The Little Book That Builds Wealth - Chapter13

This chapter explains various tools that can be used for valuation.  Some excerpts
Price to sales ratio is very useful for valuing companies that are temporarily unprofitable compared to historical returns.  Price to book is useful for financial services stocks.  Sometimes the book value itself is questionable for financial services companies. PE is the most widely used.  The earnings  component of PE is anybody guess.  For cash flow rich companies price to cash is a good tool to valuation.  Yield based calculation is helpful to compare with other alternate assets like bonds etc

The Little Book That Builds Wealth - Chapter14

This is the final chapter. This talks about when to sell a stock.  Some reasons could be when you made some mistake in your original analysis and your assumptions were wrong and no longer valid.  One should sell if the fundamental of the company changes to worse permanently.  If the market value is way beyond the fair valuation, it makes sense to sell and be on cash.  Some could sell, if the individual stock becomes huge part of the portfolio and it needs to be trimmed down.

In conclusion, this is a very good book and worth the money and time spent.  Do read when you get chance and let me know your thoughts.

The Little Book That Builds Wealth - Chapter12

This chapter deals with how to value companies that we have identified.  Intrinsic value of any asset is equal to the present value of all the cash that asset can generate.  Four important factors as per the author are earnings growth , certainty of that growth (risk), ROCE and moat.  Buying stocks at an attractive valuation makes the returns better than buying at higher valuation as the margin of safety is better.

The Little Book That Builds Wealth - Chapter11

In this chapter, the author provides some practical application of the learning and selecting stocks based on this understanding.  Some key points are

• To check for economic moat, first see if the company had a historic record of generating high return on capital.
• If it is high, ask yourself a question as to how the company can maintain this return.  Use the tools from chapter 3 to 7 to identify the moat that the company has that would let it maintain this return.  If we are unable to pin point the right moat, the chances are there is no moat  for this company.
• Once a moat is identified, think how long that moat can last for the company before it can be eroded.

The Little Book That Builds Wealth - Chapter10

As per the author, the management matters less than what we think.  It is always better to bet on the horse than the Jockey.  This seems to be in line with what Buffet said 'When a management team with a reputation for brilliance tackles a business with a reputation for bad economics, it is the reputation of the business that remains intact.'


Another one of Buffets quote that comes to my mind is 'Buy a business that any idiot can run because eventually an idiot will run it'.

This chapter makes a lot of sense because just betting on someone in management is thinking very short term.  The person could fail or may leave the company and we may end up with a bad investment.  If the business is fundamentally strong and has a very strong  moat, it will do good even if an average honest manager runs it.

The Little Book That Builds Wealth - Chapter9

This chapter deals with finding moats in various industries.  Some industries have strong moat compared to others by nature.  Per auther, Media has the highest moat % followed by utilities, financial services and energy.  Lowest moat is in Industrial materials and hardware (mostly commodity).
Generally the fourth best player in an attractive industry would have a stronger moat than the first player in the worst industry.  This is very very true.  Compare textile players to FMCG in Indian scenario and we know what this author is talking about. 

The Little Book That Builds Wealth - Chapter8

This chapter explains how moat erosion can take place.  Technology changes can erode moats in a drastic way.  There are tons of examples for this right from Typewriters to cameras.  Kodak and Polaroid were once strong moat companies and they have lost out completely to today's digital camera world.
If the companies customer base is very concentrated, then that moat is risky. If the competitors are engaged in a self destructive competition then the moat could be risky as well.
Some strong moat companies that generate great return on capital may invest in businesses that they do not have competitive advantage in and that could erode the overall moat of the company and destroy shareholder value.  They would be better off to return back the money to shareholders instead.  One good example, I can think off is Deccan Chronicle.  It has a very good newspaper publishing business which give good return on capital. The management instead of returning that money to the shareholders have invested in Odyssey retail, which not only sucked all the capital and is high on debt but always made big losses.  This and other business made the return on capital worse than a savings deposit.

