[00:02:04] I want sharks in the moat. I want it to be untouched. There are a number of different types of moats that can exist in the marketplace. One of the most well-known types of moats is a network effect, which is the phenomenon where the value of the network becomes more valuable as more people join the network, which is the case with many social media companies because these companies become more valuable with each new user that joins the social media network.

[00:02:31] Another common type of moat or competitive advantage is simply the brand. If I’m overseas in Europe or another country and I want to go grab a can of pop, odds are I’m going to be more likely to grab something like a Coca-Cola rather than another brand I’ve never seen in my life. Another example is I enjoy working out and whenever I go and get new workout shoes, I oftentimes pick Nike, even though I could probably get some other brand for a little bit cheaper.

[00:02:58] That’s a similar quality. I just know what I’m gonna get with Nike. And they have that brand power and brand awareness with millions of people worldwide. Other types of moats include being the low-cost provider, having high switching costs, having economies of scale, or a company being essentially like a toll booth that collects a fee for being the sole provider of one particular product or service.

[00:03:21] Much of what constitutes a moat can be very qualitative, but these qualitative factors can be validated using quantitative factors. If a company is consistently able to produce high returns on invested capital, while consistently pricing their products higher than their competitors, Then that is probably a good sign that the company has a strong and durable moat, because a lot of times when companies are able to achieve high returns on capital, competition comes in and makes it no longer possible to achieve those high returns.

[00:03:53] Looking at a company’s revenue, their earnings per share and the return on Avea capital are all good places to check and see if a company has a durable and longstanding moat to. In addition to a company having a strong moat, I also want to ensure that the company has a growth runway ahead of it, continuing to grow their earnings, and the company is trading at what I believe to be a reasonable price.

[00:04:15] They have a solid management team, high returns on invested capital, and also I want to be in companies that aren’t too cyclical. Looking for companies with these characteristics are ingredients for what I call a steady compounder, which I would consider to be a company that is almost certain to continue to grow and continually just steadily march their earnings per share higher, and hopefully the stock price as well.

[00:04:40] Because of the high quality of these types of businesses, the market oftentimes won’t hand you these companies for super cheap, so they aren’t going to make you rich overnight. One of my very favorite value investing books is a book called Where the Money Is by Adam Zeel. TIP had Adam on our podcast, on our Millennial Investing show, and the We Study Billionaires show in the past.

[00:05:03] His book talks about how value investors need to transition to a world that is vastly dominated by technology and value. Investors should not shy away from technology companies because of how much stronger some of these companies have become in the tremendous moats in network effects that technology has enabled.

[00:05:22] In his book, Adam states that Peter Lynch wrote and one up on Wall Street, that in the end, superior companies will succeed and mediocre companies will fail, and investors in each will be rewarded accordingly. Lynch’s words remain as true as ever, but the problem is that over the last generation, technological change has altered the economy so much that the nature and character of what constitutes a superior business has also dramatically changed the internet.

[00:05:52] The cell phone and social media didn’t exist when Lynch wrote this. Many of the everyday examples that he used to illustrate superior businesses are now laughably out of. That’s no knock on Peter Lynch. The world changes, but we must acknowledge that the same common sense that led him to those stocks now tells us to go nowhere near them.

[00:06:14] The internal combustion automobile today faces threats from both driverless and electric cars. And as for toys, arrest. Squeeze between the giant printers of Walmart and e-commerce if filed for bankruptcy protection in 2017, powered by continued improvements in computing power and related technologies, digital companies have transformed our daily lives, the world economy, and most importantly, for the purposes of this book, the stock market.

[00:06:43] Roughly half of the US markets gained since 2011 have come from the information technology and related sectors. Since 2016, roughly two thirds of the market’s appreciation has come from these sectors. A decade ago, only two of the world’s top 10 most valuable publicly traded companies not controlled by the government were digital enterprises.

[00:07:07] Today as the chart below shows, eight of the top 10 are the only two companies that aren’t technology based are Berkshire Hathaway and an oil company outta the Middle East. As the graphic suggests, the digital age has come upon us so quickly that we haven’t had time to step back and parse what it means.

[00:07:26] While it’s obvious to everyone that something dramatic and lasting has occurred, most investors seem befuddled by. As a result, most haven’t learned the language and the dynamics of a sector whose principle output consists of zeros and ones. To say that this is unfortunate would be an understatement.

[00:07:45] Companies built on a digital foundation, tech in the shorthand of Wall Street, are creating most of the incremental wealth in the world today. Tech dominates our daily lives so thoroughly that it’s natural to think that digital revolution is largely complete, but that’s not true in many ways. It’s just beginning, even after a generation of growth.

[00:08:06] Amazon’s annual retail sales volume only now matches Walmart’s. Cloud computing, which today accounts for roughly 10 to 15% of all spending on information technology, which one day will likely account for more than two thirds. Intuit, the world’s leading provider of small business accounting software reaches only one to 2% of its ultimate addressable market.

