Investing in Defensible Business

Private or public, you want to buy into defensible businesses that have loyal customers.

There are 3 types of businesses to invest in.

Today, we cover:

• Asset Light Compounders

• Reinvestment MOAT

• Legacy MOAT

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Asset Light Compounders

These are businesses that do not need excess capital to generate cash at high rates of return.

They are usually characterized by the following:

Negative Working Capital - Usually due to customers paying upfront

Low Fixed Assets - Developed Technology/Brand Name Instead

Pricing Power - Sticky Business

Typical businesses in manufacturing need to invest in new equipment/factories to grow more.

These businesses consistently win by leveraging their brand name and quality.

An example: Burger King Franchises. Sell their brand name to earn royalties. No capex.

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Reinvestment MOAT

These are businesses that are able to earn high rates of return on capital and redeploy that capital to earn similar rates of return (increasing the business’ earnings potential).

They are characterized by one of the following:

Cost Advantages - Low Structural Costs

Two Sided Network - Marketplace for buyers AND sellers

Long Business Runway - Network Effects Growth/Replicable Business Model

Red Flags:

Venture into new markets

Low TAM

Recent growth investments producing low returns on capital

An example: Walmart. Redeploy cash to open new stores. They each earn ~50% pre-tax returns on assets.

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Legacy MOAT

These businesses earn returns on capital above their cost of capital over time; however, they lack new reinvestment opportunities.

As a result, they are likely to hold cash or pay out dividends.

Example: Hershey’s and Coca-Cola. They run their business based on legacy investments and have no new capital redeployment opportunities.

We’ll have a closer look at some examples for each MOAT.

See you next week.