The Little Book That Builds Wealth - Chapter7

In this chapter the author explains about the size advantage.  Companies that can spread their fixed cost on a larger base have significant advantages than other companies and this provides a very strong moat as others would have a high fixed cost and therefore cannot compete with this company.
Economies of scale can be in three categories viz distribution, manufacturing and niche markets.  Large distribution networks provide very high competitive advantage as incremental cost as lesser but the value increases manifold.   A new player would have to make very high investment and time to replicate the distribution network of large established players.  Unless they have deep pockets and patience, they would not do it and this provides the advantage.
In manufacturing larger the facility and more the capacity, fixed costs get distributed and the cost becomes lower.
Final type of scale advantage is being a dominant player in niche market.  Even very small company can be a dominant player in a niche market.  Basically a big fish in a small pond is better than big fish in a big pond.

The Little Book That Builds Wealth - Chapter6

Cost advantages matter most in industries where competition is based on price and price determines the buying decision of the customer. Most of the commodities will fall in this category.
Cheaper processes, better location and unique resources can create cost advantages.  Cost advantage due to cheaper process can be copied by others so it is a very short lived advantage.  Some of the business co-locating with their customer provide location based advantages.  Cement companies and granite quarries that are closer has great advantages as the cost of transportation is cheaper and they tend to have lower cost than other that need to transport long distances.

The Little Book That Builds Wealth - Chapter5

In this chapter, he speaks about the moat created by network effect.  Network effect is the value created for a product or service based on the number of users.  More the numbers, higher the value.  Good examples of this are google, facebook, ebay etc.  ebay is a classic example of network effect.  Buyers go to ebay  because they see large number of listings of product by multiple sellers.  Sellers sell in ebay because, they find the maximum number of buyers in ebay and their chance to sell more is high.  Latest example is Apple iphones/ipads.  More iPhones and iPads are sold because of large number of apps that the buyers can select from.  More apps exist because more developers write code for apple iOS than any other operating system because that is the most used.  Even though Android market share is higher, when it comes to hardware sales Samsung smartphones may be a distant second to Apple.  Microsoft inspite of being a big company is unable to compete because its late in the game.
Network effect is a extremely powerful type of competitive advantage as per the author.  Its mostly found in information sharing business that connects people 

The Little Book That Builds Wealth - Chapter4

In this chapter he explains switching costs and how they work as a great moat for a company.  We may travel an extra 5 to 10 minutes if a grocery item is cheaper at some place however we generally will not switch our CA that does our taxes or the bank account that we operate.  This is because the switching cost of closing this account and then opening the bank account and again automating all the bills payment is a pain and the very thought stops us from doing this.  This creates a moat for the bank which would charge higher fees for various transactions.  Some of the ERPs and database companies thrive on this switching cost moat as enterprises do not want to risk changing their systems with a new one and ending up having business interruptions and revenue losses due to new system.  The cost or pain is much higher than the benefits enjoyed and this provides a very good moat to the company. If a company makes it tough for customers to use competitors product or service then it can charge more and maintain high returns on capital.
Most of the products like razors, printers, blood sugar monitors they cost so cheap but the refills are so expensive.  The reason is since we already bought the printer or the razor, the chances are we will keep buying the refills for that instead of buying another razor or a printer.  These companies may make small losses when they sell their razor or printer but they make big profits in refills.

The Little Book That Builds Wealth - Chapter3

In this chapter, he talks about various intangible assets of company like Brands, Patents and regulatory licenses.  Brands provide anywhere between fragile to strong moat.  He makes a very good point wherein a brand is not an asset if it does not translate into pricing power for the company by which it can earn higher profits.  Some examples that I can think off in India is Airtel.  Here the brand does not matter much.  If we compare that to say Vodafone or Idea, all give good call quality and if Airtel prices higher customer would switch to others even though the brand recall could be higher.  Compare this to a Titan.  Titan can significantly charge higher for their watches compared to other Indian brands and make better profits.
Second intangible asset is the Intellectual property.  While this asset provides some amount of protection, it is filled with litigation and other challenges.  In this area a company with more IPs is always preferred than a company with just few IP.
Third and final asset is the regulatory approval or licenses to operate.  This provides a good moat as they are not easily available.  Take rating agencies like Crisil or CARE.  Anyone cannot become a rating agency and this provides a good moat.  Also mining licenses provide a good moat.  As per the author licenses that needs multiple regulatory approval from various bodies provides much stronger moat than ones that need one big approval.