[00:08:29] The list goes on and on, and as computing power compounds, the list gets longer every. As tech creates new industries and new wealth, it is simultaneously hollowing out large parts of the legacy economy. Tech’s dramatic rise has been accompanied by an astonishing fall of the old economy’s market values.

[00:08:50] Big tech gets most of the headlines, but hundreds of smaller, lesser known tech companies have also continued to appreciate. Then a few pages later, he describes how one of the reasons that tech is taking over is because the returns on capital employed are just so much higher. As he says that if Ford wants to grow their business, they need to invest $10 to achieve $1 an additional profit.

[00:09:13] For Coca-Cola, they need to invest $6 for $1 in profit. And for so many of these big tech companies, they only need to invest, you know, two or $3 to generate the same level of profits as these legacy businesses. So because of these reasons, many technology companies are just better businesses and they have wider moats than these other businesses, I want to ensure that I at least consider these types of companies when I’m picking and choosing individual stocks for my own portfolio.

[00:09:42] The first two companies I’m going to cover today are well known big tech companies as these are just some of the strongest moats the world has ever seen, and I like the prices they’re trading at. And then the other two companies I’ll cover are companies outside of Big Tech. The first company I wanted to discuss today was Alphabet. Buffett and Munger aren’t considered the geniuses or masterminds of technology, but they’ve both commented on the strength of the moats of Al. Munger has stated that he’s never seen a company with as wide of a moat as Google’s, although it appears that alphabet’s moat may be in question. With the rise of AI and technologies like Chat, G P T, Alphabet today is one of the most dominant and profitable companies in the world, as in the trailing 12 months.

[00:10:29] They posted annual netet income just shy of $67 billion. The primary source of Alphabet’s moat is the competitive advantages built in Google search through their network effect. Once Google established itself as a leader in search, more and more people started using Google for their search queries. And the more people that started using Google search, the more data they were able to collect, which not only improves the Google search, but it also improved their targeted.

[00:10:59] For how valuable of a product Google search is for its users. It’s pretty incredible that it’s just totally free, which is the beauty of technology and the power that it brings to people. Alphabet is a trillion-dollar company built primarily on the back of a product that is free for its users, and one could also include YouTube in that discussion as well.

[00:11:19] Because of this dynamic and network effect, the search market has essentially turned into a winner take all industry. As Google Search currently holds 84% of the search market according to Stata, which essentially hasn’t really budged at all over the past decade. This also reminds me of Geiss Spear and what he looks for in businesses to invest in and Nick Sleep as well.

[00:11:41] To add to that discussion, This is win-win scenarios. All parties win using Alphabet’s platform. Whether that be the users or the advertisers. Everyone wins in working with Alphabet and Google search and when I pull up Datarama to see what Super Investors own Alphabet, I see Guy Spear owns a little bit in his portfolio.

[00:12:02] And then also Bill Miller, Bill Nygren, Lilu, Francois Rochon, Tom Gayner, and a long list of others. All own Alphabet and their funds. Portfolios as well. Google search also has a really powerful brand and people associate Google with the internet itself. So in a way it’s almost a toll road on the internet where so many people are using Google in their everyday life.

[00:12:25] So their brand name also has substantial value for the company. However, their brand alone isn’t as powerful as a company like Apple, for example. And I think YouTube has a lot of many of the same characteristics as Google search. I’ve recently tuned into the podcast episode of Mr. Beast and Lex Friedman and Mr. Beast just makes me so bullish on YouTube, given the huge staying power that YouTube has, where it’s kind of the toll road for videos. And it’s just provided so much value for creators, for advertisers, and for users. And I see YouTube in many ways in the same light as Google Search, and I’m very bullish on both long term.

[00:13:05] So Google Search I obviously believe is a great business, but Alphabet also has two other fast growing businesses within the company. I already mentioned YouTube, and then Google Cloud is another fast growing business that they. YouTube produced nearly 30 billion in revenue in the trailing 12 months, and Google Cloud produced revenues of over 24 billion, which are both growing very rapidly.

[00:13:29] YouTube remarkably is still growing its user base and has 2.6 billion users globally. I am a shareholder in Alphabet, but one of my main concerns with the company is how well their advertising revenue will hold up during a recession. During a recession and difficult economic times, companies are forced to cut back on spending to remain profitable, and oftentimes the very first place they’re going to cut spending is in their advertising budget.

[00:13:56] During the great financial crisis, advertising revenue fell sharply but quickly rebounded once economic conditions improved for alphabet. Alphabet’s advertising revenue has held up remarkably well in recent months, which is really good to see. As of Q3 of 2022, Google searches revenue was up 4% year over year, and their overall revenue was up 6%.

[00:14:19] If you take the free cash flow and subtract out roughly 19 billion in assumed stock-based compensation, I’m getting a free cash flow yield of roughly 4%. For a company I expect to continue to grow for many years to. And this is after subtracting out the net cash from the market cap for those following along with those numbers.

