Warren Buffett is credited with making moats the “holy grail” of investing. Essentially, it is about investing your money into companies with a sustainable competitive advantage over their peers, ensuring lasting success.

While this concept seems intuitive, I struggle with it. It’s not the concept that troubles me but rather its practical application. Finding these moats is just not easy!

This week, let’s discuss these moats…

What is a Moat?

To understand a moat, let’s borrow from Buffett’s analogy.

Picture a business as an economic castle under constant siege from competitors. These rivals aim to seize the castle, i.e. take market share. The moat serves as the protective barrier around this castle. It could take various forms: being a low-cost producer, holding a franchise that’s tough to replicate, facing high entry costs like establishing a power plant, or enjoying a monopoly such as a power distributor. The broader the moat, the more impenetrable the economic castle, making the business more appealing.

I probably haven’t done the description justice, so here is Buffett’s explanation:

Why is a Moat Important?

Businesses come and go, but some last much longer than others. Why is that?

Besides that, it offers a service or product that people want. It has a competitive advantage over its peers, allowing that business to survive during difficult economic times when most of its peers are forced to shut down and thrive during the good times.

Success is far from guaranteed when investing, and one sure way to lose is to invest in unsustainable businesses. The opposite also holds true: your success rate is far higher when you invest in a company that will do well during both good and bad times.

Buffett is so good at doing this, and what so many, including myself, try to replicate is finding companies with a competitive advantage that will outperform their competition over the long term.

Examples of Economic Moats

Despite the challenges in finding them, arming ourselves with knowledge is never a bad idea. So, let’s cover the various types of moats and look at examples for each.

Low-Cost Producer

A low-cost producer is a company that can manufacture or purchase goods or services at a lower cost than its competitors. This competitive advantage allows the company to offer products at lower prices, enabling it to gain market share.

Great examples are Costco and Walmart, whose sheer size enables them to procure goods at lower costs than their competitors and pass on these savings to customers. However, it’s worth noting that while this type of moat offers advantages, it’s vulnerable to disruption, as seen with Amazon’s ability to streamline operations and undercut traditional retailers.

Network Effect

The network effect occurs when the value of a product or service increases as more people use it. In other words, the more users a network has, the more valuable it becomes to each user.

It’s most commonly observed in social media platforms such as Facebook or WhatsApp, where the platform becomes more indispensable as more users join. Even Spotify has a network effect whereby its recommendation algorithm becomes more accurate with each additional user on the platform rating music.

The drawback is that switching costs can be low – it is effortless to use TikTok instead of Instagram, making it easy for users to migrate to a better alternative, as exemplified by the decline of MySpace.

High Barrier to Entry

In my view, industries characterized by high barriers to entry often possess some of the strongest moats. These barriers may be substantial capital requirements or intellectual property protections.

For instance, the semiconductor industry, which necessitates a high degree of expertise and substantial financial investments, presents formidable hurdles for new entrants. Not just anybody can set up a chip fabrication plant or design a world-class processor.

Similarly, the telecommunications sector demands significant startup capital, creating obstacles for potential competitors. However, it also faces challenges due to rapidly evolving technologies and the customer’s purchasing power, leading to ongoing capital expenditure at diminishing returns on investment.

Switching Costs

Switching costs represent another formidable competitive advantage. When it’s difficult or inconvenient for customers to switch from one provider to another because it requires significant time and resources and causes potential disruptions to operations, companies enjoy a captive customer base.

For example, Oracle customers hesitate to switch to alternatives because of the pain involved, regardless of whether better options are available. Similarly, companies like Microsoft and Apple create ecosystems that lock users into their products and services, making switching inconvenient.

Monopoly

A monopoly occurs when a single company has exclusive control over the supply of a particular product or service, effectively dominating the market and preventing meaningful competition. This control often arises from regulatory privileges, ownership of essential resources, or technological superiority. They benefit from pricing power as consumers have no alternative.

A good example is a power distributor licensed by local or national governments to distribute power through the region. It makes little sense to have two distributors in the same geophagy, and since we all need electricity, there is little we can do regarding their pricing power.

Of course, even power distributors can lose their moat with a simple change in regulation or innovation, such as home solar becoming more affordable.

Brand Loyalty

Brand loyalty, Buffett’s favorite moat, is perhaps the most challenging to quantify. Strong branding creates emotional connections with consumers, fostering loyalty that transcends product features.

For instance, I read a study on Apple vs Samsung’s branding power a few years back.

