Key Lessons from The Little Book That Builds Wealth: The Knockout Formula for Finding Great Investments (by Pat Dorsey).

The book is all about the concept of economic moats.

A long thread.

1. Identify businesses that can generate above-average profits for years. Wait until the shares of those businesses trade for less than their intrinsic value. Hold those shares until either the business deteriorates, the shares become overvalued, or you find a better investment.

2. A business that can profitably generate cash for a long time is worth more than a business that may be profitable for a short time.

3. Return on capital is the best way to judge a company’s profitability. It measures how good a company is at taking investors’ money & generating a return on it.

4. Economic moats can protect companies from competition, helping them earn more money for a long time.

5. The most common mistaken moats are great products, strong market share, great execution & great management.

6. Being more efficient than your peers is fine, but it’s not a sustainable competitive advantage unless it is based on some proprietary process that can’t be copied.

7. A company can have intangible assets, like brands, patents or regulatory licenses that allow it to sell products or services that can’t be matched by competitors.

8. The products or services that a company sells may be hard for customers to give up, which creates customer switching costs that give the firm pricing power. Some lucky companies benefit from network economics, which is a very powerful type of economic moat.

9. Great products, great size, great execution and great management do not create long-term competitive advantages. They’re nice to have, but they’re not enough.

10. The four sources of structural competitive advantage are intangible assets, customer switching costs, the network effect and cost advantages. If you can find a company with solid returns on capital and one of these characteristics, you’ve likely found a company with a moat.

11. A brand creates an economic moat only if it increases the consumer’s willingness to pay or increases customer captivity.

12. If a company can charge more for the same product than its peers by selling it under a brand, that brand constitutes a formidable economic moat.

13. If consumers will pay more for a product—or purchase it with regularity—solely because of the brand, you have strong evidence of a moat.

14. The only time patents constitute a truly sustainable competitive advantage is when the firm has a demonstrated track record of innovation that you’re confident can continue, as well as a wide variety of patented products.

15. If you can find a company that can price like a monopoly without being regulated like one, you’ve probably found a company with a wide economic moat.

16. Popular brands aren’t always profitable brands. If a brand doesn’t entice consumers to pay more, it may not create a competitive advantage. Patents are wonderful to have, but legal challenges are the biggest risk to a patent moat.

17. The best kind of regulatory moat is one created by a number of small-scale rules, rather than one big rule that could be changed.

18. In financial services, asset managers have switching costs that are somewhat analogous to those of banks. Money that flows into a mutual fund or wealth-management account tends to stay there—we call these sticky assets—and that money generates fees for many years.

19. Even a poorly managed pharmaceutical firm will crank out long-term returns on capital that leave the best refiner in the dust.

20. In orthopedic devices—artificial hips & knees—even smaller players have solid returns on invested capital & market shares change glacially.

21. In health care, firms that manufacture laboratory equipment often benefit from switching costs.

22. It is very hard for retailers and restaurants to create moats around their businesses.

23. Switching costs come in many flavors—tight integration with a customer’s business, monetary costs and retraining costs.

24. A company benefits from network effect when the value of its product or service increases with the number of users. Credit cards, online auctions, and some financial exchanges are good examples.

25. Costs matter a lot to automakers because price is a huge component of the buyer’s decision.

26. Cost advantages stem from four sources: cheaper processes, better locations, unique assets & greater scale.

27. Cement plants often create mini-monopolies in their vicinity.

28. Process-based advantages usually bear close watching, because even if they last for some time, it’s often because of some temporary limitation on competitors’ ability to copy that process. Once that limitation disappears, the moat can get a lot narrower very quickly.

29. Cheaper processes, better locations, and unique resources can all create cost advantages—but keep a close eye on process-based advantages. What one company can invent; another can copy.

30. Large distribution networks are extremely hard to replicate, and are often the source of very wide economic moats. We see this in large beverage companies such as Coca-Cola, Pepsi and Diageo.

31. Being a big fish in a small pond is much better than being a bigger fish in a bigger pond. Focus on the fish-to-pond ratio, not the absolute size of the fish.

32. Delivering stuff more cheaply than anyone else can be pretty profitable.

33. Technological change can destroy competitive advantages, but this is a bigger worry for companies that are enabled by technology than it is for companies that sell technology, because the effects can be more unexpected.

34. Auto-parts companies struggle to generate decent returns on capital, and those that do have only fleeting success. Auto-parts manufacturers operate in a cutthroat industry with truly awful economics.

35. Barriers to entry are low in asset management, but barriers to success are quite high, because it takes a large distribution network to rake in the assets. Money managers that have amassed a good pile of assets under management can generate high returns on capital.

36. In technology, software companies tend to have an easier time creating moats than hardware companies.

37. Media companies are threatened with technological disruption as the Internet blows up well-established business models.

38. You’ll find more moats among companies that sell healthcare products, like drugs or medical devices, than you will among health maintenance organizations (HMOs) and hospitals that provide health care services.

39. Companies that cater directly to the consumer, like restaurants and retailers, often have a very hard time building competitive advantages—the percentage of consumer services companies with wide moats is one of the smallest of all the market sectors.

40. Moats are hard to dig in the insurance industry.

41. Consumer goods is home of many of the companies Warren Buffett calls “the inevitables”—companies like Coca-Cola, Colgate-Palmolive, Wrigley, & Procter & Gamble, with durable brands & products that don’t go out of style.

42. Whether you are mining for metal, producing chemicals, making steel or banging out auto parts, it is very hard to differentiate your product from those sold by your competitors, which means that all your customers care about is price.

43. The fourth-best company in a structurally attractive industry may very well have a wider moat than the best company in a brutally competitive industry.

44. A random asset manager has higher long-run returns on capital than a randomly selected auto-parts company or retailer.

45. There is just not much you can do with an automaker with structurally higher costs than the competition, a fashion retailer with an out-of-date brand or a lender with too many bad loans on its books.

46. Bet on the horse, not the jockey. Management matters, but far less than moats. Investing is all about odds, and a wide-moat company managed by an average CEO will give you better odds of long-run success than a no-moat company managed by a superstar.

47. To see if a company has an economic moat, first check its historical track record of generating returns on capital. Strong returns indicate that the company may have a moat, while poor returns point to a lack of competitive advantage.

48. Over long stretches of time, there are just two things that push a stock up or down: The investment return, driven by earnings growth and dividends and the speculative return, driven by changes in the price-earnings (P/E) ratio.

49. Factors that affect the valuation of any company are how much cash it generates (growth), certainty attached to those cash flows (risk), amount of investment needed to run the business (return on capital) & amount of time the company keeps competitors at bay (economic moat).

50. Always remember the four drivers of valuation: risk, return on capital, competitive advantage and growth.