[00:14:39] I’m not trying to make it sound like I’m pumping the stock, but at a free cash flow yield of 4%. For a company of this high quality, I will gladly purchase this stock around 90, a hundred dollars. Of course, it could go lower and receive a lot of pressure with the recession, but I will gladly hold right onto it.

[00:14:58] Now most people are probably concerned about chat G P T and the disruption that may be coming from them. There was recent news that came out from Microsoft. They reportedly planned to invest 10 billion into the company open ai. Who developed this software? This investment would value open AI at $29 billion.

[00:15:19] Even Bezos, one of the most ambitious entrepreneurs on the planet, has stated that you should treat Google like a mountain. You can climb it, but you can’t move it. And Microsoft has long been wanting to get into the search business as over the years they’ve spent over $15 billion on being only to fail to tap into Google’s market share of the search industry.

[00:15:41] I got this stat from Adam Cecil’s book where the money is, here’s what Adam had to say about Google in his book that was written just last year. Microsoft and Amazon wanted a piece of Google’s actions so badly because search is likely the Internet’s mightiest and most profitable. Toll bridge search is quite literally the gateway to the information superhighway.

[00:16:04] Amazon may control e-commerce, but physical goods account for only 25 to 30% of economic. Services accounts for the other 70 to 75% and services is where Google excels. Anyone in the world who wants a divorce lawyer, a mortgage broker, or information on a Caribbean vacation, googles it, which means that every divorce lawyer, every mortgage broker, and every Caribbean related travel business must advertise on Google.

[00:16:34] The best part is that advertisers don’t mind paying Google because advertising on its site is both cheaper and more effective than advertising on traditional media. When a travel agent or a divorce lawyer advertises on TV or in the local newspaper, they’re unsure, their message will reach its intended audience On Google, advertisements are tied to keywords, so advertisers can measure whether their spending is effective or not.

[00:17:04] I discussed Google with Adam Zeel during my conversation with him on millennial investing, and he was describing to me how despite Alphabet being highly profitable today, they aren’t as optimized for profits as a company like Apple, for example. They are still very much making large investments for the future, which really leads me to believe that the free cash flow amounts that we’re seeing today are largely understated, at least to some degree.

[00:17:32] To round out the discussion on Alphabet, I wanted to end it with a clip from Bill Nygren where he digs into this idea further on the millennial investing show. Here it is.

[00:17:42] Bill Nygren: Yeah. It’s funny. I think a lot of times people get the idea that value investors are stuck investing in below average businesses, what Warren Buffett or Benjamin Graham called the cigar, but companies, but to us, value just means that you’re getting a lot more than you’re paying.

[00:18:01] And through some of these accounting issues where a company is making a lot of investments for the future that aren’t creating current earnings, it’s creating the misperception that the company’s expensive. , you look at a company like Alphabet and they’re investing a tremendous amount in autonomous vehicles, in healthcare, in Google Cloud.

[00:18:25] None of which really is earning any money today. In fact, it’s losing significant money. We think about it like if they made those investments with a venture capital firm instead, the accounting would be very different. It would be a big asset that goes on their balance sheet and the losses that are going through Those venture companies don’t go through the income statement, so we have them.

[00:18:49] So when we look piece by piece at the values, we separate out the cash, we look at the venture camp investments that aren’t earning money. We look at the under monetized investments like YouTube at Alphabet, that’s still through either subscriptions or advertising as monetizing at a fraction of what other streaming services are.

[00:19:10] And we do a piece by piece valuation. And when we sum up the parks, we, , subtract that from the stock price and say, we’re really getting the search business at lesser market multiple. And as we move to more and more of a business world that’s based on intangible assets, intellectual property, venture capital like investing r and.

[00:19:35] We think there are more and more of these opportunities where really good businesses look like they’re selling at an expensive PE ratio, but by the time you do the work and dig into it, there’s a core piece of the business that everybody agrees is a great business and we think we’re buying them at less than the market multiple.

[00:19:54] So to us, this is still just as much value investing as buying GM at six times earnings was, it’s just a little more complicated to

[00:20:02] Clay Finck: get. To add to what Bill is saying with the earnings on alphabet. I also wanted to pull in one more line from Adam Cecil’s. Tech companies could report dramatically higher current earnings if they wanted to.

[00:20:16] It’s just not in their best interest to do so early in their life cycles and with only a fraction of their markets conquered. Digital businesses are in growth rather than harvest mode. They are wisely spending dollars today that will be worth more dollars in the future. Such spending makes the E in the PE ratio look small and the multiple of current earnings to look large.

[00:20:41] But that is a misleading and deceptive snapshot of reality. It’s especially misleading when we are comparing tech companies, which are reinvesting heavily in the future to legacy companies, most of which are not. To compare Amazon’s or alphabet’s current profits to Wells Fargo is like comparing an apple orchard in the springtime to an apple orchard.

[00:21:03] In the fall, the ladder is ready for harvest while the former is just beginning to grow. End. All right. Now, the second company I wanted to talk about today is Amazon. Amazon is another widely held company amongst super investors, and I believe that’s for good reasons. Investors including Bill Miller, Bill Nygren, Tom Gayner, and even Warren Buffett all have exposure to Amazon stock.

