castle with a deep

Starting point is 00:02:02 moat around it. I want sharks in the moat. I want it to be untouchable. There are a number of different types of moats that can exist in the marketplace. One of the most well-known types of modes is a network effect, which is the phenomenon where the value of the network becomes more valuable as more people join the network, which is the case with many social media companies because these companies become more valuable with each new user that joins the social media network. Another common type of moat or competitive advantage is simply the brand. If I'm overseas in Europe or another country, and I want to go grab a can of pop. Odds are I'm going to be more likely to grab something like a Coca-Cola rather than another

Starting point is 00:02:46 brand I've never seen in my life. Another example is I enjoy working out, and whenever I go and get new workout shoes, I oftentimes pick Nike. Even though I could probably get some other brand for a little bit cheaper, that's a similar quality. I just know what I'm going to get with Nike and they have that brand power and brand awareness with millions of people worldwide. Other types of moats include being the low-cost provider, having high switching costs,

Starting point is 00:03:12 having economies of scale, or a company being essentially like a toll booth that collects a fee for being the sole provider of one particular product or service. Much of what constitutes a moat can be very qualitative, but these qualitative factors can be validated using quantitative factors. If a company is consistently able to produce high returns on invested capital, while consistently pricing their products higher than their competitors, then that is probably a good sign that the company has a strong and durable moat because a lot of times when companies are able to achieve high returns on capital, competition comes in and makes it no longer possible

Starting point is 00:03:50 to achieve those high returns. Looking at a company's revenue, their earnings per share, and the return on invested capital are all good places to check and see if a company has a durable and longstanding moat to date. In addition to a company having a strong-standing mode to date, in addition to a company having a strong moat, I also want to ensure that the company has a growth runway ahead of it, continuing to grow their earnings, and the company is trading out what I believe to be a reasonable price, they have a solid management team, high returns on invested capital, and also I want to be in companies that aren't too cyclical. Looking for companies with these characteristics are ingredients for what I call a steady compounder, which I would consider to be a company that is almost certain

Starting point is 00:04:31 to continue to grow and continually just steadily march their earnings per share higher and hopefully the stock price as well. Because of the high quality of these types of businesses, the market oftentimes won't hand you these companies for super cheap, so they aren't going to make you rich overnight. One of my very favorite value investing books is a book called Where the Money is by Adam Ziesel. TIP had Adam on our podcast on our millennial investing show and the we study billionaire show in the past. His book talks about how value investors need to transition to a world that is vastly dominated by technology. And value investors should not shy away from technology companies because of how much stronger some of these companies have become in the tremendous

Starting point is 00:05:18 moats and network effects that technology has enabled. In his book, Adam states that Peter Lynch wrote in one up on Wall Street that in the end, superior companies will succeed and mediocre companies will fail, and investors in each will be rewarded accordingly. Lynch's words remain as true as ever, but the problem is that over the last generation, technological change has altered the economy so much that the nature and character of what constitutes a superior business has also dramatically changed. The internet, the cell phone, and social media didn't exist when Lynch wrote this. Many of the everyday examples that he used to illustrate superior businesses are now laughably out of date. That's no knock on Peter Lynch,

Starting point is 00:06:05 the world changes, but we must acknowledge that the same common sense that led him to those stocks now tells us to go nowhere near them. The internal combustion automobile today faces threats from both driverless and electric cars, and as for Toys R, S, squeeze between the giant princers of Walmart and e-commerce, it filed for bankruptcy protection in 2017. Powered by continued improvements in computing power and related technologies, digital companies have transformed our daily lives, the world economy, and most importantly for the purposes of this book, The Stock Market. Roughly half of the U.S. markets' gains since 2011 have come from the information technology

Starting point is 00:06:49 and related sectors. Since 2016, roughly two-thirds of the market's appreciation has come from these sectors. A decade ago, only two of the world's top 10 most valuable publicly traded companies, not controlled by the government, were digital enterprises. Today, as the chart below shows, eight of the top 10 are. The only two companies that aren't technology base are Berkshire Hathaway and an oil company out of the Middle East. As the graphics suggests, the digital age has come upon us so quickly that we haven't had time to step back and parse what it means. While it's obvious to everyone that something dramatic and lasting has occurred, most investors seem befuddled by it. As a result, most haven't learned the language and the dynamics of a sector

Starting point is 00:07:37 whose principal output consists of zeros and ones. To say that this is unfortunate would be an understatement. Companies built on a digital foundation, Tech, in the shorthand of Wall Street, are creating most of the incremental wealth in the world today. Tech dominates our daily lives so thoroughly that it's natural to think the digital revolution is largely complete, but that's not true. In many ways, it's just beginning. Even after a generation of growth, Amazon's annual retail sales volume only now matches Walmarts. Cloud computing, which today accounts for roughly 10 to 15% of all spending on information technology, which one day will likely account for more than two-thirds.

