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If you can't hold it in your hands, is it real?
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It is one of the most often terms used in modern finance when trying to assess how a company can maintain a competitive advantage: MOAT.
When you hear the term, you think of a castle surrounded by crocodile-infested waters. A huge mahogany drawbridge comes up and down via oversized steel chain links to keep invaders out while still affording the lords and ladies of the castle the opportunity to venture out and explore new lands.
This is exactly what a company tries to do when defending itself against competitors that are trying to steal market share.
The term was popularized by Warren Buffett and explains a competitive advantage that a company has which gives it pricing power, control of profit margins, and retention of customers.
But the way that we define, build, and maintain moats are changing. Intangible assets are now much more valuable than traditional methods of simply building out Capital Expenditures (CAPEX).
This week, in <5 minutes, we’ll cover intangible assets:
The Balance Sheet Definition 👉 Goodwill & Intellectual Property
The Warren Buffett Model of Building a Moat 👉 Coca-Cola
Modern Day Moats 👉 R&D as an Intangible Asset
Example in the market 👉 Traditional (CAPEX) + Modern (Intangible) Moats
How GRIT’s Playing it 👉 Disney + New Holding!
Let’s get started!
1. The Balance Sheet Approach 👉 Goodwill & Intellectual Property
An intangible asset is a non-physical, but identifiable attribute of the business that is valuable. In other words, its something that you can’t hold in your hands but is worth something.
The two main components that accountants use to balance the intangible books are Goodwill & Intellectual Property.
Goodwill is a line item that is difficult to quantify. It tries to account for things like customer loyalty, brand reputation, and the management team. But how do you measure these things?
Those components also cannot exist outside of the business. So if they are so intrinsically linked it creates an incredibly difficult mental gymnastic exercise to value them.
Intellectual property is also a bit tricky. This includes copyrights, patents, licensing agreements, website domains, and a lot of technical know-how. It is also difficult to quantify, but later on in this piece, I will highlight why I think this is where a lot of the value is now accruing in a technology-dominated stock market.
2. The Warren Buffett Model of Building a Moat 👉 Coca-Cola
The way that Warren Buffett picks companies is usually seen as value-driven as he tries to identify companies trading for less than their intrinsic value. That is not to say that he always hunts for companies with low multiples. He identifies value through a lens whereby he sees this value increasing drastically over time.
He does this in a three-part system
Part 1: Identify a company with a competitive advantage
Warren Buffett has famously held Coca-Cola for a VERY long time. The dividend he receives from the company is now roughly equal to 60% of his original cost base. He entered this position with a $1B purchase in 1988 after the crash of ‘87 left the stock undervalued. As of today, he is up 1550% on his Coca-Cola position, not including dividends.
The competitive advantage that he highlighted with this company was the distribution network, the relationship with retail, and the strength of its brand with customers.
Distribution networks and relationships with retail take time and capital to build out, and are largely a game of scale. These assets are a component of the build-out strategy that are tangible and contractual.
They take tens of millions of dollars and decades to build out - so it is hard for startup companies to compete.
The intangible aspect of this moat is the brand. You cannot hold it in your hands.
No matter what language you speak or where you live, Coca-Cola is ubiquitous the globe over. This was built not only through the quality of the product but more so through marketing tactics that created a “lifestyle” approach around the brand. How does this product make you feel?
This is one of the oldest traditional forms of intangible assets: the brand.
Part 2: Longevity of the underlying business
The longevity of a business can be assessed through numerous things, but one of the most prevalent factors for traditional moats is the capital intensity to enter the business.
If it costs a lot of money to build out a distribution network, a manufacturing facility, or even a brand, this will deter competitors from gaining market share.
The unit economics on selling an individual bottle of coca-cola drastically improve when you produce at scale. By being able to manufacture each bottle individually for a lower price, you can pass this saving along to the consumer by lowering the price of your product, increasing the incentive of the consumer to prefer your product.
Once you get manufacturing and distribution figured out, which is VERY capital intensive, you can also build a brand and an affinity towards your product to increase your profit margins.
There are many iterations and configurations in pricing strategy, but Coca-Cola’s approach was one of massive scale and brand affinity rolled together.
