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The Quest For A Moat

Investing should be about identifying stocks with competitive advantages that cannot be easily replicated…

As I write this column, it’s abundantly clear that our stock markets are in a slump. Of course, that doesn’t really make it certain that the slump shall still be around by the time you read these words. Certainly, there’s a so-called consensus opinion that the markets are in retreat. However, over the last half a decade, we’ve seen plenty of these consensus opinions melt away in a day or two. When this issue of Wealth Insight reaches you, it’ll only be a little surprising if the indices are 5 per cent or so higher than they are now.

Still, that doesn’t really matter. Whenever the markets fall, a range of reactions are possible: you could sell and run; you could wait and watch; or you could start looking for good buys. Obviously, these things are stock specific. There are individual stocks for which each of these reactions is justifiable.

Over the last month, there has been a flood of bad news on all economic fronts. As far as stocks are concerned, the big ticket items have been the persistently high inflation and the central bank’s response to it. What is worse is that there is not much reason to hope that inflation, and thus interest rates will moderate in the foreseeable future. The net result is that everyone expects companies to pay more for funds and profits to be lower.

However, this view is of use only to short-term traders. They are supposed to generate returns by anticipating what other traders are about to do, and by doing it before the others do. That’s not what Value Research is about. Our job is to help you identify stocks that are worth buying and worth keeping in the long-term. That doesn’t mean hurriedly looking around when the markets go down and latching on to something that looks good to rise a bit in a turnaround. Instead it means being sure of a company’s fundamentals, having the right price range in mind, and then buying the stock whenever the stock enters that price range.

This has nothing to do with inflation or interest rates that have become a problem. The real problem would be buying into companies that can’t stand a little heat on the interest-cost front relative to other stocks. In general, our view is that this is a uniquely suitable time to accumulate good stocks at a reasonable value.

One of the classic concepts that can be used to identify such stocks is the concept of having a deep moat. In plain English, a moat is the water barrier that used to be dug up around forts to keep invaders out. An economic moat is something similar—a set of factors that create an advantage for a company that cannot be quickly or cheaply replicated by competitors or new entrants into a market. For example, the Indian auto industry looks very competitive, and it is in some aspects. However, Maruti’s advantage in terms of a dealer network is effectively a moat that will take some effort to cross.

At Value Research, we have conducted a research project to identify India’s deep moat companies, and evolved a methodological framework to do the same consistently. We have published the results of this study in the July 2011 issue of Wealth Insight.

Meanwhile, we hope that this will help you see the seemingly difficult situation in the markets more as an opportunity than as a threat. There are lots of great stocks that are suddenly much better value than they were and it’s a good time to create the basis for future profits.