Starting point is 00:08:21 Into it, the world's leading provider of small business accounting software reaches only one to 2% of its ultimate addressable market. The list goes on and on, and as computing power compounds, the list gets longer every year. As tech creates new industries and new wealth, it is simultaneously hollowing out large parts of the legacy economy. Tech's dramatic rise has been accompanied by an astonishing fall of the old economy's market values. Big Tech gets most of the headlines, but hundreds of smaller, lesser-known tech companies have also continued to appreciate. Then a few pages later, he describes how one of the reasons that tech is taking over is because the returns on capital employed are just so much higher. As he says that, if Ford wants to grow their

Starting point is 00:09:08 business, they need to invest $10 to achieve $1 an additional profit. For Coca-Cola, they need to invest $6 for $1 in profit. And for so many of these big tech companies, they only need to invest, you know, two or three dollars to generate the same level of profits as these legacy businesses. So because of these reasons, many technology companies are just better businesses and they have wider most than these other businesses. I want to ensure that I at least consider these types of companies when I'm picking and choosing individual stocks for my own portfolio. The first two companies I'm going to cover today are well-known big tech companies. as these are just some of the strongest moats the world has ever seen, and I like the prices

Starting point is 00:09:51 they're trading at. And then the other two companies I'll cover are companies outside of big tech. The first company I wanted to discuss today was Alphabet. Buffett and Munger aren't considered the geniuses or masterminds of technology, but they've both commented on the strength of the moat of Alphabet. Munger has stated that he's never seen a company with as wide of a moat as Googles. Although Although it appears that Alphabet's Mote may be in question with the rise of AI and technologies like Chat GPT, Alphabet today is one of the most dominant and profitable companies in the world. As in the trailing 12 months, they posted a net income just shy of $67 billion. The primary source of Alphabet's Mote is the competitive advantages built in Google Search

Starting point is 00:10:40 through their network effect. Once Google established itself as a leader in search, more and more people started to use using Google for their search queries. And the more people that started using Google Search, the more data they were able to collect, which not only improved Google Search, but it also improved their targeted ads. For how valuable of a product Google Search is for its users, it's pretty incredible that is just totally free, which is the beauty of technology and the power that it brings to people. Alphabet is a trillion-dollar company built primarily on the back of a product that is free

Starting point is 00:11:14 for its users, and one could also include YouTube in that discussion as well. Because of this dynamic and network effect, the search market has essentially turned into a winner take-all industry, as Google Search currently holds 84% of the search market according to Statista, which essentially hasn't really budged at all over the past decade. This also reminds me of Guy Spear and what he looks for in businesses to invest in, and Nick's sleep as well, to add to that discussion. This is win-win scenarios. All parties win using Alphabet's platform, whether that be the users or the advertisers, everyone wins in working with Alphabet and Google Search. And when I pull up Datorama to see what Superinvestors own Alphabet, I see Guy Speer owns a little bit in his portfolio, and then also

Starting point is 00:12:03 Bill Miller, Bill Nygren, Lee Liu, Francois Rochon, Tom Gaynor, and a long list of others all own Alphabet in their funds portfolios as well. Google Search also has a really powerful brand and people associate Google with the internet itself. So in a way, it's almost a toll road on the internet where so many people are using Google in their everyday life. So their brand name also has substantial value for the company. However, their brand alone isn't as powerful as a company like Apple, for example. And I think YouTube has a lot of many of the same characteristics as Google Search. I've recently tuned into the podcast episode of Mr. Beast and Lex Friedman. And Mr. Beast just makes me so bullish on YouTube, given the huge staying power that YouTube

Starting point is 00:12:49 has where it's kind of the toll road for videos. And it's just provided so much value for creators, for advertisers, and for users. And I see YouTube in many ways in the same light as Google Search. And I'm very bullish on both long term. Let's take a quick break and hear from today's sponsors. All right. I want you guys to imagine spending three days in Oslo at the height of the summer. You've got long days of daylight, incredible food, floating saunas on the Oslo Fjord, and every conversation you have is with people who are actually shaping the future. That's what the Oslo Freedom Forum is. From June 1st through the 3rd, 2026, the Oslo Freedom Forum is entering its 18th year,

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Starting point is 00:17:14 Back to the show. So Google Search, I obviously believe, is a great business, but Alphabet also has two other fast-growing businesses within the company. I already mentioned YouTube, and then Google Cloud is another fast-growing business that they have. YouTube produced nearly $30 billion in revenue in the trailing 12 months, and Google Cloud produce revenues of over 24 billion, which are both growing very rapidly. YouTube remarkably is still growing its user base and has 2.6 billion users globally. I am a shareholder in Alphabet,

Starting point is 00:17:49 but one of my main concerns with the company is how well their advertising revenue will hold up during a recession. During a recession and difficult economic times, companies are forced to cut back on spending to remain profitable, and oftentimes the very first place they're going to cut spending is in their advertising budget. During the great financial crisis, advertising revenue fell sharply but quickly rebounded once economic conditions improved for Alphabet. Alphabet's advertising revenue has held up remarkably well in recent months, which is really good to see. As of Q3 of 2022, Google searches revenue was up 4% year over year, and their overall revenue was up 6%. If you take the free cash flow and subtract out roughly $19 billion in assumed stock-based compensation,

