Question for the board

[Guest davidwoo]

Can anyone on the board name a small company, 500 million market value or less, that has a durable competitive advantage, wide moat, and if so what that durable competitive advantage is? 

 

Im not looking for freebie stock advice  Just having trouble conceptualizing this and was hoping for a concrete example. I'm sure many will not want to disclose such a find but maybe you have a few names in mind and one name is crazy over valued so it's not good for investment but good for the example and it's not like your giving away something of much value right now. 

 

DW

[Packer16]

Durable advantage many times has to do with the structure if the industry.  Small companies typically have a niche where the cost is too great for a competitor to retunr a decent rate of return.  Three areas/industries come to mind software, radio, lodging and distribution.  As to firms in those spaces ITEX, CSGS (Software), SGA, SALM (radio), WOLF (lodging) and DIT, CRVP (distribution).  There are probably many other examples others can provide from these sectors plus others.

 

Packer

[elltel]

ROR.LN Rotork. UK based company. Slightly larger market cap than $500m though.

[tombgrt]

ROR.LN Rotork. UK based company. Slightly larger market cap than $500m though.

 

Only 4 times the $500m market cap yes.  ;D

 

Interesting company tho, high & apparently sustainable operating margins, specialised business with high costumer dependency, CF, earnings, dividends increase year after year, ... At 20x earnings but one to keep an eye on it seems.

[augustabound]

I was reminded this week about Simpson Manufacturing (SSD).  They're the only team in the building tie industry (I build custom homes for a living and Simpson is the only name on the shelves). 

Of course it's market cap is 1.4 B.  But a dominant small-mid cap player none the less. 

[Guest Hester]

There are lots and lots and lots of sub $500 million companies with moats. Seek out niches where smaller companies can dominate, or businesses where scale/globalization are irrelevant.

 

An example of the first would be GPIC. $60 million market cap. They control over 70% of the casino chip market. Most casino's have one chip supplier and don't change. The casino chip market isn't huge, but they dominate it.

 

An example of the second would be TYBT, Trinity bank. $29 million market cap. For banks, scale can be a diseconomy. Local branches are more likely to garner deposits from the population than a big national bank, especially in smaller towns, due to the fact that the locals know the bank and the bankers. Local bankers also get to know local borrowers better. Borrowers are more likely to repay a loan if they borrowed it from their banker neighbor, rather than some anonymous big city banker from far away. Jeff Harp, the CEO of Trinity Bank is one of the best bank CEO's you'll never hear about. They've never had a loan loss, even during the Great Recession, despite $145 million in earning assets currently. They also have had 26 consecutive quarters of higher earnings and counting.

 

See their reports here: http://www.trinitybk.com/about-investorinformation.php

For more info on their financial statements check the FDIC website and their OTS call reports.

[tombgrt]

WDFC (WD-40) 666M

LRE (Lancashire Group) 1B

 

I think it is a better exercise if you try to find the moats yourself imo. Especially for LRE it should be easy to spot. If you can't find it, there is a big thread about it here, use the search function. ;)

 

 

Btw, was I the only one who thought this was a second "HarryLong with an idea"-thread?

 

[augustabound]

 

An example of the first would be GPIC. $60 million market cap. They control over 70% of the casino chip market. Most casino's have one chip supplier and don't change. The casino chip market isn't huge, but they dominate it.

 

 

Aren't they the only, or first and dominant maker of RFID chips?

[Packer16]

One of their main competitors is an interesting Asian casino play -  Entertainment Asia Gaming - which also places machines in casinos in Asia and get a % of the take and is planning in opening a casino in Cambodia.  The company is also majority owned by Melco Crown.

 

Packer 

[beerbaron]

Btw, was I the only one who thought this was a second "HarryLong with an idea"-thread?

 

Yeah, I tough it was Harry. The subjects should be changed to something meaningfull.

