A Buffett Strategy That Stands the Test of Time (MOAT)

If you watch enough NFL football, you’ve probably heard the term “West Coast Offense.” For those not familiar with football, it’s an offensive strategy devised by Hall of Fame NFL coach Bill Walsh. Today, most teams in the NFL use the strategy in some form or fashion.

Why? Because it works.

It’s been proven over time to be sound and versatile enough to be successful over a changing NFL landscape where defenders have become bigger, faster and even smarter. When you throw all this into the equation, others will emulate.

You see where I’m going… I’m about to draw a parallel between the NFL and investing. It’s August and like plenty of other red-blooded Americans, I have NFL fever. But let me get back to my point.

Investment strategies work in the same manner. Some people may get tired of hearing what Buffett, Soros and Rogers think. But you shouldn’t. Show me one head coach in the NFL that thinks that what Bill Walsh and Paul Brown taught and invented is now irrelevant – especially when it still works.

Withstanding the Test of Time

In the same fashion, what Warren Buffett told investors 50 years ago applies today. And much of it is reflected in our time-tested Investment U principles.

Jonathan Burton wrote an interesting piece in MarketWatch a few weeks ago about the early shareholder correspondence that Warren Buffett disseminated and how that message has remained on course for a half century. In 1962 he was stressing:

  • Preserving capital in bad economic stretches.
  • Resisting the urge to follow the herd in runaway years.
  • Focusing on long-term challenges and results.

It sounds familiar because he still says it, it’s proven to be successful and it’s worked for over 50 years of dynamic economic and geo-political changes.

So, with the background established, I think it’s beneficial to look a little deeper into Mr. Buffett’s specific strategies – strategies that have and should be successful going forward.

As Thomas Jefferson once said, “In matters of style, swim with current; in matters of principle, stand like a rock.”

In his 1963 letter to shareholders, Buffett presented seven requirements for his partners that he called “The Ground Rules.” The following one strikes a chord especially in our present market climate:

“While I much prefer a five-year test, I feel three years is an absolute minimum for judging performance. It is a certainty that we will have years when the partnership performance is poorer, perhaps substantially so, than the Dow. If any three-year or longer period produces poor results, we all should start looking around for other places to put our money.”

This goes back to that long-term focus tenet. What is happening presently is going to happen and affect the equity market. But what market history has shown is that those equities that are well-positioned and well-run will usually weather the storm. Buffett has historically used strategies that will win in the long run. And one of his strategies conjures up visions of knights and castles.

The Moat Strategy

Buffett has said he seeks “economic castles protected by unbreachable ‘moats.’” What he means is that when the price is right, you want to buy companies that dominate their industry for now and the foreseeable future. Basically, these are industries where the barriers to entry are just so overwhelming they discourage any would-be competitors.

Although they may have advantages, “wide-moat” companies cannot avoid the trials of shaky economic times. The difference is that these firms’ strengths and abilities to be dynamic during these periods will keep them above water and put them in a place to thrive when the recovery finally comes.

Also along those lines, in these times of economic difficulty, wide-moat stocks create attractive value plays. Warren Buffett has for a long time discussed his love for what he considers bargains in the market. They’ll get beat up when the market decides to punish everybody for no valid reason, but they have much more potential when there’s opportunity for a rebound.

This “moat” concept has become pretty mainstream. In fact, Morningstar has embraced it and describes five ways in which moats develop.

  1. The network effect where a service becomes increasingly more valuable as more consumers begin to use it.
  2. A situation where consumers have no incentive to embrace the competition.
  3. A company possesses a virtual monopoly or control of a limited market.
  4. Registered brands, patents and licenses that give a company steady cash flow.
  5. A pricing advantage where you can produce a better quality product at a lower cost than the competition

The Morningstar Index

About five years ago, Morningstar created its Wide Moat Focus Index ($MWMFT), made up of what it considers to be the 20 least-expensive wide-moat stocks within a pool of nearly 1,200 domestic equities. The majority are large caps with a broad customer base.

And once again, a Warren Buffett strategy has proven to be successful.

The index is set up so that each of stocks represented accounts for an even 5% of the weighting. The portfolio is rebalanced quarterly. For the last five years, it’s gained 7.4% annualized with dividends. Now compare that with a little bit over a 1% total return for the S&P 500 stock index.

So how can you take advantage of the “wide-moat” strategy?

Well the first thing you do is take a look at the current components of the Morningstar Index. Check out all 20 companies that currently make up the portfolio here.

If you want something cheaper and more manageable, you may want to look at the Market Vectors Morningstar Wide Moat Research ETF (NYSEARCA:MOAT). It’s only been around for about three months but already has nearly $40 million in assets under management.

Good Investing,

by Jason Jenkins, Investment U Research

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