[00:21:28] When Bill Miller was asked what the best investment decision he’s ever made, he said it’s buying the Amazon IPO. And then when he is asked what the worst financial decision he’s ever made, it was ever selling a share of Amazon. I tuned into a recent interview Bill Miller did with Wealth Track at the end of 2021.

[00:21:48] He stated that his estimate of what Amazon AW w s is worth is around 1.5 trillion if it were valued. Similar to other SaaS companies. But Amazon’s total valuation today here at the start of 2023, is around 1 trillion. So the total value of the company is valued at 1 trillion while Bill Miller’s estimate of AW w s alone is 1.5 trillion.

[00:22:14] Here’s a clip of Warren Buffett talking about Berkshire’s investment in Amazon when he was questioned. Whether it falls within a value investor’s framework back during the 2019 annual meeting.

[00:22:26] Interviewer: This question is from Ken Scar Beck in Indianapolis. He says, with the full understanding that Warren had no input on the Amazon purchase and that relative to Berkshire, it’s likely a small stake, the investment still caught me off guard. I’m wondering if I should begin to think differently about Berkshire looking out, say, 20 years, might we be seeing a shift in investment philosophy away from value investing principles that the current management has practiced for 70 years?

[00:22:54] Amazon is a great company, yet it would seem it’s heady shares. 10 years into a bull market appeared to conflict with being fearful when others are greedy. Considering this in other recent investments like Stone Co, should we be preparing for a change in the price versus value decisions that built Berkshire?

[00:23:12] Warren Buffett: Yeah, it’s interesting that the term value investing came up because I can assure you that both managers who, and one of them bought some Amazon stock in the last quarter, which we’ll get reported in another week, or 10 days. He is a value investor. The idea that value is somehow connected to book value or low price earnings ratios or anything, as Charlie has said, all investing is value investing.

[00:23:35] I mean, you, you’re, you’re putting out some money now to get more later on and you’re making a calculation. As to the probabilities of getting that money and when you’ll get it, and what interest rates will be in between an all the same calculation goes into it, whether you’re buying some bank at 70% of book value, or you’re buying Amazon at some high, very high mobile poll of reported earnings.

[00:23:55] The people making the decision on Amazon are absolutely much value investors as I was when I was looking around for all these things selling below working capital, , years ago. So that has not changed. The two people that one of whom made the investment in Amazon, they are looking at many hundreds of securities and they can look at more than I can because they’re managing less money in their possible universes , greater, but they are looking for things that they feel, they understand what will be developed by that business between now and judgment day and cash and, and it’s, it’s not a sales.

[00:24:35] Current sales can make or some difference. Current profit margins can make some difference. Tangible assets, excess cash, excess debt, all of those things go into making a calculation as to whether they should buy A versus B versus C, and they are got, they’re absolutely following value principle. They don’t necessarily agree with each other or agree with me, but they are very smart, they are totally committed to Berkshire and, and they’re very good and human beings on top of it.

[00:25:07] Charlie Munger: Warren and I are a little older than some people and damn near everybody. Yeah, and we’re not the most flexible probably in the whole world. And of course, if something as extreme as this ever development happens and you don’t catch it way other people, green boy blow by you. And I don’t mind not having caught Amazon early.

[00:25:33] The guy is kind of a miracle worker. It’s very peculiar. I, I give myself a pass on that, but I feel like ours is asked for not identifying Google better. I think Warren feels the same way.

[00:25:46] Warren Buffett: Yeah.

[00:25:46] Charlie Munger: We, we screwed up.

[00:25:48] He’s saying we blew itand we did have some insights into that because we were using them at Geico and we were seeing the results produced and we saw that we were paying $10 a click or whatever it might have been for something that had a marginal cost of them, was exactly zero. And, we saw it was working for us.

[00:26:08] So we could see in our own operations how well that Google advertising was working. and we just sat there sucking our thumbs, so we’re ashamed. We’re trying to atone

[00:26:19] Warren Buffett: When he says sucking our thumbs. I’m just glad he didn’t use some other example.

[00:26:25] Clay Finck: Now, from a high level, Amazon was a really big beneficiary of the Covid pandemic as the trend to e-commerce and online shopping really accelerated.

[00:26:34] And despite that, the stock has been getting hammered in recent months. At the time of this recording, it sits at around $97, which is nearly 50% below. Its all time high and is just slightly above the March, 2020 low. Let’s talk about the moat this company has, starting with their e-commerce business.

[00:26:56] Without a doubt, this company has one of the strongest moats to ever exist in my. In 2014, Amazon did 39 billion in e-commerce sales, and in 2022, E-commerce sales are estimated to be around 142 billion. I think of Amazon as similar to Google search in that it’s a toll road on the internet. It established that early lead, and now when anyone wants to purchase something online, oftentimes the first place they’re gonna go is to Amazon.