Starting point is 00:18:36 I'm getting a free cash flow yield of roughly 4% for a company I expect to continue to grow for many years to come. And this is after subtracting out the net cash from the market cap for those following along with those numbers. I'm not trying to make it sound like I'm pumping the stock, but at a free cash flow yield of 4% for a company of this high quality, I will gladly purchase this stock around $90, $100. Of course, it could go lower and receive a lot of pressure with the recession, but I will gladly hold right onto it. Now, most people are probably concerned about chat GPT and the disruption that may be coming

Starting point is 00:19:14 from them. There was recent news that came out from Microsoft. They reportedly planned to invest $10 billion into the company OpenAI who developed this software. This investment would value OpenAI at $29. billion dollars. Even Bezos, one of the most ambitious entrepreneurs on the planet has stated that you should treat Google like a mountain. You can climb it, but you can't move it. And Microsoft has long been wanting to get into the search business, as over the years they've spent over $15 billion

Starting point is 00:19:46 on Bing, only to fail to tap into Google's market share of the search industry. I got this stat from Adam Ziesel's book where the money is. Here's what Adam had to say about Google in his book that was written just last year. Microsoft and Amazon wanted a piece of Google's action so badly because search is likely the internet's mightiest and most profitable toll bridge. Search is quite literally the gateway to the information superhighway. Amazon may control e-commerce, but physical goods account for only 25 to 30% of economic output. Services accounts for the other 70 to 75%, and services is where Google excels. Anyone in the world who wants a divorce lawyer, a mortgage broker, or information on a Caribbean

Starting point is 00:20:34 vacation, Googles it, which means that every divorce lawyer, every mortgage broker, and every Caribbean-related travel business must advertise on Google. The best part is that advertisers don't mind paying Google, because advertising on its site is both cheaper and more effective than advertising on traditional media. When a travel agent or a divorce lawyer advertises on TV or in the local newspaper, they're unsure their message will reach its intended audience. On Google, advertisements are tied to keywords, so advertisers can measure whether their spending is effective or not, end quote. I discussed Google with Adam Ziesel during my conversation with him on millennial investing,

Starting point is 00:21:20 and he was describing to me how despite Alphabet being highly profitable today, they aren't as optimized for profits as a company like Apple, for example. They are still very much making large investments for the future, which really leads me to believe that the free cash flow amounts that we're seeing today are largely understated at least to some degree. To round out the discussion on Alphabet, I wanted to end it with a clip from Bill Nygren, where he digs into this idea further on the Millennial Investing Show.

Starting point is 00:21:51 Here it is. Yeah, it's funny. I think a lot of times people get, the idea that value investors are stuck investing in below average businesses, what Warren Buffett or Benjamin Graham called the cigar bet companies. But to us, value just means that you're getting a lot more than you're paying for. And through some of these accounting issues where a company is making a lot of investments for the future that aren't creating current earnings, it's creating the misperception that the company's expensive. You look at a company like Alphabet, and they're investing a

Starting point is 00:22:30 tremendous amount in autonomous vehicles, in healthcare, in Google Cloud, none of which really is earning any money today. In fact, it's losing significant money. We think about it, like, if they made those investments with a venture capital firm instead, the accounting would be very different. It would be a big asset that goes on their balance sheet and the losses that are going through those venture companies don't go through the income statement. So we add them back. So but we look piece by piece at the values. We separate out the cash. We look at the venture cap investments that aren't earning money. We look at the under monetized investments like YouTube at Alphabet that's still through either subscriptions or advertising is monetizing at a fraction of what other

Starting point is 00:23:19 streaming services are. And we do a piece by piece valuation. And when we sum up the parks, we subtract that from the stock price and say, we're really getting the search business at less their market multiple. And as we move to more and more of a business world that's based on intangible assets, intellectual property, venture capital like investing, R&D, we think there are more and more of these opportunities where really good businesses look like they're selling at an expensive PE rate show. But by the time you do the work and dig into it, there's a core piece of the business that everybody agrees is a great business. And we think we're buying them at less than their market multiple. So to us, this is still just as much value investing as

Starting point is 00:24:08 buying GM at six times earnings was. It's just a little more complicated to get there. To add to what Bill is saying with the earnings on Alphabet, I also wanted to pull in one more line from Adam Ziesel's book. Tech companies could report dramatically higher current earnings if they wanted to. It's just not in their best interest to do so. Early in their life cycles, and with only a fraction of their markets conquered, digital businesses are in growth rather than harvest mode. They are wisely spending dollars today that will be worth more dollars in the future. Such spending makes the E and the PE ratio look small and the multiple of current earnings to look large.

