Pat Dorsey on Mistaken Moats
Discover the dangers of "mistaken moats" and learn how to identify true, lasting competitive advantages in investing with insights from Pat Dorsey.
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I'm excited to share some key insights from Pat Dorsey on "mistaken moats" and how to spot true competitive advantages.
If you’ve ever wondered why some companies seem strong but struggle to maintain their edge, this post will help you avoid common investing pitfalls. Let's get started!
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Pat Dorsey is a renowned investment strategist and author, best known for his expertise in identifying sustainable competitive advantages—what he calls "economic moats." As the former Director of Equity Research at Morningstar and currently founder of Dorsey Asset Management, Pat has spent years analyzing companies and markets, helping investors distinguish between fleeting opportunities and long-term value. His work has been instrumental in shaping the way investors think about competitive advantages and how to identify truly great businesses.
In this post, readers will learn about the concept of "mistaken moats," as explained by Pat Dorsey in The Little Book That Builds Wealth. The post will explore common misconceptions that investors often have when assessing a company's competitive advantages, highlighting the difference between temporary successes and enduring moats. By the end, readers will have a clearer understanding of how to identify true economic moats and avoid the pitfalls of investing in companies that may not have the lasting competitive edge they appear to possess.
TL; DR
Pat Dorsey: Expert in identifying lasting competitive advantages.
Mistaken Moats: Common investor errors include overvaluing great products, market share, execution, and management as long-term advantages.
True Moats: Focus on structural, enduring barriers that protect a company from competition, not just temporary successes.
What Are Mistaken Moats?
According to Dorsey, a "mistaken moat" occurs when investors erroneously attribute long-term competitive advantages to characteristics that are either temporary or superficial. These mistaken moats can lead to poor investment decisions, as the assumed advantages do not provide the enduring protection against competition that true moats do. Dorsey identifies four primary mistaken moats: great products, strong market share, great execution, and great management.
Great Products: Short-Term Success, Not Long-Term Moats
A great product can drive significant short-term success, but it doesn't necessarily translate into a long-term competitive advantage. Dorsey explains that competitors can often replicate a successful product, eroding the initial company’s market share. For example, Chrysler’s introduction of the minivan in the 1980s brought short-lived financial success. However, this advantage quickly diminished as competitors introduced their own versions, leading to a decline in Chrysler’s profits. True moats are not just about having a great product; they are about creating barriers that prevent others from easily copying or surpassing that product.
Ethanol is a classic no-moat business. It’s a commodity industry with no possible competitive advantage (not even scale, since a huge ethanol plant would actually be at a cost disadvantage because it would draw corn from a much larger area, driving up input costs, and it would have to process all of its residual output, which consumes a lot of natural gas).
—PAT DORSEY
Strong Market Share: Not Always a Sign of a Moat
Many investors mistakenly believe that a company’s large market share indicates a strong competitive advantage. Pat cautions against this assumption by pointing out that market share alone does not guarantee long-term profitability or market dominance. The key is not just how much market share a company has, but how defensible that share is against competitors. For instance, Kodak once dominated the film industry, but its failure to innovate and adapt to digital technology led to its downfall, despite its strong market position.
Bigger is not necessarily better when it comes to digging an economic moat.
—PAT DORSEY
Great Execution: Efficiency Isn’t Enough
Running a company efficiently is undoubtedly important, but Dorsey argues that efficiency alone does not create a moat. In highly competitive industries, where efficiency is a necessity just to survive, it does not provide a sustainable competitive edge. A company may excel in executing its operations, but without a structural advantage that competitors cannot easily replicate, it remains vulnerable. Dorsey emphasizes that true moats are based on unique processes or proprietary advantages that go beyond mere operational excellence.
Absent some structural competitive advantage, it’s not enough to be more efficient than one’s competitors. In fact, if a company’s success seems to be based on being leaner and meaner than its peers, odds are good that it operates in a very tough and competitive industry in which efficiency is the only way to prosper. Being more efficient than your peers is a fine strategy, but it’s not a sustainable competitive advantage unless it is based on some proprietary process that can’t be easily copied.
—PAT DORSEY
Great Management: The Jockey Matters, But the Horse Is Key
Lastly, Dorsey warns against overestimating the role of great management as a source of a competitive advantage. While strong leadership can certainly enhance a company’s performance, it does not constitute a sustainable moat. Management teams can change, and even the best managers cannot overcome fundamental weaknesses in a company’s business model or industry dynamics. Dorsey advises investors to focus on the structural characteristics of a business—what he refers to as the "horse"—rather than being overly swayed by the brilliance of the "jockey."
A strong management team may very well help a company perform better—and all else equal, you’d certainly rather own a company run by geniuses than one managed by also-rans—but having a smart person at the helm is not a sustainable competitive advantage for a wide variety of reasons.
—PAT DORSEY
Summary
In this post, we explore the concept of "mistaken moats" as outlined by investment strategist Pat Dorsey in The Little Book That Builds Wealth. Dorsey warns investors about common misconceptions when identifying a company's competitive advantages. He identifies four primary mistaken moats: great products, strong market share, great execution, and great management. While these factors can contribute to short-term success, they do not provide the lasting protection that true economic moats offer. Dorsey emphasizes the importance of focusing on structural characteristics of a business that create enduring barriers to competition, helping investors make more informed and sustainable investment decisions.
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