It looks like buybacks are slightly preferred to dividends among readers of Value Investing News. The results show that 45% of the poll participants prefer buybacks, 41% prefer dividends, and 14% prefer “other”. These “other” respondents were instructed to explain their answer in the comments section.  Here’s what they had to say:

“If you ignore taxes it really doesn’t matter. Buybacks should be made at attractive prices and not used to pay for employee stock options (dilution).” – Nick

“If the company is great buybacks are the best second to reinvesting in the company. Then dividends. For a par subpar company with low ROIC dividends are best because the company can’t do much better with the cash itself. I’m inbetween though overall. I’m skeptical of most managers so in that case, dividends.” – Mr. Wallstreet

I expected that the results of this poll would have been more conclusive. However, as you can see from the comments above, there are good reasons to prefer buybacks in some cases and dividends in other cases.

I’m struggling to come up with a new poll for this week at Value Investing News.  If you have any suggestions, please leave a comment below.

Responses ranged from under 10% to over 60%.  The most popular response was for a margin of safety between 25% and 32%.  I voted for the 33% to 49% margin of safety category.  Thirty percent of the respondents sought margins of safety above 50%! I wish I could be skilled enough to find opportunities in quality companies that had that high a margin of safety.

Be sure to vote in this week’s poll.  We are asking members of Value Investing News: “As a shareholder, which would you rather have, buybacks or dividends? ” Please visit the previous link and voice your opinion.

What is your minimum required margin of safety for buying stocks?

Please visit the Value Investing News poll and leave a response.  After you vote, you can see the current responses to the poll.  After this week, I’ll post the final results here as well.

I think I will be running a poll every week on Value Investing News.  Do you have any questions you would like to have other value investors answer?

I didn’t even come close to guessing how high those ashtrays could be stacked. Isn’t it amazing how weak our minds are at estimating measurements? That weakness can also impact our investment decisions.

How does this apply to investing? Every day as investors we look at stock financials and try to measure the potential growth of the revenues and profits of the underlying company. Then we often also try to estimate the intrinsic value of the shares. You might be tempted to guesstimate the value of a stock after reading an interesting stock idea in Barron’s or on Value Investing News. However, you should use extreme caution in relying on your gut sense when measuring value, unless you are Warren Buffett.

If our brains have trouble determining that the circumference of a typical pint glass is almost twice the length of the height of the glass, then you can see how easily our minds can fool us when trying to size up the value of a stock. There is often a lot more at risk when making an investment decision than the cost of a pint of beer, so be sure to break out your yard sticks before betting on a stock.

Success is often a measure of your ability to maintain a competitive advantage. In economic activities ranging from your online website, your career or your business, competition will have an impact on your ability to earn “excess” profits. Basic economic theory shows that in a perfectly competitive market, competition from rivals will erode away any excess profits you earn. The competition will copy products, services, ideas and techniques while also lowering their prices to take business away from you until they are barely profitable. If you are not able to compete successfully, all your profits will disappear and you will end up with losses. Many companies in the past learned this too late and discovered the hard way that profits can evaporate almost overnight. Without a wide moat, the enemy will scale the walls of your castle and plunder your treasuries when you start to earn too much profit.

All is not lost. We know that there are highly successful and profitable people and businesses that have been that way for years. The key to their highly profitable endeavours is that they built moats around themselves to hold back competition. By building a wide moat, you can develop a sustainable competitive advantage that will allow you to earn oversized profits.

As an investor, I have discovered ten ways companies have built moats to hold back competition.  These method include the following:

