Wednesday, July 16, 2014

Lessons from Value Investing and Moat Analysis

Being a dividend growth investor does not stop me from learning lessons from other investing philosophies. After reading The Little Book of Value Investing and The Little Book that Builds Wealth, I feel value investing and searching for companies with moats that create sustainable competitive advantages will help me in my investment research. A couple key takeaways from both books are outlined below.

Value Investing:
- Searching for low Price-to-Book and Price-to-Earnings stocks is a good way to identify companies that might be set to earn superior returns in subsequent periods if they can exhibit growth.
- There's value (pun intended) in identifying stocks in which company insiders are buying. Afterall, who better to know if a stock is undervalued than the company's employees and management?
- The list of successful value investors is long, and includes such names as Benjamin Graham, Warren Buffet, and Bill Miller. All of these investors were contrarians who didn't follow the herd mentality of the markets.

Searching for Companies with Moats:
- Sources of moats include intangible assets (brands, patents, or regulatory licenses - i.e. telecoms, waste removal), customer switching costs (due to integration with a customer's business - i.e. Oracle, Adobe), network economies (value of a product increases with users - i.e. credit cards, Ebay), and cost advantages (stemming from process, location, scale, or access to a unique asset - gravel pits, Walmart).
- Moats only exist if the company can benefit by having above-average profitability over an extended period of time (measured by ROA, ROE, etc.)
- Morningstar provides moat ratings on the companies it covers, indicating if the company has no moat, a narrow moat, or a wide moat.

I'm in the process of looking to add a US stock to my RRSP next month, and will be keeping the above information in mind when undertaking my analysis. Buying a company that's relatively cheap, with a moat that will help ensure above-average long-term returns can only help identify even better dividend growth stocks.

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