Starting point is 00:24:52 But that is a misleading and deceptive snapshot of reality. It's especially misleading when we are comparing tech companies which are reinvesting heavily in the future to legacy companies, most of which are not. To compare Amazon's or Alphabet's current profits to Wells Fargo is like comparing an apple orchard in the springtime to an apple orchard in the fall. The latter is ready for harvest, while the former is just beginning to grow, end quote. All right, now the second company I wanted to talk about today is Amazon. Amazon is another widely held company amongst super investors, and I believe that's for good reasons. Investors, including Bill Miller, Bill Nygren, Tom Gainer,

Starting point is 00:25:34 and even Warren Buffett, all have exposure to Amazon stock. When Bill Miller was asked what the best investment decision he's ever made, he said it's buying the Amazon IPO. And then when he's asked what the worst financial decision he's ever made, it was ever selling a share of Amazon. I tuned in to a recent interview Bill Miller did with WealthTrack at the end of 2021. He stated that his estimate of what Amazon AWS is worth is around $1.5 trillion if it were valued similar to other SaaS companies. But Amazon's total valuation is worth is around $1.5 trillion dollars if it were valued similar to other SaaS companies. But Amazon's total valuation today, here at the start of 2023, is around $1 trillion. So the total value of the company is valued at $1 trillion, while Bill Miller's estimate of

Starting point is 00:26:21 AWS alone is $1.5 trillion. Here's a clip of Warren Buffett talking about Berkshire's investment in Amazon when he was questioned whether it falls within a value investor's framework back during the 2019 annual meeting. This question is from Ken Scarbeck in Indianapolis. He says, with the full understanding that Warren had no input on the Amazon purchase and that relative to Berkshire, it's likely a small stake, the investment still caught me off guard. I'm wondering if I should begin to think differently about Berkshire looking out, say, 20 years. Might we be seeing a shift in investment philosophy away from value investing principles that the current management has practiced for 70 years? Amazon is a great. great company, yet it would seem its heady shares 10 years into a bull market appeared to conflict with being fearful when others are greedy. Considering this and other recent investments like Stoneco, should we be preparing for a change in the price versus value decisions that built

Starting point is 00:27:21 Berkshire? It's interesting that the term value investing came up, because I can assure you that both managers who and one of them bought some Amazon stock in the last quarter, which will get reported another week or 10 days. He is a value investor. The idea that value is somehow connected to book value or low price earnings ratios or anything, as Charlie has said, all investing is value investing.

Starting point is 00:27:46 I mean, you're putting out some money now to get more later on and you're making a calculation as to the probabilities of getting that money and when you'll get it and what interest rates will be in between and all the same calculation goes into it whether you're buying some bank

Starting point is 00:28:00 at 70% of book value or you're buying Amazon had some very high mobile pull of reported earnings. The people making the decision on Amazon are absolutely much value investors as I was when I was looking around for all these things selling below working capital years ago. So that has not changed.

Starting point is 00:28:19 The two people that, one of whom made the investment in Amazon, they are looking at many hundreds of securities and they can look at more than I can because they're managing less money in their universe, possible universe is a greater, but they are looking for things that they feel they understand what will be developed by that business between now and Judgment Day and cash. And it's not it. Sales, current sales can make some difference. Current profit margins can make some difference. Tangible assets, excess cash, excess debt, all of those things go into making a

Starting point is 00:28:57 calculation as to whether they should buy A versus B versus C. And they are got, they are absolutely following value principles. They don't necessarily agree with each other or agree with me, but they are very smart. They are totally committed to Berkshire. And they're, they're very good in human beings on top of it. So shortly, Warren and I are a little older than some people. Yeah, I'm near everybody. Yeah.

Starting point is 00:29:25 And we're not the most flexible, probably in the whole world. And, of course, if something as extreme as Internet development happens, and you don't catch it, why other people are going to blow by you. And I don't mind not having caught Amazon early. The guy is kind of a miracle worker. It's very peculiar. I give myself a pass on that. But I feel like ours is asked for not identifying Google,

Starting point is 00:29:55 better. I think Warren feels the same way. Yeah. We screwed up. He's saying we blew it. And we did have some insights into that because we were using them at GEICO and we were seeing the results produced and we saw that we were paying $10 or click or whatever it might have been for something that had a marginal cost of them of exactly zero. And we saw it was working for us. So we can see in our own operations. Oh, well that Google advertising was working. And we just sat there sucking our thumbs. So we're ashamed. We atone. We're trying to atone. When he says sucking her thumbs, I'm just glad he didn't use some other example. Now, from a high level, Amazon was a really big beneficiary of the COVID pandemic as the trend to

Starting point is 00:30:44 e-commerce and online shopping really accelerated. And despite that, the stock has been getting hammered in recent months. At the time of this recording, it sits at around $97, which is nearly 50% below its all-time high, and it's just slightly above the March 2020 low. Let's talk about the moat this company has, starting with their e-commerce business. Without a doubt, this company has one of the strongest moats to ever exist in my mind. In 2014, Amazon did $39 billion in e-commerce sales, and in 2022, e-commerce sales, Two, e-commerce sales are estimated to be around $142 billion.

Starting point is 00:31:27 I think of Amazon as similar to Google Search and that it's a toll road on the internet. It established that early lead, and now when anyone wants to purchase something online, oftentimes the first place they're going to go is to Amazon. And to help lock in their customers and keep them coming back time and time again, they implemented Amazon Prime with their two-day shipping. Currently, Amazon Prime costs $15 a month or $139 on an annual basis in the U.S. I'd imagine that many American households can't really imagine living without their Amazon Prime membership and all the benefits that it offers.

