Dorsey, Pat. The Little Book that Builds Wealth. Hoboken, New Jersey: John Wiley & Sons, Inc., 2008. xviii+200 pages. No index. ISBN: 978-0470226513.
In this book, Pat Dorsey provides a fairly clear explanation of “economic moats,” a metaphor for the circumstances that make it possible for firms to earn substantial profits over a sustained period.
If you want to understand a summary of Warren Buffet's investment strategy, this book will give you some idea what Warren Buffet thinks he's doing. On the other hand, if you want to understand Warren Buffet's investment strategy, you probably are better off reading works written on his investment strategy.
Finding economic moats can be one part of value investing. If a firm has an economic moat, then it will be able to earn profits for a sustained period. After finding that a firm has an economic moat, the question is whether enough other people already have recognized this characteristic and the economic moat is reflected in the stock price. Investment analysis along the lines of value investing can help provide information on whether the stock price already reflects the economic moat. If the stock price doesn't reflect the economic moat, then buying the stock is worthwhile. If the stock price reflects the economic moat, then the intelligent investor can only move on to analyze another firm or hope that the stock price will fall for some unpredictable reason.
The list of possible economic moats in the book is fairly short, comprising intangible assets, switching costs, network effects, cost advantages and size advantages. This seemingly disparate grab bag of possible moats can be summarized in reasonably plain English. They are competitive advantages that are not easy for other firms to copy. In economist's jargon, they are called barriers to entry. With either name, the underlying principle is pretty simple.
What is not simple is identifying firms with such advantages. Many firms think they have such advantages. Some are right; some are not. Which ones are right? If you follow the advice in this book, you will be betting your money on which firm you think is right.
In addition to betting on your identification of firms with competitive advantages, you will be betting that you are paying an attractive price for these competitive advantages. If you pay an attractive price that does not reflect the competitive advantages, others may later recognize the competitive advantages, at which point the stock prices will rise. Then you will come out ahead.
This seems like a tall order for most of us. I am not inclined to bet my money on my ability to do this in my spare time. I think it is possible to accomplish this in selected circumstances, but careful analysis of firms that are not likely to be of interest to big players such as Warren Buffett seems crucial.
Leaving aside whether you should spend your time looking for economic moats, is this book particularly informative about economic moats? Personally I would say “No.” On the other hand, I am a Ph.D. economist and most readers of this book are not.
If the list of competitive advantages above does not seem obvious, then you may well find the book interesting even though Dorsey does not really provide “the knockout formula for finding great investments.” You will learn some characteristics that can be associated with sustained profits for firms. On the other hand, “cost advantages” are pretty obvious.
Perhaps the most obscure competitive advantage in the list is the one called a “network effect.” My first thought was that Wikipedia would provide a fairly intelligible discussion in plain English. I don't think so, at least as of this writing. You can decide for yourself by looking at the Wikipedia page on network effect. Actually, the basics of network effects are not hard to explain.
Windows is a handy illustration of a network effect. Because most people use Windows, software is readily available for Windows, lots of people know how to run that software and it is easy to transfer files across computers running Windows. As a result, many people buy Windows when they buy a computer. Now you know what a network effect is. Microsoft benefits from this network effect, because many people buy Windows because other people have Windoes. So Microsoft has an “economic moat” that is liable to persist for some time.
Overall, this book has the least content of the books in the Little Book Big Profits series. It also is likely to be the least valuable for improving your portfolio of stocks and stock mutual funds. It is well written overall though, so if you're in the mood to read about economic moats, it can be worthwhile to read it.