[00:27:28] To help lock in their customers and keep them coming back time and time again. They implemented Amazon Prime with their two day shipping. Currently Amazon Prime costs $15 a month or $139 on an annual basis in the us. I’d imagine that many American households can’t really imagine living without their Amazon Prime membership and all the benefits that it offers.

[00:27:51] Just from 2019 through 2021, the number of prime members increased from 150 million. To 200 million. So this company is definitely still in growth mode despite being just such a large business. Today, I see quite a bit of optionality with Amazon’s e-commerce business. First is the potential to profit off of every single sale that occurs on their platform.

[00:28:17] Since this is a business built on the internet, they are easily able to tweak the pricing of their products that they sell on Amazon, or tweak the fees that they charge for others that sell on. This is also referenced as their third party seller service. So they have the revenue they’re collecting from the selling themselves.

[00:28:36] They have revenue from the third party seller services, and then they have revenue from Amazon Prime. And last but not least, they have their revenue from their advertising business. Their advertising business unit is extremely valuable because when someone searches for an item on Amazon, they enter that search query with the intention of buying a product.

[00:28:55] This leads to massive amount of dollars spent on advertising to try and catch these users attention. I was chatting with John Huber on millennial investing back on episode 1 65, and during that episode he talked a lot about how good of a business the digital ad segment is, and how much more valuable those ads are given that the customers seeing those ads entered the search query with the intent of making a purchase.

[00:29:20] A lot of people talk about the e-commerce space and E A W S, but the digital ads business may also be a really big driver for Amazon’s stock performance over the coming decade. I’d encourage the audience to check out that episode with John Huber if they’d like to learn more about why John made Amazon his largest stock position in his fund.

[00:29:40] Amazon’s advertising business grew by 25% in the most recent quarter, and in the trailing 12 months, their ad business generated over 35 billion in revenue. And then last but not least, Amazon’s cash cow is their AWS business. This business in the trailing 12 months generated 76 billion in revenue with revenues in Q3 of 2022, increasing by 27%.

[00:30:07] Their AWS business is not only a very large and very fast growing business, it’s also very high margins as EBIT margins are 30% and give Amazon the cash needed to help fund the ever-growing retail business and other necessary investments they’re making in their continued future growth. In relation to Amazon’s moat, let’s not forget that Nick Sleep, who’s an investor that puts so much emphasis on quality still to this day, as far as we know, has owned Amazon stock for the last 20 years.

[00:30:39] When Sleep was researching the best companies to own, he discovered the incredible power of companies with what he calls scaled economy. Meaning that as the companies grow, they’re able to continue to offer lower and lower prices, which in turn only attracts more and more customers. It’s the ultimate win-win situation.

[00:30:58] So Sleep identified Amazon, Costco, and Berkshire Hathaway back in the early two thousands and put his entire net worth practically in these three stocks. That’s not to say that we should invest in whatever companies the super investors buy, but I believe that Amazon has a very large moat around its business.

[00:31:16] Amazon, over the many years continues to ensure that they’re providing low prices to customers, especially since many of them are signing up for their annual prime membership. In order to provide that fast and easy two day shipping, Amazon had to spend so much money to build out that fulfillment.

[00:31:35] Because of the amount of capital that took to build all that out. This is just another factor that plays into their moat because they have all these fulfillment centers and it becomes extremely difficult for other companies to compete in, achieve profitable margins. In addition to all the capital they’ve had to invest, they also have immense network effects, especially with Amazon Prime, essentially locking customers in giving these customers massive incentives to continue to shop on Amazon.

[00:32:02] The network effects also tie into the scaled economy share that Nick Sleep describes as they’re able to continually have a cost advantage over the long. As the company continues to grow year in and year out, I did a bit of research into Amazon’s market share and how that’s trending as well. I’m seeing varying statistics from different sources, but multiple more conservative sources stated that in 2021, Amazon accounted for 40% of all e-commerce sales.

[00:32:33] Walmart, of course, is also making a push for e-commerce and is growing as well, but today they only account for around 6% of e-commerce sales. Amazon also has the largest cloud business in the world with aws and with the continued increase in spend and commitments on aws, more and more companies are getting locked into that AWS ecosystem, and there’s high switching cost if they ever wanted to switch to another cloud provider.

[00:32:59] Recently, Amazon’s free cash flows have dipped into the negative territory, dragging the stock down with it. BuTIPersonally believe that these headwinds from a free cash flow perspective are temporary. When I look at the company’s top line for each of their important business segments, I see strong and consistent growth.

[00:33:17] And when I look at the big picture and the secular trends of e-commerce and the cloud industries, Amazon is a massive beneficiary for these trends. I believe that if Amazon really wanted to produce a ton of free cash flow in the near term, they could definitely do that. But instead they’re opting to continue to reinvest back into the growth of the company and reinvest and create that customer goodwill by continually offering those low prices.