 

BeerBaron

[Packer16]

One of the key metrics that I look for as an indication of a moat is a high return on tangible assets over a few business cycle (last 10 -15 years).  If a firm can do this over a 10 to 15 year period, they have an advantage others cannot obtain.  For example look at SGA (Saga Communications), its EBITDA pre-tax return on tangible assets (fixed assets + NWC) is 42% or SALM 37% or TVL 75%.  The reason for these moats are the duopoly licenses they are granted from the FCC.  For distributors DIT and CRVP the numbers are 35% and 62%, respectively.  The reason for the moats in these distrbutors is the cost to re-create all the relatioships is greater than economic benefit obtained from them but the incremental costs are small so existing players have an advantage.  You may want to read Dorsey's book "The Little Book That Builds Wealth" to give you a framework to examine moats with.  I agree with most of what he says but I do disagree with there definition of a large moat as also having the ability to invest capital at high incremental returns.  

 

Packer

[Guest Hester]

 

Aren't they (GPIC) the only, or first and dominant maker of RFID chips?

 

Yes they are the dominant maker of RFID chips. Their patent runs out in 2015, I think. I'm not sure if they can extend the patent if they innovate the product a little, but even after patent expiration they should still hold market share steady as casinos are unlikely to switch. Casino chips are a small cost for a casino, and yet are a big security concern.

[scorpioncapital]

There are no small companies with a durable competitive advantage or wide moat. Small companies either don't have these traits or they are developing them. If they had them, they wouldn't be small. A more interesting question is what are the signs of a developing advantage.

[Guest Hester]

 It can't be the CEO or better management, because that's not lasting, though I probably would agree if the argument was made as to a good culture...  

Does anyone else see the problem I'm having.  I say durable and lasting competitive advantage, wide wide moat, and I get responses that say look at all these companies and look how obvious their moats are, but surely this exercise can't be this easy and numerous.  

Let me try to come at this from a different angle....

Buffett has suggested that the true test of a moat is whether or not a competitor with gobs and gobs of capital could come in and do some serious lasting damage to your business.  

 

 

TYBT has a moat for the same reason a small textile manufacturer in New England had a moat. The culture and lending prowess of Harp and his colleagues. They operate in Forth Worth/Dallas Texas. Obviously a large city. Every dominant national bank has offices there. Most if not every regional bank in that area has offices there. There are dozens of community banks there. There are gobs and gobs of capital trying to solicit depositors and good borrowers to lend to. How does TYBT not have any loan losses, better ROE's and ROA's than their competitors? The last 4 quarterly reports included letters from Harp. In it he's quoted Warren Buffett, Kyle Bass in the latest one, and has talked about Mr. Market. How many other community banks do you know that do that?

 

As for GPIC, their patents and casino relationships/history mean that competitors couldn't do much. That's my opinion at least.

 

[Guest Hester]

There are no small companies with a durable competitive advantage or wide moat. Small companies either don't have these traits or they are developing them. If they had them, they wouldn't be small. A more interesting question is what are the signs of a developing advantage.

 

If you say that, then you also have to say there are no diseconomies of scale in any industry or sector in the universe. You also must say that their are no sub $500 million niches or markets out there that a small company can dominate like a large company dominates a large market. While diseconomies of scale and smaller narrow specialization might be harder to see than say Cotsco or Google's obvious moat, it doesn't mean their not there.

 

 

[tombgrt]

There are no small companies with a durable competitive advantage or wide moat. Small companies either don't have these traits or they are developing them. If they had them, they wouldn't be small. A more interesting question is what are the signs of a developing advantage.

 

If you say that, then you also have to say there are no diseconomies of scale in any industry or sector in the universe. You also must say that their are no sub $500 million niches or markets out there that a small company can dominate like a large company dominates a large market. While diseconomies of scale and smaller narrow specialization might be harder to see than say Cotsco or Google's obvious moat, it doesn't mean their not there.

 

 

 

Exactly. They are hard to find but they exist.