Part 3: Great Management teams
Often, when looking at a company there are just too many unknowns in the future. Since the world is incredibly dynamic, you need to be able to bet on the horse in the race and trust that they will provide superhuman judgment capabilities when faced with strategic decisions.
This “secret sauce” in the founder team is also one of the early forms of intangible assets.
Now, let’s check in with our Outrageous Chartered FinMEME Analyst Dr. Patel and see what he thinks about Intangible Assets?
3. Modern Day Moats 👉 R&D as an Intangible Asset
Today, I believe there is a massive amount of intangible value accruing in research and development spend in software companies - and the stock market agrees with me.
Research & Development is listed as an operating expense on the income statement and usually is not depreciated over time. However, this is an expense that is directly contributing to the intellectual property that is being built out at software companies.
Currently, R&D is spent in one year, then never mentioned again in the 3-statement system. But what that R&D spend is going towards is building out the product (Intellectual Property) that reaps massive rewards that shows up as revenue growth.
In software land, the “bottoms-up” approach is product-centric rather than sales-driven. Great examples of these companies are Atlassian and Twilio. They are closely tied into software developer communities and are heavily investing in the research and development of their products.
If you look at Atlassian, it has one of the heaviest R&D line-item costs as a percentage of revenue (+47%). But that’s because the growing has just begun.
There is a pretty famous billionaire that is launching himself into space (actual space, not just really high in the sky) that was also extremely customer-focused. That seemed to work well for him.
By investing so much in the early stage in R&D in the product, what Atlassian is doing is creating rabid fans of their product in the developer community. What they are also doing is building up a huge asset that you won’t really find in their 3 statement financials or in your CFA textbooks – intangible assets.
To me, this looks like a massive moat being built in an incredibly fast-growing industry. “Move fast – and care about your end product users” should be the new Silicon Valley mantra.
When you look at the characteristics of these bottom-up companies they typically are cash flow negative, but earn a higher revenue multiple because they are growing at insane clips.
In a nutshell, it’s short term pain (big R&D spend) for long term gain (massive growth and stock multiple)!
4. Example in the market 👉 Traditional (Capex) + Modern (Intangible) Moats
The way I like to look at moats combines the moats of old with those of new. An example I like to make is Facebook.
Facebook has built an incredible media platform that sells ads. The way that they can contextualize user data to deliver niche audiences to advertisers makes it the most efficient way for any business to get in front of their customer.
The moat that they have built is that of a network. In the movie The Social Network, Zuck’s character very purposely does not want to put in ads early in Facebook’s trajectory because they didn’t know what it was yet - and ads are not cool. Once they had scale, then they could turn on the monetization pipes.
On the other hand, this aggregation of data + network effect has a very “moats of old” vibe to it when you look at Facebook’s CAPEX spend. Facebook spends more than $15 billion per year in capital expenditure to build out its infrastructure network.
This is 15x more than their closest competitor in the social network space.
Awesome symbiosis of how to think where a company spends money to form a competitive advantage.
Under the Radar…
Novamind recently DOUBLED their clinic footprint! Their network of psychiatry clinics, research sites, and therapeutic retreats is growing ahead of schedule which means they’ll be able to give more patients access to innovative, evidence-based psychedelic treatments! See how it’s going here*!
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Why is BILLIONAIRE mining mogul Richard Warke steadily increasing his position in SOLARIS RESOURCES* to the tune of $122 MILLION DOLLARS and counting? Maybe because they’ve made a MAJOR discovery at the beginning of a NEW COPPER supercycle!
Where is the best place to produce gold? The place it’s already happened! Omai Gold Mines* produced MILLIONS of ounces while the gold price was less than US$350/oz. I wonder what happens when the gold price is +$1800/oz ; )
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5. How GRIT’s Playing it 👉 Disney + New Holding!
Another example of combining old and new moats is one of my top holdings: Disney. If you think about what Disney is at its very foundation - it is an IP powerhouse. The House of Mouse owns all the most recognizable brands and imaging in all of entertainment.
They acquired Marvel back in 2009 for $4B, adding a portfolio of brands that would go on to become an absolute juggernaut in the box office (Avengers).
They leveraged this massive brand affinity in a highly scalable way through their streaming service, Disney+. Early subscriber growth was absolutely massive and it seems like it would be almost criminal to not get a subscription if you have a screaming 3 year old in the back of the car on that long family road trip.