Starting point is 00:32:04 Just from 2019 through 2021, the number of Prime members increased from $150 million to $200 million. So this company is definitely still in growth mode, despite being just such a large business today. I see quite a bit of optionality with Amazon's e-commerce business. First is the potential to profit off of every single sale that occurs on their platform. Since this is a business built on the internet, they are easily able to tweak the pricing of their products that they sell on Amazon or tweak the fees that they charge for others that sell on Amazon.

Starting point is 00:32:42 This is also referenced as their third-party seller service. So they have the revenue they're collecting from the sales. selling themselves, they have revenue from the third-party seller services, and then they have revenue from Amazon Prime, and last but not least, they have their revenue from their advertising business. Their advertising business unit is extremely valuable because when someone searches for an item on Amazon, they enter that search query with the intention of buying a product. This leads to massive amount of dollars spent on advertising to try and catch these users' attention. I was chatting with John Huber on Millennial Investing back on episode 165, and during that episode, he talked a lot

Starting point is 00:33:22 about how good of a business the digital ad segment is, and how much more valuable those ads are, given that the customers seeing those ads entered the search query with the intent of making a purchase. A lot of people talk about the e-commerce space and the AWS, but the digital ads business may also be a really big driver for Amazon stock performance over the coming decade. I'd encourage the audience to check out that episode with John Huber if they'd like to learn more about why John made Amazon his largest stock position in his fund. Let's take a quick break and hear from today's sponsors. No, it's not your imagination. Risk and regulation are ramping up, and customers now expect proof of security just to do business. That's why VANTA is a game changer.

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Starting point is 00:37:06 other information can be found in the income funds prospectus at fundrise.com slash income. This is a paid advertisement. All right. Back to the show. Amazon's advertising business grew by 25% in the most recent quarter, and in the trailing 12 months, their ad business generated over $35 billion in revenue. And then last but not least, Amazon's cash cow is their AWS business. This business in the trailing 12 months generated $76 billion.

Starting point is 00:37:36 in revenue, with revenues in Q3 of 2022, increasing by 27%. Their AWS business is not only a very large and very fast-growing business, it's also very high margins, as EBIT margins are 30% and give Amazon the cash needed to help fund the ever-growing retail business and other necessary investments they're making in their continued future growth. In relation to Amazon's mo, let's not forget that Nick Sleep, who's an investor that puts so much emphasis on quality, still to this day, as far as we know, has owned Amazon stock for the last 20 years. When Sleep was researching the best companies to own, he discovered the incredible power of companies with what he calls scaled economies shared, meaning that as the companies grow, they're able to continue to

Starting point is 00:38:26 offer lower and lower prices, which in turn only attracts more and more customers. It's the ultimate win-win situation. So Sleep identified Amazon, Costco, and Berkshire Hathaway back in the early 2000s, and put his entire net worth practically in these three stocks. That's not to say that we should invest in whatever companies these super investors buy, but I believe that Amazon has a very large moat around its business. Amazon, over the many years, continues to ensure that they're providing low prices to customers, especially since many of them are signing up for their annual prime membership.

Starting point is 00:39:01 In order to provide that fast and easy two-day shipping, Amazon had to spend so much money to build out that fulfillment network. Because of the amount of capital that took to build all that out, this is just another factor that plays into their moat because they have all these fulfillment centers and it becomes extremely difficult for other companies to compete in achieve profitable margins. In addition to all the capital they've had to invest, they also have immense network effects, especially with Amazon Prime, essentially locking customers in, giving these customers massive incentives to continue to shop on Amazon. The network effects also tie into the scaled economy share

Starting point is 00:39:42 that Nick's sleep describes as they're able to continually have a cost advantage over the long term as the company continues to grow year in and you're out. I did a bit of research into Amazon's market share and how that's trending as well. I'm seeing varying statistics from different sources, but multiple more conservative sources stated that in 2021, Amazon accounted for 40% of all e-commerce sales. Walmart, of course, is also making a push for e-commerce and is growing as well, but today they only account for around 6% of e-commerce sales. Amazon also has the largest cloud business in the world with AWS, and with the continued increase in spend and commitments on AWS, more and more companies are getting locked into that AWS ecosystem, and there's high

Starting point is 00:40:32 switching costs if they ever wanted to switch to another cloud provider. Recently, Amazon's free cash flows have dipped into the negative territory, dragging the stock down with it, but I personally believe that these headwinds from a free cash flow perspective are temporary. When I look at the company's top line for each of their important business segments, I see strong and consistent growth. And when I look at the big picture and the secular trends of e-commerce and the cloud industries, Amazon is a massive beneficiary for these trends.

Starting point is 00:41:02 I believe that if Amazon really wanted to produce a ton of free cash flow in the near term, they could definitely do that, but instead they're opting to continue to reinvest back into the growth of the company and reinvest and create that customer goodwill by continually offering those low prices. I don't know when the situation will improve in terms of Amazon's financials, but when the stock price of a great company drops by 50%, and is trading below what I believe the value to be, then I think when the financials improve and the economy eventually recovers, these lower share prices will prove to have been potentially great buying opportunities.