 

davidwoo, if you want a very clear example of this I suggest you read chapter 6 "A wonderful little franchise : The earnings power of WD-40" of the book "Value Investing From Graham to Buffett and Beyond" by Bruce C.N. Greenwald & others.

[shalab]

There are no small companies with a durable competitive advantage or wide moat.

 

This statement is plain wrong. Check out WD40 for instance - has a market cap of 600M.

 

 

[Packer16]

I agree that newspapers are declining due to internet by radio and broadcast TV are not.  These 2 media continue to increase in size but at a slower rate than previosly and I think they can co-opt the internet much the same way Incumbant Telcos have been able to co-opt cell phones.  I know this is not a concensus view but that is why these firms are cheap.  As to return on capital calcs, SGA as an example has had EBITDA of $35.5 million in 2010 with Fixed Assets of $65.6 and Net Working Capital of $18.1 million which results in $35.5/($65.5 + $18.1) = 42%.

 

Packer

[StubbleJumper]

There are no small companies with a durable competitive advantage or wide moat. Small companies either don't have these traits or they are developing them. If they had them, they wouldn't be small. A more interesting question is what are the signs of a developing advantage.

 

 

I have a fuzzy recollection that there's supposedly some small listed company that operates a gravel pit in the vicinity of NYC.  The economics of gravel are such that it really doesn't make sense to transport it any farther than you absolutely have to, so supposedly this little (mythical?) company effectively has a near monopoly in the NYC area because it's damned near impossible for a competitor to get a new gravel pit approved.

 

I've never actually dug around to verify whether that legend is actually true, but it is an example of a way that a small-ish company could have a sustainable moat.

 

SJ

[Guest Hester]

I suggest reading this book:

http://www.amazon.com/Hidden-Champions-Twenty-First-Century-Strategies/dp/0387981462/ref=sr_1_1?s=books&ie=UTF8&qid=1307828308&sr=1-1

 

I have it, and haven't read it yet, but here really good things. It mainly covers mid and small cap companies that dominate niches.

[rranjan]

There are no small companies with a durable competitive advantage or wide moat. Small companies either don't have these traits or they are developing them. If they had them, they wouldn't be small. A more interesting question is what are the signs of a developing advantage.

 

I think there can be some small companies with decent moat if the market size of product is fairly small. Gravel pit and some small/medium size German companies can be good example of having moat. Though it will be tough to find a company with wide moat if they are small. With bigger sizes they are easier to spot.

 

If a product market size is huge then I do agree that any company having wide moat will become big in fairly quick time.

[vinod1]

WD-40 has been mentioned and it is a good example. Also See's Candies is a good example of a very small company with moat - not public but Buffett has commented on this quite a bit and addresses your question.

 

Vinod

[Rabbitisrich]

There are no small companies with a durable competitive advantage or wide moat. Small companies either don't have these traits or they are developing them. If they had them, they wouldn't be small. A more interesting question is what are the signs of a developing advantage.

 

A bemoated company can stay small due to limited reinvestment opportunities. Strong moats also tend to attract mediocre management. Avalon Holdings is a good example.

 

[maxprogram]

Though more big business as a % probably have moats, size doesn’t mean much. A company can have a very defensible moat but the industry/product segment they’re in just isn’t very big.

 

There can be many small companies will durable advantages in a local market (whether geographically local or a niche market). A few off the top of my head:

 

• See’s Candy (back when Buffett bought it in 1972, it was for $25mm or $132mm adjusted for inflation) had a wide moat. See’s biggest advantage is high mindshare, or the habit associated with buying the recognized “See’s Candies” brand for a special occasion, year after year. When people buy chocolates, they don’t shop for price or quality (though quality must be maintained to keep image up), they shop for the BRAND. This advantage is geographically local – the reason why Buffett hasn’t been able to expand on the East Coast. Also some local economies of scale in distributing & manufacturing (especially since vast majority of sales are in holiday season and enormous volumes are produced in short amount of time).
  
