Build Wealth With Moats

Good Evening! 👋

Happy Wealth Wednesday! In this newsletter, we will discuss one of the most important things when investing in stocks.

Here’s What You Missed Last Week:  

1. The Bean Breakdown

2. Top 5 Stocks To Watch In October

3. Is This The Modern Day Geico?

Dear friends,

Warren Buffett and Peter Lynch have both had a profound impact on the way I think about investing. These two legends have shaped the core of my strategy, and today, I’d like to share some of those principles with you.

I believe anyone can make money in the stock market by focusing on a few key fundamentals. One of the best pieces of advice from Warren Buffett is to invest within your "circle of competence."

(Always remember—when you buy a stock, you're buying part of a company. You become a part-owner.)

The first thing to do when considering a stock is to ask yourself, "Do I actually understand this business?" Understanding goes beyond knowing the name; it’s about grasping what the company does, how it makes money, and where it’s headed.

For example, Apple is a company most people are familiar with, but understanding its competitive advantage involves knowing more than just its product lineup. It’s about knowing how deeply integrated Apple is into its customers’ lives—so much so that switching to a competitor is more inconvenient than it’s worth. That’s why their business remains strong, even when competitors release similar products.

Another important part of investing is being able to value a company. As some of you know, I have a solid understanding of tech companies and geopolitics. These areas fall squarely within my circle of competence. On the flip side, I avoid sectors I don’t understand. For example, pharmaceuticals. I don't know enough about how companies like Moderna or Pfizer price their drugs or what influences their long-term growth. And that’s okay! It’s better to stick to what you know than risk making uninformed decisions.

For those of you who prefer short-term trades and use technical analysis, catalysts are your best friend. A catalyst is an event that can significantly impact a stock’s price. For instance, when oil prices rise, the stocks of energy companies like ExxonMobil often follow suit. Or take Bitcoin—when its price surges, stocks like Marathon Digital, which mines Bitcoin, typically benefit.

When you invest for the long term using fundamental analysis, you’re looking for something different—a moat. A moat is what protects a company from competition. Imagine a castle surrounded by a wide moat, making it difficult for attackers to break through. In investing, the company is the castle, and the moat is what keeps competitors at bay.

Let’s take a closer look at the five different types of moats that can shield a company from competition:

1. Brand Moat

A brand moat is when a company’s name becomes synonymous with the product itself. It’s more than just having a recognizable brand—it’s about owning the category in the minds of consumers. This is incredibly powerful because it creates an automatic association between the need for a product and the brand that provides it. Think of Google. When people need to search for something online, they don’t say, “Let me search for that,” they say, “Let me Google it.” Google has built such strong brand loyalty that even though there are other search engines like Bing or Yahoo, they hardly compete on the same level.

Take Apple, for example. The company’s brand is so strong that when people consider upgrading their smartphones, many instinctively think of the iPhone. Apple’s products are also integrated into a broader ecosystem, making it even harder for customers to switch brands. Apple doesn’t just sell products; they sell a lifestyle, a status symbol, and a seamless user experience. That’s what gives their brand moat its power.

Another great example is Disney. When people think of family entertainment, vacations, or theme parks, Disney comes to mind. It’s not just that they have parks or produce movies—it’s that they’ve built an emotional connection with generations of consumers. This emotional attachment makes it nearly impossible for competitors to replicate the same brand power.

2. Price Moat

A price moat is created when a company can sustainably offer lower prices than its competitors, not because they choose to, but because they have a structural cost advantage. This kind of moat is very hard to establish and maintain because it requires operational excellence and often scale advantages.

Costco is a textbook example of a company with a price moat. The company operates on a membership model and offers products in bulk at prices that are often unbeatable by regular retail stores. Costco’s massive scale allows it to negotiate better deals with suppliers, keeping prices low for its members. The genius behind this strategy is that it’s nearly impossible for smaller competitors to offer the same low prices without sacrificing margins.

Geico is another example. Known for offering low-cost car insurance, they’ve cut out the middleman by operating as a direct-to-consumer business. Their lean operational model allows them to pass savings on to customers, making it very difficult for traditional insurance companies with agents and brokers to compete on price.

Price moats are tricky because anyone can lower prices temporarily, but a true price moat requires that a company can maintain low prices while still being profitable. That’s where the competitive advantage lies.

3. Secrets Moat

A secrets moat is built around intellectual property—think patents, proprietary technology, or even trade secrets that give a company a competitive edge. Companies with secrets moats often dominate their industries because they can produce something no one else legally can, or they have developed technology that’s difficult to replicate.

Pharmaceutical companies are perhaps the most obvious example of a secrets moat. When Pfizer or Moderna patents a new drug, they have exclusive rights to manufacture and sell it for a specific period. During this time, competitors are legally barred from creating a generic version, allowing the company with the patent to charge premium prices. This can be incredibly lucrative, especially if the drug addresses a major medical need, as we saw with COVID-19 vaccines.

Tech companies often have secrets moats as well, although in different forms. Think of Tesla’s early leadership in electric vehicle technology. They pioneered much of the battery and electric motor technology that powers their vehicles, giving them a huge head start over competitors. While other automakers have caught up, Tesla’s early advantage allowed them to establish dominance in the electric vehicle market.

4. Toll Bridge Moat

A toll bridge moat exists when a company controls an essential service or resource that others must pay to access. In many cases, these are companies that have exclusive government contracts or natural monopolies in specific regions. Utility companies are a perfect example of a toll bridge moat. In most cities, there’s only one electric company or one water provider, meaning residents and businesses have no choice but to use their services.

Consider PG&E in California. Despite facing significant challenges, including wildfires and bankruptcy, the company remains in business because there are very few alternatives. When a utility company has an exclusive contract or is the sole provider in an area, it’s nearly impossible for competitors to break in.

Another example is Palantir, a data analytics company with deep ties to the U.S. government. Palantir has long-term contracts with government agencies for defense and security work. These contracts are incredibly difficult for competitors to penetrate because they require extensive knowledge, expertise, and trust that takes years to develop. Once a company like Palantir is embedded in a government contract, it becomes the go-to provider for future projects.

5. Switching Moat

Switching moats are built on making it incredibly inconvenient for customers to switch to a competitor. Think of your bank or phone service provider—once you’ve set up direct deposits, automatic bill payments, or become used to a specific platform, switching to a new provider feels like more trouble than it’s worth. This creates customer loyalty, not necessarily because the company provides the best service, but because switching would create too much hassle.

Banks, for example, thrive on this type of moat. Changing banks can involve opening new accounts, transferring funds, updating billing information, and more—most people would rather stay put than go through that hassle, even if a competitor offers better rates or services.

In the tech world, companies like Adobe or Microsoft have switching moats. Once a user or business is integrated into their software ecosystems, switching to an alternative provider can mean significant disruptions to workflow. Adobe’s Creative Cloud suite is a great example—once designers and businesses are fully integrated into its tools, moving to another platform would require retraining and a considerable time investment. This creates a strong retention moat that is hard to penetrate.

In Conclusion

When evaluating a company, always ask yourself: Does this company have a strong enough moat to protect it from competitors? Could a billionaire with unlimited resources come in and destroy this company? If the answer is no, you’ve likely found a business worth considering. Take Coca-Cola, for example. Even if someone gave me a billion dollars to create a new soft drink, there’s no way I could unseat Coca-Cola’s dominance in the market. That’s the power of a moat—it's the ultimate protector of a company's long-term success.

Cheers,

The Bean Team

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