[00:33:43] I dunno when the situation will improve in terms of Amazon’s financials, but when the stock price of a great company drops by 50% and is trading below what I believe the value to be, then I think when the financials improve and the economy eventually recovers, these lower share prices will prove to have been potentially great buying opportunities.

[00:34:04] I think this will also be a really big test for Andy Jassy as he’s facing a lot of pressure in terms of the overall economy and inflation, but I think there’s a lot of options for him and levers he can pull, such as the trimming the employee count, or increasing their prices a little bit, or just tweaking some of their business segments.

[00:34:22] I think there’s so much optionality in so many levers that management can pull to, you know, achieve that long term profit. Lastly regarding Alphabet and Amazon, I wouldn’t be surprised at all if either of these two companies have really depressed earnings in 2023 and it pushes their stock prices even lower.

[00:34:41] The emphasis for me is on the really long term and the secular trends that will benefit these companies. When looking at Alphabet, for example, and what looks like a relatively low PE today, we need to consider that those earnings in the future may decline. We may see lower earnings in 2023, so the stock might look cheap today.

[00:35:00] So I guess that’s my way of saying to be prepared for a potentially bumpy ride with these two companies. As the market is a voting machine in the short run and a weighing machine in the long. Transitioning to the third company I wanted to talk about in today’s episode. This is a new one I haven’t done into prior to researching for this episode.

[00:35:20] It’s a company called S&P Global, ticker, SPGI Value Stock Geek, which is one of my very favorite blogs for company deep dives did a pretty detailed article on this company. So shout out to him for his great writeup on his blog called Security Analysis.

[00:35:37] Plus my colleague Shawn O’Malley, who’s our newsletter writer at TIP, used to work at this company, so I was able to get some interesting insights from him as well. Shawn is doing great work on TIP’s daily newsletter called We Study Markets. If you’re not yet subscribed for that, you can do so by going to theinvestorspodcast.com/westudymarkets.

[00:35:59] Now S&P Global describes themselves as the leading provider of transparent and independent ratings, benchmarks, analytics, and data to the capital and commodity markets worldwide.

[00:36:12] Their claim to fame is their creation of the S&P 500 and Dow Jones Industrial Average Indexes, and they’re also one of the three major corporate credit rating agencies along with Moody’s and Fitch. So they operate in an oligopoly in this market, which provides them with one of the most powerful moats in the world.

[00:36:33] Many of our listeners may be aware that Buffett has roughly a 6 billion position in Moody’s and has owned the company since the year 2000. Any corporation that wants to issue debt, which is practically every company, they’re going to need to get a credit rating in order to do.

[00:36:50] SPGI is also a data company, as in 2020, they acquired a company called IHS Market.

[00:36:58] IHS Market has various products that provide things such as economic forecasting data, financial data for securities and derivatives, data and analytics for the energy market and various other niche data. So from a high level, SPGI has four major business segment. First is the ratings business. This is the supplier of credit ratings on corporations and sovereign governments.

[00:37:23] The blog post from security analysis states that the data collected from this segment supplies the market intelligence. Business ratings are the most cyclical segment of the company as it depends on new deals and debt issuance, which we’ll pick up when the economy is hot. Ratings represent nearly 57% of operating profit.

[00:37:44] The second segment is their indices business as they’re the index provider for indexes like the S&P 500. When a company like iShares, Vanguard or BlackRock wants to create a product based on the S&P index, they have to pay SPGI a fee. This segment represents 17% of operating profits. Third is their market intelligence segment that represents subscription software that supplies data to investment professionals, government agencies, corporations, and universities.

[00:38:14] So this brings that recurring revenue in for providing an essential product for financial professionals. This is 15% of operating profits, and fourth is what’s called their Platt segment. This is a data provider of information and benchmark prices for commodity and energy markets. So what S&P is to the equity markets?

[00:38:34] Platts is to the commodity markets. This is 11% of operating profits. 39% of the company’s revenues are subscription based, and they’re very sticky due to the nature of their agreements, and they’re high switching costs as well. The index business is also a very sticky business because if a company like BlackRock creates an S&P 500 index, it’s not like they can easily shut that down and stop paying SPGI their fees, and this helps provide entrenchment in the company’s moat.

[00:39:05] SPGI is priced as if it’s a great company. Their PE ratio is around 30 and their EV to EBIT is around 24, which is a metric that got as low as six during the great financial crisis, which was quite an extreme event for the company. Like many other companies, they’ve outperformed the market over the past 10 years as shares of averaged 22% annual growth over the past decade versus just 12% for the S&P 500.

[00:39:32] Even since the mid 1980s, it’s been a really strong outperformer as they’ve continued to deliver strong growth in their e p s and their free cash flow per share. The company went through some structural changes back in 2016, and ever since they’ve seen considerable improvements in their operating margins.

[00:39:50] Prior to 2016, operating margins were around 30%, and now operating margins are around 50%. Their returns on capital are also outstanding, averaging north of 20%, and the company also has a really good management team. They’ve recently acquired Market, which helped expand their moat, and they’ve rebranded the company over the previous decade from McGraw Hill to S&P Global.

