A fact about moats you should never miss - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

A fact about moats you should never miss 

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In this issue:
» Fiscal deficit crosses 76% of full year estimate in 1HFY14
» The British worry over the operations of Chinese banks
» India Inc's obsession with interest rates
» The uncertainty surrounding the Euro
» and more....

'Economic moat' is a term made famous by Warren Buffett. It is defined as the competitive advantage that a company has over its peers. The wider the moat, the larger and more sustainable is this competitive advantage. And why is a moat important? Well, it enables a firm to consistently earn above its cost of capital and thus prove extremely rewarding for its shareholders.

A gentleman by the name of Pat Dorsey provided interesting insights on how people make mistakes in identifying a moat in a company. Take the example of a company having a great product. Is it the source of a long lasting moat? We don't think so. Sure, a product may do well in the short run, thereby helping a company post a good financial performance. But in the absence of other long lasting advantages, it would be a matter of time before competitors enter the market with similar products. Besides, one can also not rule out the possibility of an improved product being launched which could take away market share from the company in focus.

If this is the case with some companies, it would be essential to figure out how and whether the share is defensible. If you do not find a convincing answer, then in all probability the company lacks an advantage over its peers. There are many examples in history of big brands with great products (at the time) dying or losing out because of not coping up competition. Kodak and Nokia are just to name a few.

Similarly, strong brands are also easily mistaken as competitive advantages. It would not be wrong for one to think that a well known brand would be able to sell products with ease. Sure! That it may be able to do. But how profitably is the key question. Creating a brand costs a lot of money. Profitability of the same is essentially what one must gauge. That can only be done when customers are willing to pay a premium to what is available in the market. In other words, if a company is easily able to pass on costs, and more importantly, if customers are willing to buy products at a premium, you may have found yourself a company that is has an advantage over it peers.

The key takeaway is that companies can benefit from certain advantages in the short run. But in the long run, the incremental returns tend to slow down and eventually die away. So next time you select a identify a stock that you would like to hold for the long term, make sure you find the answers to the points mentioned above before proceeding further.

Do you believe that a good brand or product provides a company with a competitive advantage? Let us know your comments or post them on our Facebook page / Google+ page

01:25  Chart of the day
In the first half of the last year, India's fiscal deficit had reached about 66% of the full year target. This time around (in FY14), it's at a much higher figure of 76%. While this is definitely an area of concern, the silver lining is that the month on month (MoM) increase has been declining. In other words, the deficit has been increasing at a slower pace. As can be seen from the chart below, the MoM increase in the fiscal deficit number (as a percentage of the estimated budget) has been slowing at a gradual pace.

Is the fiscal deficit under control?

India's FM has been seemingly confident on meeting the fiscal deficit target of 4.8% of GDP, with the argument that the revenues are usually back ended. These hopes hinge on the improving tax collections as the economy picks up coupled with revenues from divestments. What must however be kept in mind is that that the fiscal deficit was targeted on expectation of a higher GDP growth rate. With the latter coming down as compared to what was anticipated at the start of the year, it is possible that the actual figure may be higher than anticipated (in percentage terms). Is this why the FM is forced to use his accounting gimmickry skills to make the situation seem better than it is?

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We recently came across an interesting interview with the head of markets - South Asia of Citibank, Mr Pankaj Vaish, published by Economic times. The interview covered his thoughts on what is driving the FII rally in India and whether this would continue or not. And if you think about it, these are questions that we should ask ourselves. Despite all the macroeconomic problems that India is facing, FIIs have still continued to pump money into the markets. As per Mr Vaish, the FIIs have been investing in India simply because they do not wish to miss out on a rally. This is what happened way back in 2009, when most FIIs missed out on the rally that followed the elections. Therefore they are investing because they wish to avoid a repeat of that.

But what we would like to know is isn't it the FIIs that are causing the rally in the first place? A few days back, there was a study done by Economic Times. It indicated that retail participation has dropped to a 10 year low. At the same time, FII participation in the markets has actually gone up to 47%. This shows that most of the so called rally that we are seeing is caused by the FIIs investing money. This again is more a function of the money printing exercise carried out by the developed countries. Since India still offers better returns compared to the developed world, most of this money has found its way into our shores. But whenever the floodgate is shut down, the trend will most likely reverse. Therefore investors would do well to avoid reading FII trends and instead, concentrate on picking up fundamentally strong stocks. That is the way to both build as well as preserve your wealth.

The problem with Chinese banks is neither new nor unknown. Government influenced lending, camouflaged NPAs and excessive exposure to the realty sector haven been risks associated with these banks for long. Ironically some of the top banks in China are also amongst the largest in the world in terms of asset size. And while most banks in China have global presence, very few are subject to global regulatory supervision. That compounds the risk to global economy from these banks. The former Bank of England Governor Mervyn King, had once said, "Banks live globally and die locally." And Chinese banks seem to be going all out to take their aggressive growth plans world over. As per Moneynews, IMF economist Simon Johnson has blamed the British banking regulator for its oversight of the risks associated with Chinese banks. He believes the British are enabling the expansion of China's banks and their move to possible disaster. Instead the Chinese banks operating in Britain should have been subject to UK's banking regulations. We are glad that Chinese banks have hardly any presence in India and the RBI is very careful about the operations of other foreign banks as well.

