Matt Franz : Zealous For Knowledge

Moats Aren’t Always Metaphors

If you lived during medieval times you’d know that a moat is a deep, broad, water-filled ditch that surrounds a castle. It protects the castle from invaders.

If you’re a value investor you know that a moat is something that protects a business from the competitive forces of capitalism. It protects a business’s economic castle from invaders. Companies with strong and widening moats are valuable because they can earn out-sized returns on their capital for a long time.

Have you ever seen the coffee maker on an airplane? It looks like something out of the 1970’s. And that’s because airplane coffee makers have hardly changed since the 1970’s.

Transdigm makes these along with lots of other airplane parts. Every part in an airplane in meticulously tested and approved by the FAA, which is why flying is so safe. The long and costly testing required for something like a coffeemaker means that no one has bothered to try and compete with Transdigm. It’s just not worth their time, money and energy to try and take market share. This is a classic example of a metaphorical moat. The regulatory burden prohibits competitors from competing with Transdigm, allowing Transdigm to make out-sized returns.

But sometimes an economic moat is a real moat in the medieval sense. The Wall Street Journal ran an article recently about how the KMart in Guam is thriving. The reason is simple: Guam is 6,000 miles from California and its nearest competitors (Target, Walmart, Amazon).

This isn’t the only example either. Have you ever noticed that Hawaiian banks are unusually profitable? The reason is that no mainland banks operate there. You won’t find a Wells Fargo, JPMorgan, Citi, or Bank Of America branch in Honolulu. It’s not that the money center banks haven’t tried either. It turns out that Hawaiians are unusually loyal to their banks and suspicious of mainland banks.

The result is that, once again, the Pacific Ocean has acted as a moat. It protects Bank Of Hawaii and First Hawaiian from the competitive forces of capitalism. A lack of vigorous competition means these banks earn significantly higher returns on capital than their mainland peers.

Airplanes and the internet made moats irrelevant. But the Pacific Ocean will continue to protect Hawaiian banks because it continues to protect Hawaiian culture. Extreme geographical features have always shaped and isolated cultures, which can provide unique investment opportunities. In the U.S. Alaska, Hawaii, Puerto Rico, and the Pacific islands offer fertile hunting grounds for these types of businesses.

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