Ah, another little book. I read and reviewed several of them already. Some are good; some not so.
- The Little Book That Beats the Market by Joel Greenblatt (*)
- The Little Book of Bull Moves in Bear Markets by Peter Schiff (***)
- The Little Book of Value Investing by Christopher Browne (****)
- The Little Book of Common Sense Investing by John Bogle (*****)
- The Little Book That Makes You Rich by Louis Navellier (*)
This book, The Little Book That Builds Wealth, is written by Pat Dorsey. Mr. Dorsey is Director of Equity Research at Morningstar. He’s in charge of Morningstar’s equity ratings. In addition to rating mutual funds with one to five stars, Morningstar also rates individual stocks on the same scale.
If the book can be condensed into one word, it’s “moat.” The concept of moat is said to have come from Warren Buffett. It means structural competitive advantages a company holds over its rivals. Warren Buffett mentioned the moat concept as early as more than 20 years ago in his 1986 letter to shareholders:
“The difference between GEICO’s costs and those of its competitors is a kind of moat that protects a valuable and much-sought-after business castle. No one understands this moat-around-the-castle concept better than Bill Snyder, Chairman of GEICO. He continually widens the moat by driving down costs still more, thereby defending and strengthening the economic franchise.”
This book says that, all else being equal, companies having wide moats will deliver higher returns to investors than companies having no moats or narrow moats. The investing strategy therefore comes in three steps:
- Find companies with wide moats
- Buy the stocks at or below their intrinsic values
- Sell when a company’s moat erodes or when its stock price exceeds the intrinsic value
The book explains what factors contribute to moats and what look like moats but are really not moats. According to Mr. Dorsey, moats are made up of:
- Intangible assets: brands, patents, regulatory licenses
- High customer switching costs
- Benefits from network economics
- Cost advantages: process, location, scale, or access to a unique asset
On the other hand, great products, great size, great execution, and great management are not moats. The book includes many examples for how each of the factors above gives a company moat. It’s written in language that’s both engaging and easy to understand.
Moats are not everything. Valuation also matters. The last 20% of the book touches on the intrinsic value of a company. It introduces the valuation metrics: price to sale, price to book, price to earnings, price to cash flow, and dividend yield. Not much new there. The Little Book of Value Investing by Christopher Browne has more materials in this area.
I don’t invest in individual stocks. I wrote Picking Stocks Is a Waste of Time in 2007. If I were to pick stocks though, buying wide moat stocks below intrinsic value makes more sense to me than magic formula, rule #1, or growth investing.
Coincidentally, Morningstar publishes a Morningstar StockInvestor newsletter that uses the “wide moat below intrinsic value” strategy. Unlike the other authors (Greenblatt, Town, and Navellier), Pat Dorsey did not make sales pitch for this Morningstar newsletter in the book. He didn’t mention it at all. I applaud Mr. Dorsey for that. I want to read a book, not a marketing brochure.
According to Morningstar, the two model portfolios in the StockInvestor newsletter (“Tortoise” and “Hare”) returned 34.2% cumulatively since their inception on 6/18/2001 through 6/30/2009 while the S&P 500 returned -11.8% during the same period. Very nice.
The Morningstar StockInvestor newsletter costs $120 a year. Compared to other newsletters, it’s not exorbitantly expensive. You can see some of the trades in the model portfolios even if you are not a subscriber. Using the numbers Morningstar published in its 2008 update, I reconstructed the annual returns for the Tortoise (conservative) and Hare (aggressive) portfolios as follows:
| Tortoise | Hare | S&P 500 | |
| 2008 | -22.2% | -32.4% | -37.0% |
| 2007 | 1.6% | 5.4% | 5.4% |
| 2006 | 13.7% | 21.9% | 15.7% |
| 2005 | 8.2% | 3.2% | 5.1% |
| 2004 | 13.0% | 26.8% | 10.8% |
| 2004-2008 average | 1.9% | 2.6% | -2.2% |
If I were to invest in individual stocks, I would look more into these moat strategies. But I’m not a stock picker and I’m not interested in becoming one. To each their own.
Rating: **** (good).
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