Ever since the slowdown in the Indian economy, there is a lot of pressure on the RBI to lower rates. And the government is not the only one breathing down on the neck of the central bank. India Inc. also has expectations of a rate cut. But the RBI has been in no mood to relent. And very rightly so we believe. Infact, as per an article in the Economic Times, the Prime Minister's economic advisor Mr Rangarajan has criticized India Inc. for being obsessed with interest rates. The RBI has a tricky job trying to balance growth and inflation. Growth may have slowed down in India. But retail inflation continues to remain high at around 10%. In such a scenario, the central bank has no choice but to raise rates. What will certainly ease the pressure though is the implementation of some key reforms from the government. Once that begins to happen, there is no reason why growth should not pick up in the Indian economy.

In the drumbeats of 21k and Fed's continued QE, one event has surprisingly been left overlooked. And it is the strengthening of the Euro. Apparently, this common currency of the Eurozone hit its highest level since 2011 recently. And there is no reason on the horizon to believe that this trend will reverse in the near future. Or is it? Well, the fact is that we live in extremely uncertain times. And while the Euro zone does look in good shape today, there is a lot of easy liquidity out there that's supporting it. As a matter of fact, the US dollar, the currency against which the Euro is most often pitted is in no great shape either.

To cut a long story short, most of the developed world is mired in debt and the policymakers seem hell bent to prevent the inevitable for as long as possible. This is leading to massive intervention, making currency predictions a very difficult task. Consequently, our guess is as good as anybody else's out there. What we are certain though is that it would not be a bad idea to have some part of one's investments in the yellow metal gold.

Property prices in India are in an overheated zone. Inventory levels have been rising. External liquidity support in the form of bank loans is drying. All these factors signal towards only one thing. A correction in property prices! However, you may have noticed that this phenomenon has been prevailing for quite some time now. And this has only strengthened expectations of a correction. Yet, there hasn't been any meaningful correction in the real estate space. But why? Even real estate is an asset class that is subject to demand supply dynamics. So, with demand dwindling prices should correct. But the reason prices aren't correcting is that this asset class is unique. This is because the micro structure of real estate varies from region to region. Also, every developer's financial situation is different. Pricing, property features, geographical location, amenities are also different from project to project. All these factors influence the demand supply dynamics and thus prices. Hence it is very unlikely that there will be an across the board correction in real estate market. However, as highlighted earlier, the state of the property markets is not good. This means that correction would happen but only in certain pockets at a gradual pace. And this would be good news for home buyers after a long time.

After hitting an all-time high during the early part of today's trading session, Indian stock markets pared gains and dropped towards the dotted line. At the time of writing, the benchmark BSE-Sensex was up marginally by 6 points. Sectoral indices were trading mixed with realty and metal stocks leading the gains. However, FMCG and consumer durables stocks were leading the losses. Asian stock markets were trading on a mixed note with China and South Korea trading firm, while Japan and Indonesia led the losses. The European markets have also opened on a mixed note.

04:50  Today's investing mantra
"Basically, price fluctuations have only one significant meaning for the true investor. They provide him with an opportunity to buy wisely when prices fall sharply and to sell wisely when they advance a great deal. At other times he will do better if he forgets about the stock market and pays attention to his dividend returns and to the operating results of his companies." - Benjamin Graham

Editor's note: There will be no issue of The 5 Minute WarpUp on 2nd November and 4th November on account of Diwali.

We wish all our readers a very happy and prosperous Diwali!
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5 Responses to "A fact about moats you should never miss"


Nov 10, 2013

Economic Moat is a very interesting Concept.Like many other concepts used and popularized by Warren Buffet, this too is a concept, which is essential for medium / long term Investors. The ability to grow constantly and profitably in the long term contains factors innate to Economic Moat.But, Moat can never be a static idea. For the same company, moat can go on changing in every 2-3 years. I would say, more than a product / service, the dynamism and flexibility of a management to hold on to a competitive advantage when one exists and to create one, when the existing one is withering away - is the Economic Moat. Ultimately, it is the management which must create and sustain the Moat. So, look at the management first, then at the product and its competition, then the size of the Market and the Growth potential. Other than Management, there is no other single Moat factor. they keep changing in the long term. In the long term, all products are dead.An Agile Management is the only insurance for the Investor.That too could change some times.


Venkat S. ananth

Nov 5, 2013

Even real estate is an asset class that is subject to demand supply dynamics. So, with demand dwindling prices should correct. But the reason prices aren't correcting is that this asset class is unique. This is because the micro structure of real estate varies from region to region........, this subject has been dealt with in the movie"Assault on Wall Street"....try to watch this if possible.....it's about investor's faith in a broker who promotes this asset class on a Research Company's advice...after watching this movie guys will ose interest in Research Company's forecasts....

Venkat, S. A.



Nov 3, 2013

I call it KFI to avoid struggling in whichever moat or ditch u r. KFI is constant F innovation to ease ur own life and also that of ur customers. chill Happy Diwali



Nov 3, 2013




Nov 2, 2013

Before investing in a company you have to analyse the competitive advantage of the product in the market, to see how well that product is performing in the market you have to analyze the financial statement of the company.Every company starts from the position of monopoly. Then few other companies, attracted by the huge profit, enter the industry. This brings the price down. But this cycle does not happen immediately. so the oligopoly continues. So does the abnormal profit of these companies continues in the mid term. In the mean time all companies strive for product differential and ultimately product innovation.

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