My name is [INAUDIBLE], and I'm very pleased to welcome you

for another special talk in our Value Investing series.

We have a very special speaker with us today.

But before I get into his introduction,

I want to talk briefly about this term

"moat," which you are going to be hearing

a lot about in today's talk.

Well, according to Wikipedia, a moat

is a deep, broad, ditch, either dry or filled with water,

that surrounds a castle, other building, or town, historically

to provide it with a preliminary line of defense.

However, thanks to Mr. Buffett and a legion

of value investors, this word "moat"

has become an excellent metaphor to identify companies

with durable competitive advantage.

Very few people, though, have managed

to develop and synthesize a framework that systematically

helps to identify moats from an investor's perspective.

Pat Dorsey, our author for today,

has done a great service to students

and individual investors trying to do exactly that.

In his bestselling book, "The Little

Book That Builds Wealth," he has shared actionable insights

to identify modes in the business world.

His book is also a great introduction for anyone

interested in learning more about value investing.

We are very, very pleased to have Pat here with us.

So without further ado, ladies and gentlemen,

please join me in welcoming Pat Dorsey.

[APPLAUSE]

PAT DORSEY: Thanks for the kind intro.

I'm glad we have the technology, at least working mostly,

here in one of the world's most successful technology

companies.

[LAUGHTER]

You would have thought I was presenting

in Redmond, Washington.

No, I'm joking.

Sorry, sorry, it was just right down the middle.

It was too easy.

It was too easy.

You give me a fat pitch, I'm going

to hit it-- or invest in it, I suppose.

So we've done the intros.

I'm Pat.

I used to run Morningstar's Equity Research Group,

currently have my own investment firm called

Dorsey Asset Management, which is

a global firm, a global mandate.

We can invest anywhere in the world, any market cap.

We're very concentrated.

And our goal really is to find 10 to 15

of the world's most competitively

advantaged businesses that can compound at high rates

overtime, invest in them, and then leave them alone

to make lots of money over time.

That's our job, and that's what we're actively

engaged in doing right now.

And the framework we use is in large part based

on the work I did at Morningstar and the concept

of economic moats and reinvesting capital

at high rates of return.

And that's what I want to talk about today.

So the basic foundation of thinking

about economic moats and competitive advantage

is that-- shocker-- capitalism works,

and that capital seeks the highest returns possible.

If a company is making a lot of money,

others will seek to compete with it.

That intuitively make sense.

If I wrote each of you a $50 million VC check and said,

go start a business, you would probably

try to do something profitable.

If you are smart, you probably would not start airlines.

[LAUGHTER]

I hope.

I hope.

High profits attract competition, I mean,

as surely as night follows day.

So intuitively this makes sense.

Empirically it makes sense as well.

If you go back over time and look at, say,

take T1, companies in the highest

decile of returns on capital.

Then roll the clock forward 10, 15 years

and look at that cohort of companies.

Most will have lower levels of profitability.

Most will have lower returns on capital

as their returns on capital have drifted down

to some mean as competition has come in.

Of course there is a minority of businesses

where that's not the case.

So most businesses you see high returns

on capital decrease over time as competition comes in.

However, there is a very small minority

of businesses that enjoy many years

of high returns on capital.

They essentially beat the odds.

They defy economic gravity.

And the question simply becomes, how?

And in my view, it's because they've

created structural advantages, economic moats,

a way of insulating themselves, buffering themselves

against the competition, that enables them to maintain

supernormal returns on capital longer

than academic theory and the averages would suggest.

Because absent a moat, competition

destroys excess returns-- period, end, full stop.

Any highly profitable business that is easy to compete

with, you will see that come down over time-- very common

in the fashion industry, very common, say,

in if you guys remember back in NVIDIA,

and what was the other big graphics company, chip company?

[INAUDIBLE]?

They would swap market shares like every six months.

One had the best chip.

Oh, now I've got the best chip.

Do-do-do-do.

And there's no moat there.

The moat was just, what do I got that's great today?

And then you had a lot of smart engineers

at the other place trying to make the next best thing.

So the basics of moats is that there

are structural and sustainable qualities that

are inherent to the business.

A moat is part and parcel of the business

that you're looking at.

It's not a hot product.

We all probably remember the Krispy Kreme debacle.

They taste good, but sugar is not a moat.

Heelys-- anybody remember Heelys or have a kid?

Remember those little shoes with the wheel in the heel?

That was an $800 million company at one point.

I mean, yes, as Dave Barry would say, I am not making this up.

People were valuing Heelys as if it had a moat.

Aside from the massive product liability issues,

once basically schools started banning them,

that's a problem if your target audience of 12-year-olds

can't buy your product anymore.

And so that business went to hell pretty fast.

It's not just a cool piece of technology.

We talked about in video and the graphics companies

a moment ago.

Remember Iomega?

Remember that was going to be the thing?

It's just a cool piece of technology.

And frankly, any cool piece of technology

can be replicated by other smart engineers,

unless there's some switch in cost, some lock-in effect that

occurs or an industry standard is created.

But anything that one smart bunch of guys can develop,

there's probably another smart bunch

of guys somewhere else trying to make it even better.

And of course, it's not the biggest market share.

You'll often hear companies talk about, oh, we're the biggest.

We're going for market share.

Let's think about GM.

Let's think about Compaq.

It didn't work out so well.

Big is not a moat.

In fact, small is often a better moat than big.

Moats generally manifest themselves in pricing power.

A company that can't raise prices

is unlikely to have a strong moat.

And in fact, if you invest, this is a test often

that businesses are losing competitive advantage.

If you have a company who typically raises prices 2%, 3%,

4% every year.

They're able to kind of keep pricing power moving up.

And then one year, suddenly they don't.

They say, well, the economy's tough

or we want to take it easy on the customers this year.

That's a load of crap.

It means that something has changed in that industry.