Chasing Value: Williams Co., Beyond a Wide Moat

Many a value investor looks to allocate capital in companies that have “wide moats” which limit competition and contribute to pricing power. This is something long advocated by “my pal Warren” and comes from the idea that a wider moat makes it harder to storm the castle walls. In the Williams Companies, Inc. (WMB), which is in the business of moving natural gas through its network of 38,000 miles of pipeline, you might find a company with more than a wide moat. It might perhaps have an impenetrable castle, or close to it.

For comparative scale, Williams’ 38,000 mile network is longer than the roughly 32,000 miles of rail line making up the Union Pacific Corporation (UNP) railroad, which is the largest in the United States. That is a lot of pipes! It should be clear that it would be very difficult to replicate that infrastructure. But let’s go look even deeper.

Suppose you were given free of charge all the pipes, fittings and related material to replicate the network. Furthermore you were given the management, engineering design and construction labor free of charge as well. Add to this a free and clear “right of way” approved by congress and signed into law by the president that would allow you to build your network without disruption even if you wanted to run it through the middle of city hall, your local church or country club, or even the most environmentally sensitive path. Finally you were given a blank check to accommodate any unforeseen necessities to accomplish your build out and the hiring of all the people it would take to run and maintain the business.

What an amazing gift all of this would be, and with all that you could not compete with the Williams Companies. The reason is there is one very important missing ingredient, time. How long would it take to build out the network? Ten years? Twenty years? Perhaps even thirty years? The actual existing network took far longer. Since you do not have all of these gifts and no magic wand I think we can agree it would be a very long time to replicate WMB. So long in fact that it may be close to impossible, thus giving it an impenetrable barrier to entry. This is why you find businesses of this type are often aggregated with others, growing organically, and by acquisition, reducing competition all the while.

It is very important to create a watch-list to follow companies like this with the objective of someday having an irrational market present you with a buying opportunity. Patience is not just a virtue, it is profitable.

Disclosure: As of the time of this post we own stock and options positions in The Williams Companies, Inc. (WMB)

Chasing Value: A Few Lesson’s Learned From “My Pal Warren”

This is my first post on our redesigned web-site, so it is appropriate to pay tribute to Warren Buffett, the CEO and Chairman of Berkshire Hathaway (BRK.A / BRK.B), who has made a large contribution to our investment education. I strongly recommend reading his book Letters to Shareholders 1965 – 2013 (also available on Berkshire Hathaway’s web-site). Buffett has often repeated his most important rule #1 “don’t lose money”, and rule #2 “remember rule #1″. That said there are many other facets to his investment protocol.

The Most Desirable Holding Period is “Forever”

The reason this so often holds true is that your capital allocation can compound tax-free and without transactional expenses, maximizing the amount of capital working for you. When you sell an appreciated stock you incur state and federal taxes (the capital gain). Investments that would instantly provide you with an immediate gain, equal to what you gave away, to reach the previous level of invested capital are even more remote.

When would we sell an asset? When something at the company changes so that it no longer supports our original thesis for acquiring it in the first place.

To achieve this goal we have found it is advantageous to focus on a limited number of businesses. For example, Buffett made his largest investment to date in the Burlington Northern Santa Fe Railroad, a business that dates back to 1849 and is likely to be around for a very long time. Had he acquired something like Netflix (NFLX) he could have made a great deal of money too — but might be subject to technological obsolescence and feverish competition. However, unlike a railroad company, the likelihood that Netflix could be held for decades is very uncertain. The longevity of an investment is not the only criteria for stock selection but it is always relevant and it is a limiting parameter.

Favor Dividend Paying Stocks

Although Berkshire Hathaway does not pay a dividend, you will find that almost all of its individual stock holdings do pay a dividend. Three of Berkshire’s top holdings include Wells Fargo (WFC), Coca-Cola (KO), and American Express (AXP), which pay 2.5%, 3.3% and 1.3% yields respectively. The yields based on Berkshire’s original invested capital are many times greater since these positions were accumulated many years ago.

The emphasis on dividends is no accident. Dividends Were Responsible For 42% Of Stock Market Returns Since 1930 In addition to the enhanced returns over time  Investopedia outlines numerous other benefits in “Why Dividends Matter”.

Avoiding Potential Technological Obsolescence

High-tech equipment manufacturers have to be very concerned about inventory depreciation. The rate of change in the tech industry makes this a more significant factor than other industries. How much R&D is required to keep up with competition in the tech world versus basic materials or slow moving industries? For example Nokia (NOK) and Blackberry (BBRY) were crushed by Apple’s (AAPL) introduction of the iPhone. Will Apple always be the generator of the best new ideas? If you constantly have to invent to stay relevant it is more difficult to build up long term equity, an imperative for consideration as a long term investment.

This is not meant to imply that investing in technology is always detrimental, however, there is a reason that “my pal Warren” has made more than anyone else allocating capital. He aligns everything he can in his favor for the long term.

There are many more factors that go into Warren Buffett’s outperforming the market which will be discussed in future posts.

Disclosure: As of the time of posting The Chasing Value Fund I, LP and many private accounts currently hold stock, and/or options in Berkshire Hathaway (BRK.B) and Wells Fargo (WFC).