Client Login 800.541.0170

Beyond the Numbers

Beyond the Numbers

Trusted advice to help you think big and plan bigger.

Thoughts on Moats and Management

image
Research Analyst
Research, Cincinnati

“If you have a castle in capitalism, people are going to try to capture it. You need two things – a moat around the castle, and you need a knight in the castle who is trying to widen the moat around the castle.” – Warren Buffett

Readers sent in some thoughtful responses to my recent post, “What Is and Isn’t a Moat.” Most of the comments centered on whether or not a company’s management can be an economic moat source.

Those who say that management can be a moat make a fair point: management can create cultural advantages or make value-creating investments. 

I don’t disagree; however, while management can build (or destroy) a moat, I don’t think they are a moat themselves. Consequently, I find it better to analyze moat and management separately.

Here’s why

In theory, an executive can leave a company at any time. Surprise retirements are not uncommon, for example, particularly following a successful stretch. With smaller companies, a larger firm with deeper pockets can lure away promising leaders. And in rare cases, individuals depart the company due to family issues or tragedy.

Given that the median tenure of S&P 500 CEOs is about six years, according to data company Equilar, it’s hard to judge beforehand which CEOs will remain in place over the next decade.[1]

As such, management alone can be an unreliable source for long-term competitive advantages. 

A different take

Even if you think you’ve found the next Jeff Bezos or Mark Zuckerberg, I still find it more instructive to consider what will endure beyond a leader’s tenure. In other words, how is management creating or strengthening the economic moat? It is these advantages which, if successfully cultivated, can be durable across decades.

Consider Disney CEO Bog Iger’s acquisitions of Pixar, Marvel Entertainment, and Lucasfilm over the last eleven years. These investments added, among others, the Star Wars, X-Men, Toy Story, Finding Nemo, Spider-Man, and Iron Man franchises to Disney’s already-impressive portfolio of characters and intellectual property.

In the event you had billions of dollars at your disposal to create characters to take on Disney, you’re up against some major obstacles. Ultimately, there’s only one Darth Vader, one Wolverine, and one Dory. Good luck competing with that.

Iger recognized the distribution potential of these unique characters, as he explained in the 2009 Marvel acquisition conference call. “The popularity of Marvel characters and stories transcends gender, age, cultural and geographic boundaries,” he noted, “and can be told successfully across a wide range of both traditional and new media platforms.”

These strategic investments widened Disney’s intangible asset-based moat, which should benefit Disney shareholders well past Iger’s retirement date. Though subsequent Disney CEOs will need to maintain, and ideally further improve, Disney’s moat, Iger himself is not the moat. Rather, he is the “knight” responsible for widening it.

Bottom line

Understanding the intersection of moat and management is a framework that I’ve found helpful for evaluating a business’s long-term viability. Both are critical components of a company’s – and by extension, its investors’ – success. As such, I find it most useful to separate the two when conducting research.

Once you’ve identified a company’s moat source, you have a good filter through which you can view management and determine how they might be widening (or narrowing) the moat through capital allocation and corporate culture.

Stay patient, stay focused.

Best,

Todd

You can contact the author by email.

Also by the author:

You can also follow Johnson Investment Counsel on Twitter @johnsoninv

(Cover image: Armor for Man and Horse, Kunz Lochner. Metropolitan Museum of Art)

[1] http://www.equilar.com/blogs/59-ceo-tenure.html

Disclaimer

Todd Wenning is a Research Analyst with Johnson Investment Counsel (“Johnson”). Some Johnson clients own shares of Disney.

This article is not meant to be a recommendation toward the sale or purchase of any of the securities mentioned in the article. The contents of this article express the opinions and views of the author and do not necessarily reflect the opinions or views of Johnson or its employees.

The views and opinions presented in this article are intended for entertainment and educational purposes only and should not be construed as a solicitation to effect transactions in securities or the rendering of personalized investment advice.  The views and opinions expressed in this article are not intended to be tailored financial advice and may not be suitable for your situation. No person should assume that any advice or strategies presented in this article serves as the receipt of, or a substitute for, personalized individual advice from an investment professional. You should consult with a professional before taking any action inspired by the views and opinions presented in this article.

The links provided contain documents and materials owned and prepared by third parties. Johnson has no control over the materials that are accessible in the links provided and does not endorse or have responsibility for any content provided in the links. Your use of each site shall be subject to the terms and conditions set forth in each site. Johnson shall not be responsible for any damages or losses arising directly or indirectly from your use of, or action taken in reliance on, any documents or materials provided in or mentioned in the links. Johnson is not responsible for examining or evaluating the content or accuracy of materials from third parties and makes no warranties or representations, either expressed or implied, as to the reliability, accuracy, correctness, or completeness of, and will not have any liability or responsibility for, any third-party materials posted to the links, or for any other materials, products, or services of third parties. The links are provided for informational purposes only and should not be construed as an endorsement by Johnson.