Starting point is 00:41:40 I think this will also be a really big test for Andy Jassy, as he's facing a lot of pressure in terms of the overall economy and inflation. But I think there's a lot of options for him in levers he can pull, such as the trimming the employee count or increasing their prices a little bit, or just tweaking some of their business segments. I think there's so much optionality and so many levers that management can pull to achieve that long-term profitability. Lastly, regarding Alphabet and Amazon,

Starting point is 00:42:07 I wouldn't be surprised at all if either of these two companies have really depressed earnings in 2023, and it pushes their stock prices even lower. The emphasis for me is on the really long term and the secular trends that will benefit these companies. When looking at Alphabet, for example, in what looks like a relatively low PE today, we need to consider that those earnings in the future may decline. We may see lower earnings in 2023, so the stock might look cheap today. So I guess that's my way of saying to be prepared for a potentially bumpy ride with these two companies, as the market is a voting machine in the short run and a weighing machine in the long run. Transitioning to the third company I wanted to talk about in today's episode, this is a new one

Starting point is 00:42:52 I haven't done into prior to researching for this episode. It's a company called S&P Global, ticker SPGI. Value Stock Geek, which is one of my very favorite blogs for company Deepdives, did a pretty detailed article on this company. So shout out to him for his great write-up on his blog called Security Analysis. Plus, my colleague, Sean O'Malley, who's our newsletter writer at TIP, used to work at this company, so I was able to get some interesting insights from him as well. Sean is doing great work on TIP's daily newsletter called We Study Markets. If you're not yet subscribed for that, you can do so by going to The Investorspodcast.com slash we study markets. Now, S&P Global describes themselves as the leading provider of transparent and independent ratings,

Starting point is 00:43:43 benchmarks, analytics, and data to the capital and commodity markets worldwide. Their claim to fame is their creation of the S&P 500 and Dow Jones Industrial Average Indexes, and they're also one of the three major corporate credit rating agencies, along with Moody's and Fitch. So they operate in an oligopoly in this market, which, provides them with one of the most powerful moats in the world. Many of our listeners may be aware that Buffett has roughly a $6 billion position in Moody's and has owned the company since the year 2000. Any corporation that wants to issue debt, which is practically every company, they're going to need to get a credit rating in order to do so. SPGI is also a data company, as in 2020,

Starting point is 00:44:30 they acquired a company called IHS Market. IHS market has various products that provide things such as economic forecasting data, financial data for securities and derivatives, data and analytics for the energy market, and various other niche data. So from a high level, SPGI has four major business segments. First is their ratings business. This is the supplier of credit ratings on corporations and sovereign governments. The blog posts from Secure, analysis states that the data collected from this segment supplies the market intelligence business. Ratings are the most cyclical segment of the company as it depends on new deals and debt issuance, which will pick up when the economy is hot. Ratings represent nearly 57% of operating profits.

Starting point is 00:45:20 The second segment is their indices business as they're the index provider for indexes like the S&P 500. When a company like I-Shares, Van Goghawk, or BlackRock once, to create a product based on the S&P Index, they have to pay SPGI a fee. This segment represents 17% of operating profits. Third is their market intelligence segment that represents subscription software that supplies data to investment professionals, government agencies, corporations, and universities. So this brings that recurring revenue in for providing an essential product for financial professionals. This is 15% of operating profits. And fourth is what's called their Platt segment. This is a data provider of information and benchmark prices for commodity and energy

Starting point is 00:46:06 markets. So what S&P is to the equity markets, Plats is to the commodity markets. This is 11% of operating profits. Thirty-nine percent of the company's revenues are subscription-based and they're very sticky due to the nature of their agreements and their high switching costs as well. The index business is also a very sticky business because of a company like BlackRock creates an S&P 500 index. It's not like they can easily shut that down and stop paying SPGI their fees. And this helps provide entrenchment in the company's moat. SPGI is priced as if it's a great company. Their PE ratio is around 30 and their EV to EBIT is around 24, which is a metric that got

Starting point is 00:46:51 as low as six during the great financial crisis, which was quite an extreme event for company like many other companies. They've outperformed the market over the past 10 years as shares have averaged 22% annual growth over the past decade versus just 12% for the S&P 500. Even since the mid-1980s, it's been a really strong outperformer as they've continued to deliver strong growth in their EPS and their free cash flow per share. The company went through some structural changes back in 2016. And ever since, they've seen considerable improvements in their operating operating margins. Prior to 2016, operating margins were around 30%, and now operating margins are around 50%. Their returns on capital are also outstanding, averaging north of 20%.