[00:40:14] The fundamentals have improved substantially over the past few years as revenues have grown by over 50% since 2019, and operating income has increased by 64%. I think that if we see poor economic conditions in 2023, then the somewhat cyclicality of S P G’s business will likely come to haunt them like it did during the great financial crisis.

[00:40:38] But the business itself won’t be going anywhere. So we could see some great buying opportunities in this company if we do end up seeing, , rough recess. To be honest, I don’t love the valuation at these prices, but it’s definitely one of the strongest moats for a large cap public company. I could really find the returns on capital are really, really good, but if you see their earnings multiple mean revert, you could see a 30 to 50% markdown in the shares to the 180 to $260 range.

[00:41:09] At their current level of earnings. So this company is more so one to add to my watch list to keep an eye on if we do end up seeing a recession in a sharp drawdown in the stock price. Other than the price, it really checks all the boxes for me from a value investor’s perspective. All right, so transitioning to the fourth and final wide mo company, I wanted to discuss during this episode, it was somewhat hard to just pick one company.

[00:41:32] There are a number of companies I’ve talked about in the past that would probably be what I call honorable mentions, such as Dollar General Home Depot, Adobe. Or there are companies that are frankly pretty expensive on a multiple basis like Costco, visa, MasterCard, and some of the other big tech companies like Apple and Microsoft.

[00:41:50] But that’s the trouble with these great companies is that for a lot of the companies lifetime, they’re gonna be trading at what looks to be pretty expensive prices. Now let’s talk about a company that is likely impossible to be disrupted by technology, and that is Sherwin William. Another special shout out to my friend Adam Zeel for touching on Sherwin Williams in his book, and it really piqued my interest in the company.

[00:42:14] Sherwin Williams started all the way back in 1866 and it’s widely known for manufacturing, paint and paint products. Today they have about 4,800 locations in the us, Canada, Latin America, and the Caribbeans. Their business is primarily driven by three main segments, consumer brands at the AmericaS&Performance coatings.

[00:42:36] The consumer brands is what is sold to retail stores like Lowe’s. The Americas is what is sold in their own Sherwin-Williams locations, which drives over 50% of their revenue. And then the performance coatings are there. Industrial customers such as automotive companies and floor manufacturers, the company is somewhat tied to the housing market.

[00:42:57] People do home improvements. They may be redoing their pain job and their home. Of course, looking back at their history, revenues did decline in 2009, but quickly rebounded in the years that followed the company continued to produce positive net income throughout the great financial crisis as well. Over the past 10 years, this boring, stable business has produced average annual returns of 16% annually, not including the small dividend that they’ve been paying out, which right now is about a 1% yield.

[00:43:27] Sherwin Williams has a pretty strong moat for a number of reasons I think. For the foreseeable future, we’re gonna always need paint. New houses are always being built. People are always doing updates on their houses. I think that their consistent operating margins show that they’re able to continually increase prices over time without being disrupted by competitors.

[00:43:48] They’ve built out these really strong relationships with contractors, and they’re able to either deliver products to them in a timely manner, or have them pick up the products at somewhere like a Lowe’s or in their own Sherwin-Williams store. Because a lot of these contractors value speed in getting the job done quickly.

[00:44:05] Sherwin-Williams is able to deliver fast delivery to customers better than anyone else because they have the largest distribution network of stores in the us similar to S B G I. Sherwin-Williams is a quality company trading at a premium price. The EV to ebis is around 27, which got all the way up to 36 at the end of 2020.

[00:44:27] And it’s now trading more in line with where it was in 2017 prior to then it could be purchased at a multiple in the low teens. So I’d say that the market has definitely recognized the quality of this company. Sherwin-Williams has three things I really like to see in a company. On top of their return on invested capital, being in the mid-teens, they’re continually growing their earnings year after year.

[00:44:50] They’re repurchasing shares at around one to 3% per year, and they’re steadily increasing their dividend. Which is a really strong indication that the management team is looking out for the best interest of their shareholders. I think that investors will do just fine buying at this price, but more cautious investors may put it on their watch list and see if the multiple drops from the mid twenties to below the twenties to the mid-teens, which is where it’s been for a good amount of its history.

[00:45:17] It’s more so what Buffett would call a wonderful company at a fair price than something that happens to be trading at a wonderful price as well. Let’s remember that alphabet, which I talked about earlier, is trading at a multiple of 14 to 15 before factoring in any stock-based compensation. Also for Sherwin Williams.

[00:45:34] I wanted to read another excerpt from Adam Diesel’s book because I just really enjoyed this book and he has so many good pieces in it. All my non-tech companies are largely tech proof, but none is more so than Sherwin Williams. You just can’t render paint digitally, at least not. Meanwhile, there’s something deep within human beings that drives them to coat their walls either for decoration or to protect against the weather.

