Know your moats to find value

You often hear about moats, but this chart provides a nice visual on the five types of moats that businesses may have. They are not the same, but the result is the same. There is a strong barrier that is not easy to scale. The moat argument does not mean that these stocks cannot be overvalued, but if there is an opportunity to buy cheap, they are always worth looking at. There can be a continuum of moats. Some are strong. Some are narrow, and some just do not exist.

The real value is finding moats that are being formed or in niche areas. This requires some heavy research.

There is a corporate life cycle which requires changing metrics

 

Professor Aswath Damodaran of NYU is one of the best practical minds in finance today. He has developed ideas on the life cycle of the corporation which I find very compelling. The corporation, while supposed to have infinite life, will behave like the rest of us with a life cycle. There are view corporation that age well. Corporation often do not have the capacity to change and thus they wither and age on an old idea. Even with a good idea, corporations will change and thus need to have an adjustment on the metric that work best for valuation. The chart above provides some insight on the changing metrics during the life of the corporation.

Strategy - there are trade-offs between agreement and certainty

The Stacey Matrix is and interesting way to compare certainty with agreement. This combination is often not considered in investment decisions, but a surprising amount of investment decisions are made as a group or committee decisions. There is a continuum on the certainty of the strategy or decision and there is a continuum associated with the level of agreement. When there is little certainty or agreement, there will be chaos. It does not happen often, yet we should expect that chaotic situations do exist. We move between simple, complicated, complex and finally chaotic. 

Realize that having agreement does not mean that you have the right strategy. I find the Stacey matrix had to fit with specific situations since certainty and agreement are hard to define, yet it is critical to think about the issues that will cause failure in strategic thinking and decisions.  

The great Rotation of July being upended in August

 

It is truly surprising how fast expectations and themes can change in equity markets. July was being called the Great Rotations from growth and momentum into smaller caps and value based on the view that inflation was solved, and rates would come down likely in September. The inflation problem was being licked and US economic growth was still considered reasonable. The result was interest sensitive sectors like real estate and utilities did well. Small caps did well. Value was doing better than those growth and momentum driven stocks. 

The story has now changed over the course of two days since the Fed meeting. Initial jobless claims have moved higher. The Sahm Rule may have been hit. The employment number moved lower relative to expectations. The unemployment rate moved higher, and the talk has been about Fed making a policy mistake and a 50 bps cut is on the table. 

All the facts are true; however, there is a sense of market over-reaction. The Mag Seven may come down to more reasonable levels and there should be a careful review of small cap names. The equal-weighted over market-cap trade looks more attractive at this time. Macro models will tilt to lower exposure to stocks and more to bonds, but it may be early to suggest that this is the beginning of major correction. Unfortunately, a correct is biased by the mega cap names and not the average name.