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The Buffett moat, the Apple moat [ClearOnMoney]
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The Buffett moat, the Apple moat

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Commentary

The Buffett moat, the Apple moat

17 Dec 2012 by Jim Fickett.

Warren Buffett has beaten the market for a long time, too long to think that it is just luck. He has talked quite openly about his way of investing, and he has no patent on it. Why haven't many others taken away his advantage by imitating him? Or, to use a common Buffett term, what is Buffett's moat?

I don't claim to know what Buffett would say. I'd say that to invest in the Buffett style requires four relatively rare qualities:

  • A feel for numbers. Most people who look at a company's financial reports see an ocean of meaningless numbers, or apply the same rote formulas to every company, hoping a spreadsheet ranking will automatically pick out the best investment. But if you are going to invest on the basis of value, the numbers should speak to you. Sure, apply standard metrics like P/E and NPV. But as you look at the numbers, trends and trouble spots that others miss should jump out at you.
  • Solid judgement. Almost every investor would say they rely on and trust their own judgement but, in fact, almost everyone follows the crowd. Even “contrarians” take their direction from the crowd, by going in the other direction. But value investors have to genuinely rely on their own understanding and ignore the market. And so, as a consequence, they had better have good judgement. I suppose almost everyone thinks they have good judgement; the only way to find out if you really do is to invest on your own for a few years and see how you do.
  • Willingness to work hard on valuation. If you depend on your own judgement, you have to really understand the businesses you evaluate; to do that you have to be willing to work long hours hunting down the facts you need for that understanding; and to do that you need the confidence that your answer is going to be meaningful. Most people would rather work long hours doing things that are much more predictable, and better for typical career advancement, like holding meetings, answering email, and writing up powerpoint presentations.
  • Patiently holding to a consistent strategy. This is the polar opposite of the breathless two-paragraph analysis style so common in the news and on investment sites. The successful value investor (1) understands his/her own optimal style, (2) holds to his/her principles, and (3) almost always says no.

Part of Buffett's success is no doubt genetic; he probably was born with quantitative intuition and, to some extent, good judgement. But these traits can be developed, to some extent, as well. And certainly the last two traits above can be developed to a great degree; it just doesn't come naturally to most people to do so.

Buffett's moat, then, is partly talent and partly the lack of inclination on the part of most investors to do things the way he does them. The moat is soft, but it seems to be effective.

Apple

There is an interesting parallel with Apple.

The growth in Apple's net income and free cash flow has been phenomenal:

Although there is no sign at the moment of Apple's popularity fading, such growth clearly cannot continue for too much longer, or Apple would own the entire market. So everyone is asking whether Apple's business can continue to expand.

That is not the most relevant question. Apple's growth in market share, as well as Apple's very high profit margins, are due to customers seeing their products as a cut above everything else. And Apple's great vulnerability is that at some point their products could become merely very good, rather that industry-leading.

Many analysts confuse this with novelty, and think Apple can continue to succeed only with brand new, revolutionary products every few years. But note that iPods and Macs are still very successful, despite being only incrementally improved each year. The key question is whether Apple can continue to design products that many customers feel are a step above everything else on the market. And that is where Apple has an interesting moat.

(1) Apple concentrates on just a few products. Can you imagine Samsung, LG, or Nokia offering only one phone? It is hard to do many things really well, and Apple has chosen not to hedge its bets, but to make what it considers to be the world's best possible phone, music player, laptop, tablet, etc, and to offer each in only a few minor variants. Few companies have such focus, and fewer still are likely to have such courage.

(2) Apple is making the electronics interface completely human. It seems a long time ago now, but remember when the best phones out there had 1.5” screens and one had to go through endless menus to get anything done, trying to figure out your phone's view of the world to dig out where various options were hidden? You can still find menus on the iPhone and iPad, but Apple has made great progress in making the phone or tablet think like you, rather than forcing you to think like it. Instead of searching the file system for an image file, you open the photo application and see all your pictures arranged by date. Instead of looking for a menu option to rotate a picture, you reach out and turn it around. These are not just a bag of neat tricks, as many people seem to think, but rather a consistent strategy of making it so natural to interact with computers that you don't need any training to do so. We're not completely there yet, certainly, but that means there is still considerable room for Apple to lead.

In my view, then, Apple's moat is that they are not just making products that people already know they want, or designing products with lots of neat features; rather they are in a decades-long process of redefining how humans interact with computers, and they are sufficiently surefooted to bet everything on just a few products which get easier to use all the time. As with Buffett, this is a mixture of talent and inclination. It is an open question whether a key part of the talent left when Jobs died. But Jobs hired some others, like head designer Jony Ive, who also have remarkable talent. And it seems pretty clear that, at least for now, no other company has the inclination to follow Apple's strategy.

Note that Apple's current price is reasonable even if there is no further growth in income. The current market cap is $488bn, so the P/E and P/FCF are both in the neighborhood of 12. But of course even to maintain current income requires those high profit margins and the ability to continue making products that many consumers regard as quite special. I.e. the moat must hold.

Although I do not yet see the margin of safety that I would like, I think the most likely outcome is that the moat will hold, Apple will continue to lead for some time yet, and the current price will turn out to yield solid returns.