[00:46:01] In 1866, Henry Sherwin and Edward Williams founded the company that would introduce the world’s first guaranteed ready to use paint. As the industrial age progressed, paint became coatings and was used to finish anything that needed protection from the elements such as automobiles, ships, and airplanes.

[00:46:21] Sherwin Williams developed many of these modern finisheS&Patented them, then kept investing money into research and development to deepen its product mo to make the Sherwin-Williams brand instantly recognizable. It also kept spending on marketing. Today, Sherwin Williams has competitive advantages that stem from 150 years of innovation and brand loyalty.

[00:46:45] But what really distinguishes the company is its incredible retail presence. Sherwin Williams operates a network of nearly 5,000 company owned stores, and its nearest competitor PPG operates roughly 1000 stores. Why does this network of owned stores give Sherwin an edge? Because only Sherwin Williams has a store base extensive enough to touch American painters every day.

[00:47:11] Like many gray businesses, Sherwin Williams created its moat by asking what does my customer care about? And then working backwards until computers learn about how to cope buildings, the economics of house painting will remain simple. 80% of a painter’s expenses are labor and 20% is paint Time is therefore money to a painter and Sherman Williams focused on that fact like a laser beam.

[00:47:37] Given these unit economics, wouldn’t painters reward the company that saved them time? If so, why not roll out so many stores that most would drive by them every day on the way to their job? , that’s what Sherwin Williams has done. They even offer free curbside pickups so the painters don’t have to get out of their trucks in free donuts as well.

[00:47:58] The company supplements this network with a fleet of 3000 trucks whose drivers make constant runs to job sites to replenish low supplies. PPG owns their stores, but roughly one fifth, the number of Sherwin Williams PPG doesn’t have the density required to make the network ubiquitous. Benjamin Moore has more contact points because only Sherwin Williams can handle national accounts, and only Sherwin Williams can roll out a new and improved finish in a consistent nationwide brand.

[00:48:31] Only Sherwin Williams has a mobile app that allows a painter to order 10 gallons of eggshell white in the evening, then show up at his local store the next morning and find it ready for him. Sherwin’s store network gives in an edge, and this edge is continuing to grow. Every year. Sherwin adds nearly 100 new company owned stores.

[00:48:53] PPGs annual new store count barely reaches double digits. Little wonder that Sherwin Williams is growing its North American paint sales at six to 7% per year twice the rate of the competition. Meanwhile, Sherwin Williams has a low share of a large and growing market. The worldwide painting and coating sector remains fragmented.

[00:49:14] Insure wind only has about 10% of it at nearly 150 billion in annual. The market is huge and growing slightly more than the worldwide economy. Management is also excellent. Unlike Bezos at Amazon or Murphy at Cap Cities, there is no single star executive There is, however, a culture at Sherwin-Williams that enunciates an every employee from the lowest store trainee to the C E O.

[00:49:42] The discipline of thinking like an owner, Unlike many companies, Sherwin doesn’t just leave it to the CFO to understand principles like return on capital and capital allocation. You can tell this is not only from how executives talk, but how they act. Sherwin Williams rarely buys companies, but when they do, they do it brilliantly.

[00:50:02] In 2017, they bought Valspar, a leading industrial coating company using a hundred percent debt financ. Like Tom Murphy at Cap Cities, the reasoned that they didn’t need to use stock. Instead, they could use Sherwin-Williams ample cash flow to pay down the debt over several years. Then enjoy the acquisition forever without any dilution to shareholders.

[00:50:25] Unlike other less disciplined businesses, Sherwin Williams articulates clear priorities for its cash flow and then sticks to them if reinvest money in it, store, network, and product development. And in the Sherwin brand, anything leftover goes back to shareholders either as dividends or share purchases.

[00:50:44] So as you can tell, Zeel has so much respect for Sherwin Williams as a brand and their business fundamental. And I also discovered back in 2018, Lowe’s announced that they would be the only nationwide home center outside of Sherwin Williams owned store. Now Lowe’s and Home Depot are in a race to partner with the very best brands, and this partnership Lowe’s, established with Sherwin Williams not only shows how strong of a brand Sherwin Williams has, but also helps widen their mow.

[00:51:13] As anyone who shops at Lowe’s and wants to purchase paint, they have no other choice than to buy from Sherwin Williams. If that’s not a mo, I don’t know what. A Lowe’s executive stated that we do a tremendous amount of research related to customer preferences, and through that analysis we draw insights, which has led us to some of the most important brands in Sherwin, William being one of those.

[00:51:37] Although the partnership with Lowe’s is great news, the company earned 75% of its profit from the Americas group, which is essentially its own stores, and they completely dominate the US with 50% market. Their competitive advantage in this division is their vertical integration within their operations and their stores being so close to their customers.

[00:51:59] So again, Sherwin-Williams, it’s a great company, likely trading at a fairly high multiple, but it’s come back a little bit in 2022 and 2023 here. So I think it’s one for considering if you’re really looking for companies with really, really strong moats. All right, that wraps up today’s episode. I hope you enjoyed this episode covering four wide moat companies to consider for 2023.

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