One of my main pillars when comparing or choosing a stock to invest in is understanding the business model.
Understanding the model, its strength, weakness, threats and opportunity goes a long way in
- Estimating the predictability of cash flow (lumpy or consistent)
- sustainability of a conservative estimate of cash flow (e.g. In down times can it still pay X minimum amount of dividend I require)
- Business continuation in next 10 years
- How susceptible is it to substitute
- Could company lose its business advantage
- Would people still expect to use so much of thee goods/services
- Risk management (how can you kill this goose?)
Economic Moat talks about,if a company/industry/segment have an advantage over others, how we they can protect this advantage to earn better returns
Good Management = Moat?
Today we focus on management. Many people will think a good management is an advantage.
You essentially buy a good management on many stocks.
Stockist are stocks whose business deals with trading things they do not produce, but use their expertise to expand channels to sell to their customers. Key management skills are reading the business cycles, managing supply risks, increasing sales channels, streamlining operations.
The case of steel stockists such as Lee metal, Asia enterprise holdings, sin ghee huat.
Their goods are commodities that, if one of them runs into a supply problem, the customers can buy off another one. These companies are essentially traders controlling their supply risks such as price, specifications, grade versus the demand.
You need good management to be able to see so many wild swinging business cycles.
The goods are commodities and you have no advantage over your competitors, but management makes them a good stock.
Asia Enterprise Holdings have been profitable for the past 30 years. That is through many business downturns. It pays a 4-5% yield usually.
There are many other businesses that are essentially stockists as well such as The Hour Glass. They don’t manufacture but distributes and markets. Their distributor can be their competitor going by recent trends that the distributor are also setting up boutique stores.
Not exactly commodities, but good management are able to anticipate trends, stock up supply at reasonable price at the same time ensuring they do not buy something that would be unpopular in the future.
Hour glass have been performing well recently.
From one luxury stockist to a construction one. Kian Ann engineering which i bought end of last year for a 4% yield is a supermarket for heavy construction vehicle parts. Their sales channels are all over the world. They don’t make their goods, they just tap their sales channels.
Fund Managers/ Trust Managers
The companies that is classified under this would be listed real estate investment trusts (REITs), business trusts, listed funds.
While the trusts and funds invest in underlying assets that generate cash flows have some form of other economic moats (e.g. toll bridges such as expressway, ports, railway stations, physical scarce properties on land), these managers buy, sell the underlying based on their discretion.
The key management skills are identifying opportunities,maximizing current assets under management, forecasting business and investment cycles, managing leverage.
Readers would be acquainted with REITs. Good managers like Ascendas, Fraser and Mapletree leverage up at the right time to buy into assets at rising rental trends, optimizing assets through enhancements, perform risk management in terms of the lease life of their assets and leverage.
The bad ones monkey see monkey do and lived off fees from asset management without adding value.
Similarly, business trusts/funds such as Babcock and Brown, GIL, Macquarie International Infrastructure, Cityspring, First Shipping Lease drew a lot of flak for killing shareholders’ money.
Are business trusts all bad? Look across to US where you have MLP and Canada with their Canadian Royalty Trust giving share holders returns many times that of traditional stocks.
The difference? Better governance and of course better management who focus on shareholder returns.
Family run business/Founder centric business
There are some businesses that are doing very well because of the foresight of the founder and in a lot of cases, the founder is supplemented by able lieutenants that helps him or her out.
These lieutenants are either the founders’ family members or inspired by the leadership capabilities of the founder to join this venture.
This category of business are very focus on what they do well.
Some examples of this are kingsmen creative, boustead, uob, osim.
The problem with good management
It takes time and effort to uncover companies with better management, but the investor may be lured into a sense of security they this business has a Moat because of this management.
Fraser may have concentrated thee good property managers but we may never know their capable manager iss lured away from it. In their absence, a manager with a less enviable track record might take over and it iss only after some major earnings or stock disappointment that we realise that.
Founder or family based business face the prospect of thee shrewd management stepping down and taking over by less illustrious management.
An example here is where Pteris, which was known as Interroller previously, performed worse after the old management decide to retire.
Another that I find perhaps is shifting the same way is Noble Group, where Richard Ellman was not able to find a solid replacement for himself.
