The phrase ‘economic moat,’ when used in the context of investing, is likely popularized by octogenarian billionaire investor Warren Buffett. It describes something which can help protect a company’s profits from the relentless attack of competitors. When you can identify companies with that ‘something,’ they may go on to become great long-term investments. Things like network effects, cost advantages, intangible assets (think brands or intellectual property), and high customer switching costs are often identified as sources of economic moats. But, I’d like to submit one other example: Management itself. Something Buffett shared in a 1991 lecture he gave to…
The phrase ‘economic moat,’ when used in the context of investing, is likely popularized by octogenarian billionaire investor Warren Buffett. It describes something which can help protect a company’s profits from the relentless attack of competitors.
When you can identify companies with that ‘something,’ they may go on to become great long-term investments. Things like network effects, cost advantages, intangible assets (think brands or intellectual property), and high customer switching costs are often identified as sources of economic moats.
But, I’d like to submit one other example: Management itself. Something Buffett shared in a 1991 lecture he gave to MBA students in the U.S. inspired this thought (emphasis mine):
“We literally will pay hundreds of thousands of dollars for things that happened years back. On the other hand, overall, it can be a good business [referring to insurance] if you’re disciplined.
We have a rule, we’re very Japanese in that, we never lay off anybody. We tell them, in times like this where we’re writing way less than we were writing a few years ago, we tell them that under no conditions will they be laid off for lack of business because otherwise they’ll go out and write some business. I mean, it’s the easiest thing in the world to do.
And we tell them we’ll buy them golf memberships, country club memberships, if they’ll promise to play golf during business hours, because we don’t want them in the office during business under terms that are generally available these days.”
Buffet was describing his insurance businesses in the quote above. For those unaware, Buffett’s famous as the leader of the US-based US$330 billion conglomerate Berkshire Hathaway.
Having been the leader of Berkshire since 1965, Buffett has helped the company grow its book value per share by an astounding compound annual rate of 19.4% from 1965 to 2014 through acquisitions of companies and investments in stocks. And the backbone that underpins all that growth is Berkshire’s insurance businesses.
Insurance is a quirky business. Policies you underwrite today to insure a certain event can come back years or even decades later to haunt you if you’re not careful. For that reason, insurers must be careful when underwriting policies – you do not want to accept risks without receiving adequate insurance premiums.
The problem is that insurance services can at times be undifferentiated – and providers of undifferentiated services can only compete on price. That’s where less-careful insurers can hurt themselves by accepting risks without the commensurate premiums. Buffett understands this danger.
He’s so aware of it that he’s willing to take unusual moves, such as making the promise of never firing someone, in order to ensure that his underwriters do not write policies with unfavorable terms just to generate business – in the process harming the long-term health of the company – because they fear for their jobs over the short-term.
It takes someone with intellect and an unusual psychological makeup to do something like this; not everyone can be like Buffett and keep the bigger picture in mind while suffering short-term pain (it’s not easy to see your company’s business being slow and not have the urge to fire someone).
What that translates into is an edge that Buffett’s insurance business has over the competition, an edge which other insurers cannot replicate simply because their leaders can’t think and act in the same way like Buffett.
In Singapore, I have what I think may be a similar example: Raffles Medical Group Ltd (SGX: R01). The company runs Raffles Hospital that’s located along North Bridge road in Singapore. As you can see in the chart below, the hospital, which officially opened in 2002, has grown in a remarkably steady fashion: Its revenue has increasd in each year over the past decade from 2004 to 2014.
Source: Raffles Medical’s annual reports
Raffles Hospital has contributed to Raffles Medical’s 1,727% growth in earnings from S$3.7 million in 1997 to S$67.6 million in 2014. Along the way, the healthcare provider’s share price has jumped by 1,055% from its listing price of S$0.38 (Raffles Medical got listed on 11 April 1997) to S$4.39 today.
The hospital has been run based on an institutionalised Group Practice Model for many years. The model gathers healthcare specialists from different areas to work in a multi-disciplinary team to ensure patients can receive quality healthcare.
According to the company’s 2012 annual report, the Group Practice Model, which is adopted by renowned medical institutes like the Mayo Clinic, “has set Raffles Medical Group apart from other private healthcare providers and propelled its growth over the past 36 years.”
Raffles Hospital and Raffles Medical’s successes are not something hidden. But why is the Group Practice Model still something unique even after so many years? My conclusion is that it stems from the way Dr. Loo Choon Yong, Raffles Medical’s founder and executive chairman, thinks about the intersection of medicine and business. It may be something which other healthcare business leaders find hard to replicate.
Given all the above, great business leaders can be a source of an economic moat. It thus follows that betting on such people may be one way we can find successful long-term investments. I’d like to end here with some similar thoughts on the matter from The Motley Fool’s co-founder David Gardner. In a recent Motley Fool Rule Breaker Investing Podcast, David said this:
“What I mean by that is it’s really the people that are running these companies that to me are adding much of the value. Not all of the value. Beyond just a glamorous CEO like Steve Jobs, there’s an entire culture at Apple. There’s an entire culture, very celebrated, at Google. So it’s not just about a single CEO or one visionary person. It’s just as much about the culture at each of these companies.
But those are the things I think most traditional Wall Street analysis misses, or doesn’t really think about or value, and we look deeply at that and say, “I want to own Jeff Bezos for as long as I can.” And there’s going to be some tough times for Amazon. Sometimes they get negative press, but taken all in all, he’s creating an incredibly great customer experience for me, anyway, as a long-term, dyed-in-the-wool Amazon Prime member.
We just want to own Reed Hastings at Netflix, and Howard Schultz at Starbucks. You just want to buy part ownership in these people, which is what you’re doing when you’re buying the companies that they own a lot of themselves.
[Apple, Google, Amazon, Netflix, and Starbucks have all been tremendous multi-baggers since their respective listings in the U.S stock market]
And so betting on the jockey — in an unpredictable world where you’re not really sure what’s going to happen next — the best thing that we can know is that human nature will tend to persist and, in general, in my experience in life, anyway, the winners typically keep on winning. Not always, but that’s the best bet.”
The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore writer Chong Ser Jing owns shares in Berkshire Hathaway, Raffles Medical, Apple, Amazon, Netflix, and Starbucks.