Starting point is 00:47:38 And the company also has a really good management team. They recently acquired Market, which helped expand their mo and they rebranded the company over the previous decade from McGraw Hill to S&P Global. The fundamentals have improved substantially over the past few years, as revenues that have grown by over 50% since 2019, and operating income has increased by 64%. I think that if we see poor economic conditions in 2023, then the somewhat cyclicality of SPGI's business will likely come to haunt them like it did during the great financial crisis, but the business itself won't be going anywhere. So we could see some great buying opportunities in this company if we do end up seeing a rough recession

Starting point is 00:48:24 To be honest, I don't love the valuation at these prices, but it's definitely one of the strongest modes for a large-cap public company I could really find. Their returns on capital are really, really good, but if you see their earnings multiple mean revert, you could see a 30 to 50% markdown in the shares to the $180 to $260 range at their current level of earnings. So this company is more so one to add to my watch list to keep an eye on if we do end up seeing a recession and a sharp drawdown in the stock price. Other than the price, it really checks all the boxes for me from a value investor's perspective. All right, so transitioning to

Starting point is 00:49:02 the fourth and final wide moe company I wanted to discuss during this episode, it was somewhat hard to just pick one company. There are a number of companies I've talked about in the past that would probably be what I call honorable mentions, such as Dollar General, Home Depot, Adobe, or there are companies that are frankly pretty expensive on a multiple basis like Costco, MasterCard and some of the other big tech companies like Apple and Microsoft. But that's the trouble with these great companies is that for a lot of the company's lifetime, they're going to be trading at what looks to be pretty expensive prices. Now, let's talk about a company that is likely impossible to be disrupted by technology, and that is Sherwin Williams. Another special shout

Starting point is 00:49:44 out to my friend Adam Ziesel for touching on Sherwin Williams in his book, and it really piqued my interest in the company. Sherwin Williams started all the way back in 1866, and it's widely known for manufacturing paint and paint products. Today, they have about 4,800 locations in the U.S., Canada, Latin America, and the Caribbean. Their business is primarily driven by three main segments, consumer brands, the Americas, and performance coatings. The Consumer Brands is what is sold to retail stores like Lowe's. The Americas is what is sold, and the their own Sherwin-Williams locations, which drives over 50% of their revenue, and then the performance coatings are their industrial customers, such as automotive companies and floor manufacturers.

Starting point is 00:50:30 The company is somewhat tied to the housing market as people do home improvements. They may be redoing their paint job and their home, of course. Looking back at their history, revenues did decline in 2009, but quickly rebounded in the years that followed. The company continued to produce positive net income throughout the great financial crisis as well. Over the past 10 years, this boring, stable business has produced average annual returns of 16% annually, not including the small dividend that they've been paying out, which right now is about a 1% yield. Sherwin Williams has a pretty strong moat for a number of reasons, I think. For the foreseeable future, we're going to always need paint. New houses are always

Starting point is 00:51:13 being built, people are always doing updates on their houses. I think that their consistent operating margins show that they're able to continually increase prices over time without being disrupted by competitors. They've built out these really strong relationships with contractors, and they're able to either deliver products to them in a timely manner or have them pick up the products at somewhere like a Lowe's or in their own Sherwin-Williams stores. Because a lot of these contractors value speed in getting the job done quickly, Sherwin-Williams. is able to deliver fast delivery to customers better than anyone else because they have the largest distribution network of stores in the U.S. Similar to SBGI, Sherwin-Williams is a quality company

Starting point is 00:51:54 trading at a premium price. The EV to EBITs is around 27, which got all the way up to 36 at the end of 2021, and it's now trading more in line with where it was in 2017. Prior to the end, it could be purchased at a multiple in the low teen, so I'd say that the market has definitely recognize the quality of this company. Sherwin Williams has three things I really like to see in a company. On top of their return on investing capital being in the mid-teens, they're continually growing their earnings year after year, they're repurchasing shares at around 1 to 3% per year, and they're steadily increasing their dividend, which is a really strong indication that the management team is looking out for the best interest of their shareholders. I think that investors

Starting point is 00:52:39 will do just fine buying at this price, but more cautious investors may put it on their watch list and see if the multiple drops from the mid-20s to below the 20s to the mid-teens, which is where it's been for a good amount of its history. It's more so what Buffett would call a wonderful company at a fair price than something that happens to be trading at a wonderful price as well. Let's remember that alphabet, which I talked about earlier, is trading at a multiple of 14 to 15 before factoring in any stock-based compensation. Also, for Sherwin-Williams, I wanted to read another excerpt from Adam Diesel's book because I just really enjoyed this book and he has so many good pieces in it. All my non-tech companies are largely tech-proof, but none

Starting point is 00:53:22 is more so than Sherwin Williams. You just can't render paint digitally, at least not yet. Meanwhile, there's something deep within human beings that drives them to coat their walls. either for decoration or to protect against the weather. In 1866, Henry Sherwin and Edward Williams founded the company that would introduce the world's first guaranteed ready-to-use paint. As the industrial age progressed, paint became coatings and was used to finish anything that needed protection from the elements such as automobiles, ships, and airplanes. Sherwin Williams developed many of these modern finishes and patented them, then kept investing money into research and development to deepen its product moat. To make the Sherwin-Williams brand instantly

Starting point is 00:54:10 recognizable, it also kept spending on marketing. Today, Sherwin-Williams has competitive advantages that stem from 150 years of innovation and brand loyalty. But what really distinguishes the company is its incredible retail presence. Sherwin-Williams operates a network of nearly 5,000 company-owned stores and its nearest competitor, PPG, operates roughly 1,000 stores. Why does this network of owned stores give Sherwin an edge? Because only Sherwin Williams has a store base extensive enough to touch American painters every day. Like many great businesses, Sherwin Williams created its moat by asking, What does my customer care about and them working backwards?