“Here’s some Moana little one, now go to sleep.”
But they also built out a moat through physical CAPEX and infrastructure spend when you look at a large part of their revenue: PARKS. These are not cheap to build out, and when vaccinated patrons begin their pilgrimage of revenge travel + spending in the US, this will come back to life in a huge way.
The stock recently perked up on the back of a re-open the world trade!
I also added another VERY exciting position that I’ve been doing deep dive work on for a long time now. I have talked to the largest shareholder, waited for a pullback after a hot run, and now have huge conviction on this name.
Subscribe to the paid version of my newsletter to get my inside scoop on this, and many other ideas from my own portfolio!
If you look at the prices of stocks, there are two components.
Fundamental x Sentimental = Price
Fundamentals are things like sales, earnings, and book value that you draw some sort of basis of intrinsic value on. Sentimental is what is commonly referred to as a “multiple” that you pay in hopes the company will deliver future growth.
More and more of that future growth today is gathered around leveraging intellectual property which Research & Development fuels.
This is why high-technology companies deserve the high multiples they have today, because of the scalable intangible assets they will monetize down the line.
Until next time. Always Yours. Incessantly Chasing ROI,
-Genevieve Roch-Decter, CFA
P.S Peter Thiel, the PayPal ‘Mafia King’ (who never sleeps), is taking a $9B crypto deal public. In the last 12 months he took Palantir (meme/software/defense) public, then Affirm (buy now/pay later), then Atai (let’s get psychedelic), and now this!
What else we Grittin’ On?
iBanking. Banks reported (near record) earnings last week, helped, in part, by the release of billions in reserves that had been set aside for loan losses (COVID). Another tiny driving factor? INVESTMENT BANKING. Global deal volume hit $1.42T last quarter alone!
Blackrock is buying every single family house they can find, paying 20-50% above asking and outbidding normal home buyers. Why is the largest asset manager in the world doing this? Predictable cash flow + inflation-protection. How can you get in? Greenbriar Capital*, one of only a handful of land developers that are publicly traded!
Oil Spike. OPEC oil producers FINALLY reach an agreement to boost oil supply as prices spike to nearly 3-year high. Seriously, all this fuss over 150k barrels?
What’s better than psychedelics? Environmentally friendly psychedelics. Psybio Therapeutics is developing a portfolio of pharmaceutical candidates using BIO-SYNTHESIS which offers advantages in space, consistency, stability, production and makes them GREENER. The best part? Not only are they already a top-performing stock, but they soon plan on filing their first IND with the FDA and also plan to list on the NASDAQ*!
iPhone to the Moon. Apple wants to boost iPhone production by 20% after last year’s 5G super cycle. Translation, people will literally pay anything to watch TikTok videos of dancing cats one second faster.
Blockchain Foundry has been on a tear! Through various partnerships, they’re developing white-label NFT products for sports & entertainment, building an extended reality NFT marketplace, AND a crypto & NFT gifting platform! Get blockchain exposure without the steep price tag*.
Used Cars. +30% of June’s month-on-month rise in CPI came from the appreciating value of second-hand cars. Who would have thought your rusty Toyota corolla is now worth more than you bought it in 2003 ; )
JPMorgan thinks proof of stake will be a $40 billion industry by 2025. Want exposure? iMining is the place for everything crypto! They currently provide staking services. Soon, through their intent to acquire BitBit Financial, you’ll be able to trade, stake + lend crypto all on the same platform*.
Goldman Sachs has "aggressively" and quietly liquidated a quarter of its equity investments. The sales were so extensive that the topic was brought up on their earnings call. What does that mean in English? Simple: Goldman is "aggressively" dumping its positions in an environment that is "supportive", i.e., in which the dumb money is providing a constant bid into which whales such as Goldman can sell.
North America’s leading cannabis distribution solution just got THAT much better. After helping lead Supreme Cannabis, Aphria (now Tilray), and Southern Glazers, new CEO Joel Toguri is ready to take Humble & Fume to the next level! Invest now*!
Revenge Travel. U.S. gasoline demand rose to highest on record last week. U.S. gasoline prices have jumped by around 40 percent since the beginning of this year. People will do just about anything (including ignoring the price at the pump) to get out of their house and into some fun this summer!
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