The title may seem a bit flippant, but Pat Dorsey’s The Little Book That Builds Wealth (2008) is not your usual get-rich-quick book. It does not offer hare-brained schemes that promise to double your bank balance in a few years. It is instead a serious book that advises on the types of stocks to include in your portfolio for the long term.
So which companies to pick? Dorsey’s short answer is: Pick companies with “specific structural characteristics called competitive advantages or economic moats. Just as moats around medieval castles kept the opposition at bay, economic moats protect the high returns on capital enjoyed by the world’s best companies.” Companies with moats will generate economic profits for a longer stretch of time than companies without moats and are hence more attractive for stock pickers.
There are several features of a business that can offer a moat. One of them is intangible assets. Examples are brands, patents, and regulatory licences. For instance, Tiffany is able to charge more for a diamond compared to Blue Nile or Borsheims solely due to its brand name. Brands are attached to differentiated products like Coke, Oreo cookies or Mercedes-Benz cars. The brand reduces the customer’s search costs and hence protects the company. But if the brand loses its lustre, the company will no longer be able to charge a premium price.
On the other hand, pharmaceutical companies protect their products by patents which provides long term profitability to the company. Companies like Merck and Eli Lilly have a good positioning due to hundreds of patents they own.
Another sign of a moat is high switching costs. An example is Intuit. Intuit makes the software products QuickBook and TurboTax which have a high market share. This is because once a customer uses their software, she is reluctant to switch over to another software later due to the effort involved in relearning. This happens even if the newer software has slightly better features. Thus a company with high switching costs is able to protect its turf.
Other examples of moats are network economy and cost advantages, i.e., offering goods or services at a lower cost than the competitors.
But identifying moats alone is not what the book is about. The book also discusses when to buy a stock from a company that has a wide moat and covers valuation techniques. It also discusses when to sell a stock, how to decide whether a moat is eroding, etc. A good book to possess if you are into value investing.
So which companies to pick? Dorsey’s short answer is: Pick companies with “specific structural characteristics called competitive advantages or economic moats. Just as moats around medieval castles kept the opposition at bay, economic moats protect the high returns on capital enjoyed by the world’s best companies.” Companies with moats will generate economic profits for a longer stretch of time than companies without moats and are hence more attractive for stock pickers.
There are several features of a business that can offer a moat. One of them is intangible assets. Examples are brands, patents, and regulatory licences. For instance, Tiffany is able to charge more for a diamond compared to Blue Nile or Borsheims solely due to its brand name. Brands are attached to differentiated products like Coke, Oreo cookies or Mercedes-Benz cars. The brand reduces the customer’s search costs and hence protects the company. But if the brand loses its lustre, the company will no longer be able to charge a premium price.
On the other hand, pharmaceutical companies protect their products by patents which provides long term profitability to the company. Companies like Merck and Eli Lilly have a good positioning due to hundreds of patents they own.
Another sign of a moat is high switching costs. An example is Intuit. Intuit makes the software products QuickBook and TurboTax which have a high market share. This is because once a customer uses their software, she is reluctant to switch over to another software later due to the effort involved in relearning. This happens even if the newer software has slightly better features. Thus a company with high switching costs is able to protect its turf.
Other examples of moats are network economy and cost advantages, i.e., offering goods or services at a lower cost than the competitors.
But identifying moats alone is not what the book is about. The book also discusses when to buy a stock from a company that has a wide moat and covers valuation techniques. It also discusses when to sell a stock, how to decide whether a moat is eroding, etc. A good book to possess if you are into value investing.
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