How to differentiate between Moats and Hawa Mahals ?

For most of us, its common sense to pay more for something that is more durable. Fr
om kitchen appliances to cars to houses, items that will last longer are typical
ly able to command higher prices, because the higher up-front cost will be offse
t by a few more years of use. Hero Motor corp bikes costs more than TVS bikes, A
sian paints costs more than Berger paints and so forth.
The same concept applies to the stock market. Durable companies that is, compani
es that have strong competitive advantages are more valuable than companies that
are at risk of going from hero to zero in a matter of months because they never
had much of an advantage over their competition.
What is an Economic moat?
"The idea of an economic moat refers to how likely a company is able to keep com
petitors at bay for an extended period. One of the keys to finding superior long
-term investments is buying companies that will be able to stay one step ahead o
f their competitors."
Moats Matter for Lots of Reasons
Why else should moats be a core part of your stock-picking process?
Thinking about moats can protect your investment capital in a number of ways. Hi
gh returns on capital will always be competed away eventually, and most companie
s must be ready to face the competition. Bargaining power with customers, Bargai
ning power with suppliers, Entry barriers, Rapid changes in business environment
, Government policy etc are the factors that determine the economic moat.
Flipkart is currently facing huge competition from global online gaint Amazon.
Exide batteries had failed in this aspect and loosing it's market share to Amaro
n batteries.
BSE also failed in this area and lost most of the market share to NSE.
Bharti Airtel v/s Tata Teleservices
L&T v/s Hindustan Constructions
HDFC bank v/s Central Bank
Prestige home appliances v/s Ganga home appliances
and the list goes on (some comapnies in the above list can also be considered as
duopoly in the markets).
Moats give us a framework for separating the "Here-today-and-gone-tomorrow" stoc
ks from the companies with real sticking power.
Finally in Buffet's own words "I want a business with a moat around it. I want a
very valuable castle in the middle. I want the Duke(management) who is in charg
e of that castle to be very honest and hard working and able"
All said, now the interesting part :)
How to identify Hawal Mahal companies and stay away from them?
There is a jargon in investment community, "Bet on the Jockey, not on the horse"
. Well it may not work all the time. What if the world best Jockey is given a sh
etland pony. Nothing much can be done. No matter what, we have to emphasize on b
oth Horse and Jockey (because we are poor retail investors)
Pantaloons was once a wealth generating machine (Basant Maheshwari sir made a fo
rture of out it), but does it have a Moat around it. Absoultely NO. It failed to
the competitors. Bajaj auto case was almost the same (but thanks to it's Bajaj
Pulsar) later back in the game.
Hence always look for:
1) The products or services that a company sells maybe hard for customers to giv
e up, which createscustomer switching costs that give the firm pricing power.
2) Companies have cost advantages, stemming from process, location, scale, or ac
cess to a unique asset, which allow them to offer goods or services at a lower c
ost than competitors.
3) Sources of structural competitive advantage are intangible assets, high custo
mer switching costs, and cost advantages. If you can find a company with solid r
eturns on capital and one of these characteristics, youve likely found a company wi
th a moat.
Following are the companies which didn't fit in the above characteristics and fa
iled miserably. Need not say about the it's investors
Hawa Mahals of India:
Suzlon
Unitech
Relaince Capital
DLF
Reliance Power
Pantaloons
"All I want to know is, where I am going to die, so that I will never go there"
- Charlie Munger
Companies without Economic moats are the ones where you will suffer i if you ent
er
A pig with lipstick is still a pig.