• Most of Berkshire’s small acquisitions -- those that would be trading for <$1bb if they were public: Nebraska Furniture Mart, Borsheims, RC Willey (may be worth over a billion). All have geographically local advantages.
  
• Standard Parking (STAN) – parking lots themselves have a demand-based advantage from their locations. Parking lot management has economies of scale if they have high market share in certain localities (Standard has a 90% retention rate for management contracts and very high ROIC). 
  
• Clear Choice Health Plans (familiar to the board, acquired last year for <$50mm) – dominated local Medicare/Medicaid markets in eastern Oregon & surrounding area. Moat based on both switching costs for consumers and local economies of scale. If a bigger company wanted in on the market, it would be extremely difficult and costly. Would be far cheaper just to buy Clear Choice out (clear durable advantage for foreseeable future). *This moat also applies to many other local insurance companies and banks*
  
• Local utilities (Gas: CPK, EGAS, DGAS, RGCO; Water: PNNW, CTWS, SJW; Electric: CV, OTTR, EDE) – Not super high returning businesses but regulated moats nonetheless. Clearly durable advantages as profits are regulated and cannot be eroded by competitors.
  
• Customizable machine manufacturers (HURC, FLOW, HDNG) – These companies make expensive, customizable machine tools for other manufacturers. Most require specialized knowledge or have patents protecting their specific designs. Because of the large upfront investments required by customers (and close relationships with tools cos) switching costs are high. Probably less durable than the others but advantages still lasting many years that competition can’t immediately replace.
  

 

Also it should be noted that no competitive advantage is forever durable. Not Coca-Cola, AmEx, Microsoft, etc. So defining “durable” may be helpful (something like 10-20 years from now. See this article by Michael Mauboussin for a more in-depth take: http://www.capatcolumbia.com/Articles/FoFinance/Fof1.pdf

 

[greenwave]

A tiny micro-cap , IDND.ob ,(INTERNATIONAL DISPENSING CORP.) may qualify as a wide moat company "eventually".  ****CAUTION.. THERE IS ALMOST NO TRADING IN THE STOCK (VERY LIMITED).****

 

I have followed ,(and invested very modestly), in this company since its start-up years ago, when I learned that Lou Simpson was involved with the founders as an investor. I believe his wife may also be an investor.

 

It owns a patent for "revolutionizing aseptic packaging." They call it:  "The Answer™ because it is the answer to virtually any dispensing issue."

 

The following is a copy/paste from their web-site:  http://www.idcdispensing.com/index.asp ........

_________________

 

"In the early-1990s while traveling abroad, IDC founder Greg Abbott set foot in a grocery store and was amazed to see rows of what would ordinarily be perishable products, displayed without refrigeration in little brick-shaped packages. This was his introduction to the Tetra Brik® Pak, which enables products to remain shelf-stable almost indefinitely.

 

However, as with any perishable product, once a Tetra Brik® Pak is opened the clock starts ticking and the product becomes susceptible to bacteria, mold, and other microorganisms. It is a great single-serve package, but less than ideal for multi-serve applications that take days and weeks to consume.

 

It occurred to Abbott and like-minded investors that if one could devise a method of dispensing shelf-stable liquids without exposing the remaining contents to bacteria, and without recourse to refrigeration or preservatives, it would take the Tetra Pak concept to the next generation and open up enormous markets in food service, bulk retail, and humanitarian relief.

 

That was the vision on which IDC was founded in 1996. While most food, beverage, and packaging companies were slashing their R&D budgets, IDC spent over 10 years and millions of dollars to develop, patent, test, validate, certify, and commercialize The Answer™.

 

****************

 

The beauty of The Answer™ is that it is universal. It can dispense low and high-acid products without breaking sterility; it is effective with and without refrigeration; it can extend the use-life not only of aseptically processed products, but also of retort and hot-fill. It cuts across all categories and revolutionizes aseptic packaging. We call it The Answer™ because it is the answer to virtually any dispensing issue."