Starting point is 00:54:56 Until computers learn about how to coat buildings, the economics of house painting will remain simple. 80% of a painter's expenses are labor, and 20% is paint. Time is therefore money to a painter, and Sherman Williams focused on that fact like a laser beam. Given these unit economics, wouldn't painters reward the company that saved them time? If so, why not roll out so many stores that most would drive by them every day on the way to their job? That's what Sherwin Williams has done. They even offer free curbside pickup so the painters don't. have to get out of their trucks and free donuts as well. The company supplements this network

Starting point is 00:55:37 with the fleet of 3,000 trucks, whose drivers make constant runs to job sites to replenish low supplies. PPG owns their stores, but roughly one-fifth the number of Sherwin-Williams. PPG doesn't have the density required to make the network ubiquitous. Benjamin Moore has more contact points because only Sherwin-Williams can handle national accounts, and only Sherwin-Williams can handle national accounts, and only Sherwin Williams can roll out a new and improved finish in a consistent nationwide brand campaign. Only Sherwin Williams has a mobile app that allows a painter to order 10 gallons of eggshell white in the evening, then show up at his local store the next morning and find it ready for him. Sherwin's store network gives it an edge, and this edge is continuing to grow.

Starting point is 00:56:24 Every year, Sherwin adds nearly 100 new company-owned stores. PPG's annual new store count barely reaches double digits. Little wonder that Sherwin Williams is growing its North American paint sales at 6% to 7% per year, twice the rate of the competition. Meanwhile, Sherwin Williams has a low share of a large and growing market. The worldwide painting and coding sector remains fragmented, and Sherwin only has about 10% of it. At nearly 150 billion in annual sales, the market is huge and growing up. growing slightly more than the worldwide economy.

Starting point is 00:57:02 Management is also excellent. Unlike Bezos at Amazon or Murphy at Cap Cities, there is no single-star executive. There is, however, a culture at Sherwin Williams that inculsates in every employee. From the lowest store trainee to the CEO, the discipline of thinking like an owner. Unlike many companies, Sherwin doesn't just leave it to the CFO to understand principles like return on capital and capital allocation. You can tell this is not only from how executives talk, but how they act. Sherwin Williams rarely buys companies, but when they do, they do it brilliantly. In 2017, they bought ValSpar, a leading industrial coatings company using 100% debt financing.

Starting point is 00:57:46 Like Tom Murphy at Cap Cities, they reasoned that they didn't need to use stock. Instead, they could use Sherwin Williams' ample cash flow to pay down the debt over $7,000. several years, then enjoy the acquisition forever without any dilution to shareholders. Unlike other, less disciplined businesses, Sherwin Williams articulates clear priorities for its cash flow and then sticks to them. It reinvest money in its store network, in product development, and in the Sherwin brand. Anything left over goes back to shareholders, either as dividends or share repurchases. So as you can tell, Ziesel has so much respect for Sherwin Williams as a brand and their business fundamentals. And I also discovered back in 2018, Lowe's

Starting point is 00:58:30 announced that they would be the only nationwide home center outside of Sherwin Williams' own stores. Now, Lowe's and Home Depot are in a race to partner with the very best brands. And this partnership Lowe's established with Sherwin Williams not only shows how strong of a brand Sherwin Williams has, but also helps widen their moat. As anyone who shops at Lowe's and wants to purchase paint, they have no other choice than to buy from Sherwin Williams. If that's not a mo, I don't know what is. A Lowe's executive stated that we do a tremendous amount of research related to customer preferences, and through that analysis, we draw insights, which has led us to some of the most important brands in Sherwin William being one of those. Although the partnership

Starting point is 00:59:15 with Lowe's is great news, the company earns 75% of its profit from the America's group, which is essentially its own stores, and they completely dominate the U.S. with 50% market share. Their competitive advantage in this division is their vertical integration within their operations and their stores being so close to their customers. So again, Sherwin-Williams, it's a great company, likely trading at a fairly high multiple, but it's come back a little bit in 2022 and 2023 here. So I think it's one for considering if you're really looking for companies with really, really strong moats. All right, that wraps up today's episode.

Starting point is 00:59:53 I hope you enjoyed this episode covering four wide moat companies to consider for 2023. If you don't already, be sure to click follow on the podcast app you're on so you can get notified of all of our future episodes coming out in the future. Also, if you enjoyed this episode, I would really, really appreciate it if you shared it with just one person you think would also enjoy it, or maybe even you decide to share it on your favorite social media platform that you use day to day. This will really help us out as we continue to provide these episodes to you for free. TIP is my full-time job. And if you're

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