According to the study, loyal Apple customers showed the same emotional connection to the Apple brand as they did with their relatives (the ones they liked anyway 😆 ). In contrast, Samsung generally showed a shallow emotional connection to the Samsung brand and an adverse reaction to Apple, suggesting they didn’t like Samsung but rather hated Apple.

That is a powerful brand and perhaps why Buffett bought Apple shares in 2016.

Finding a Moat Isn’t Easy

While understanding the concept of a moat is relatively straightforward and widely touted as the ultimate investing strategy, I’ve personally struggled with it, and I believe many others do, too.

People often cite examples like Google, Amazon, or Netflix to illustrate moats due to their industry dominance. I agree they are fantastic companies with wide moats, but it is easy to recognize them in hindsight. What value does that bring to an investor after the fact, especially when competitors are already breaching the castle walls?

The actual skill lies in discovering a moat before others do. In the next section, we’ll look at a real-life example of a company I believe has a significant moat.

Let us continue our discussion on competitive advantages.

I thought it would be valuable to share with you a company I believe has a wide and sustainable moat - The St. Joe Company

How is this about learning from the experts?

As discussed below, the largest shareholder is a very well-respected value investor, Bruce Berkowitz. I learned about JOE by reading the company’s annual reports, listening to annual shareholder meetings, reading Berkowitz’s commentary about the company, and watching interviews with him. Therefore, he taught me about the company, and I want to pass it on to you!

I hope you enjoy it!

The St. Joe Company: An Economic Castle with a Wide Moat

Company Description

The St. Joe Company (JOE) is a property company with 168,000 acres of land in Northwest Florida with development rights. Rumor has it that Walt Disney originally wanted to build his Disney World theme park on this land but was rejected by the company’s CEO at the time.

JOE is in the process of developing this land, but what makes it stand out from other property developers is that it has an owner-oriented mindset, meaning it develops residential communities, hospitality and commercial projects with the idea of owning as much of these developments as possible while getting a third party to manage the day to day operations.

This business strategy does two things:

1. It sets up a lifetime of recurring revenue stream from land it develops – The more it builds, the larger the revenue stream becomes, and JOE has only developed 2% of the 168,000 acres!

2. As the area’s densification increases, the land will increase in value, and JOE benefits from that appreciation - the land is held at cost on the company’s balance sheet, meaning it is significantly undervalued.

Owned by a Respected Investor

JOE’s largest shareholder is Fairholme Capital Management, led by respected investor Bruce Berkowitz, who is also the Chairman of JOE. Fairholme owns over 38% of the company, but more importantly, JOE counts for almost 90% of Fairholme’s fund, so you can be assured that the Chair will protect the interest of the shareholders.  

The Moat - No Competition

Because of the size of the land JOE owns, it can develop without risk of competition, giving it a monopolistic feature. 

As discussed in the Investing Chronicles, a monopoly can be a powerful moat; however, regulatory risk can be a threat. In JOE’s case, it owns the land and has been granted development rights. The risk of the rights being taken away is low, and since JOE owns the land, the risk of Florida allowing competition into the area is even lower.

Therefore, JOE has a powerful monopoly in the area and, consequently, a wide moat. Just take a look at what they are building…

The Pandemic: The Catalyst it Needed

For JOE to reach its true potential, the majority owner in 2017 stated the company needed a catalyst. In 2020, it appears that that catalyst occurred.

Lockdown across the United States resulted in the migration of people away from urban areas the the coast in the South of the country. “If I don’t have to go to the office, I ain’t going to live in New York” became the mentality as people left the cities.

Northwest Florida became one of the fastest-growing areas in the country because of this migration—this growth continues to this day. As more people flocked to the area to buy homes, the need for services such as hospitals, schools, hotels, and shopping centers increased, and Northwest Florida reached critical mass.

JOE has, therefore, been building homes, clubhouses, hotels, office parks, retail outlets, hospitals, schools, etc. Most exciting is that the company has only developed 2% of its land thus far, so the growth should continue for years to come.

At least, that is the plan!

So, while I believe JOE has a moat, I cannot say anything with 100% certainty because things may go wrong. People could stop moving to the area, or perhaps development rights are taken away, but until that happens, I will own shares in the company, continue to monitor the business as it develops and hopefully will be a shareholder of what appears to be an impenetrable castle for many, many years.

Resources

• Bruce Berkowitz - 2017 Bloomberg Interview: See from 37:31

• Bruce Berkowitz - 2023 Wealthtrack Interview: See from 19:10

• Bruce Berkowitz - 2024 Richer Wiser Happier Podcast: See from 34:47

• The St Joe Company Annual Reports

• The St Joe Company Presentations

• The St Joe Company Project Updates