Management – hard to repeat but not a Moat by itself
A business with a management as the only factor it is doing better than others, is not a Moat to me because it is not lasting.
However, good management may be hard to replicate because you cannot teach foresight, bold execution, charisma to attract the best talent.
Good management, at times cannot be repeated. When it cannot be repeated, somewhere down the line, they lose that edge.
Ask yourself if you are given 1 billion can you hire a MBA graduate to run a steel stockists, another luxury watch distributor, another reit. If it’s easy to do that and kill this existing business then there isn’t much Moat.
Similarly, if an idiot is put in charge to run thee business and it wouldn’t kill it, then the business has a Moat but it’s probably not down to management.
Management Culture as an economic moat
Geoff Gannon, who writes in his latest article that he believes that management is misunderstood as having no Moat:
That’s true. But it’s also different from a big company making a hit tech product. They have nothing that can be defended. The profits are due to scale. But the scale – market share – is threatened by something others can and will try to take away.
There’s a book – in fact a whole series – on repeatability.
They both downplay management. On the one hand, they are right to do this. Management is not a moat. On the other, they are wrong. Management often grows a culture around a moat.
In fact, today’s management is often less important than the management that formed the company’s identity. Day to day decision making is not important. Keeping the company focused on the moat is. The key manager doesn’t have to be alive to do that. People just have to remember him.
The most durable advantage a company can have is a cultural identity locked up in a moat. Most companies should not try to be cost leaders in everything they do. But if that is your moat – you shouldn’t spend a minute thinking about anything else.
The reason Southwest (LUV) and Wal-Mart (WMT) built the moats they built is due to the cultures their management created. They had one good idea. And they took it seriously.
Most companies are more scatter brained. If they see a good idea, they act on it. But ideas do not exist in isolation. A chain of good ideas often leads to one really bad habit.
I kind of agree with him that, if a structure is put in place to manage a business with some little moat in the first place, that is a strong economic Moat that is tough to replicate.
This usually come down to identifying the right mission statement, vision to lived up to, a single important focus.
The management coming could do it differently with different ideas. At times they will fail with the implementation but this management culture or vision would be able to haul them back
The best examples are probably the Jardine group which lasted for hundred years, the Dupont, Walmart(WMT), Macdonalds(MCD).
Macdonalds is an interesting one. It is probably a business that if you have the money you could do something like that, but for me the focus on operations and being able to consistently test products to be relevant are hallmarks why it has a certain moat.
Staff and management are brought up internally in the best way, but the key here is a focused management culture.
Take the management of the restaurant or the products and it might not have such a lasting advantage, but making it such that the business is so focus on what needs to be relevant, that is a very strong advantage that is hard to replicate overnight.
Companies like Kingsmen Creatives need to put that in place, identifying where are their core competency, building a management culture focus on design and bringing up people through that culture. Focus on customers externally and enriching staff internally would go a long way in creating a bulwark around a business that traditionally is very competitive.
In a certain sense, you can say that Capitaland, Mapletree and Ascendas have the advantage because they can always attract the best managers due to their size, but it is easy to lose focus and not focus on shareholder value creation in the long run. However, these large companies have other competitive advantages to offset mistakes. A company like First REIT, well managed by Bowspirit, may one day run into a situation where the good manager is lured away, to the detriment of shareholders.
Understanding business models, comes with age and experience but also with how much you are willing to get exposed to this area.
Identifying the strength and weakness, the extent of it, how its affected by external and internal forces enables you to separate the metrics used to further analyze the company.
It enables you to invest with a view that you know risk triggers and symptoms (doesn’t mean if it does not have a long lasting moat its not a good investment, you just have to watch it more carefully) and take the appropriate actions where necessary.
The strength of your understanding also separates you from the pack to find the hidden gems.
If you are interested in similar topics on business models and fundamental analysis you can take a look at my best resources section.
One book that are highly recommended are the following:
This is a book that I like a lot because i think it is such a easy read, yet shows you great businesses falling into each moat category. The whole book is about 200 pages odd which makes it a quick read.
I do read this often and it acts as a check list whenever I come across new companies.
This book I have yet to purchase but if its recommended by Gannon, it should be something that can expose ourselves to the management aspects of business. Definitely on my reading list.
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