1. Low cost leader – The product attribute many customers look at is price. Developing a lean an efficient operation allows you the room to survive price wars. Large operations often leverage economies of scale to become the low cost leader.
2. Brand name franchise – Developing a great brand can be a long and involved process to develop customer trust and mind share. Creating a brand is not enough to gain a wide moat. You need to be able to convert that brand into a franchise that customers connect with at many levels. A brand that can be converted into a franchise can then be expanded into other related products and services and keep competition from nibbling away at your corners.
3. Trademarks -  A distinctive design protected by law that you can use to develop an instantly recognizable mark that can instill a positive emotional response in your customers. Trademarks alone rarely create moats but they can be very powerful when combined with a brand name franchise.  Think the Nike swoosh or the Ralph Lauren Polo Logo that automatically command a price premium from almost any product they are placed on.
4. Copyrights – Maintaining exclusive rights to either your writing or someone else’s unique work can produce a long term profits. Publishers that own the copyrights of famous books and owners of the copyrights of enduring songs, such as “Happy Birthday to You” have sustainable competitive advantages and can continue to collect hansom profits for years under long lived copyright laws. It makes you think twice before adding that open source or Creative Commons license on your work.
5. Patents – A government grant of exclusive rights (think legal monopoly) granted in exchange for publicly disclosing the details of an invention. Patents are the power behind Big Pharma, GE, and many technology companies.
6. Trade secrets – Trade secrets are the even wider moat version of patents. These are undisclosed secrets associated with the creation of product, a manufacturing process or a delivery of a service that are not easily replicated (rare now a days). The biggest trade secret I know of is Coca Cola’s secret formula, which was stolen recently and almost given to their biggest competitor Pepsi Co.
7. Government protection - Government protections can take on all sorts of forms, but licenses, permits, exclusive contracts, and financial backing can all establish a wide moat. Individuals get professional licenses that restrict the number of people entering a profession, such as lawyers, doctors and accountants. Companies such as Sallie Mae, Fannie Mae and Freddie Mac had the financial backing of the federal government. Companies without those financial backings had serious competitive advantages.
8. High switching costs - If you can produce a high value business that customers depend on and work very closely with you, it can be very hard for those customers to switch over to competitors and thus can give you a wide moat. Company’s such as ADP that handle outsourced payroll and human resource functions can be very difficult to leave after using their services for a few years. Even simpler things like email addresses used for business can make your very dependent on the email service provider if they own your email address.
9. Network effect – This is one of the most powerful and unique methods of building a wide moat. The network effect wide moat is established when you create a business where the more people use your service, the more valuable that service becomes for other customers. A good modern example of this is eBay. The more buyers and sellers appear on eBay the more useful eBay becomes for other buyers and sellers by giving buyers and sellers a greater chance of making a match. Cell phone provides that offer free in network calling also make it so their network becomes more valuable to customers as more people join it because it increases their their chance of being able to make free calls. Verizon Wireless has created a network effect for my extended family.
10. Toll bridges – Toll bridges are the epitome of wide moat enterprises. A toll booth on a bridge like the Delaware Bridge can command huge premiums in tolls for all who pass. The key to building a toll bridge is to identify choke points in commerce and then claim ownership over them. Because of the monopoly power that this powerful economic moat can convey, most toll bridges are run by governments. (However, many governments have started to sell off their toll roads and bridges to private companies.) Another good example of a toll bridge type moat is ownership of a key downtown parking lot.  All must pay to visit by car. If space is limited, competition can be virtually non existent.

Using these ten economic moats, you can probably think of ways to enhance your careers, your businesses, or your investments. I need to thank Warren Buffett, the master investor, for opening up my eyes to these exceptions to perfect competition. I hope you find these ten ways to build economic moats to hold back competition as powerful as I have. Let me know if you know of other powerful ways to build durable competitive advantages.

• The show started with scenes from the Berkshire Hathaway (BRK.A) (BRK.B) annual meeting and some discussion of how this annual meeting has grown into something unique, a celebration.
• There is a scene of Warren Buffett singing and playing his eukalalie.
• Buffett complains about corporate governance checklists.  Buffett wonders how can board members that make up half their income being board members be truly independent. 
• Charlie Munger: Board member should be perfectly willing to leave at any time and willing to make the tough calls.
• Buffett notes that Charlie Munger is the best partner that anyone can have.  He has plenty of things to think of but Buffett can call him at any time and Charlie knows him and the company.
• Warren Buffett’s investment partnership formed with seven members of his family that wanted him to manage their money.  Then others stumbled into the partnership.
• The partnership worked on buying cheap stocks but Berkshire was a terrible company. 
• He then bought Jack Ringwald’s (sp?) insurance companies.
• Insurance companies give off a lot of money that can be invested if the insurance part is managed decently.
• Buffett notes that it would have been better not buying these investments and putting them into Berkshire.  He just stuck with it.  He notes it would have been better selling Berkshire Hathaway.
• Buffett closed out the investment partnership at the end of the sixties because the market was leaving him behind and he didn’t understand the market at that point. [Stock prices were high.  Think the nifty 60.]
• Berkshire Hathaway only got out of textiles in 1985.  Buffett even added a textile company to add to Berkshire Hathaway during that time period.
• Buffett discussed his purchase of Washington Post (WPO).  
• Washington Post was selling for $100 million at the time but he thought it was worth $500 million.  His $10 million investment turned into a $1.5 billion investment.
• Buffett advised Mrs. Graham, CEO of the Washington Post, to buy the stock that Warren wanted to buy but agreed not to buy of Washington Post.
• Mrs. B couldn’t read or write but built Nebraska Furniture Mart that Buffett bought for $60 million.
• Buffett bought The Coca-Cola Company (KO) probably after reading the ’87 annual report.  The company was heavily repurchasing shares and had good management.
• Buffett notes that it is hard to get a big position in a wonderful company.
• GEICO was a great investment three separate times for Buffett.  He put three quarters of his net worth when he was in his 20s into the company, a $10,000 investment. 
• He has no regrets of any companies that he didn’t buy into recently. [I've heard him say he wished he had bought Wal-Mart, but that was several years ago.]
• GM is too tough to figure. [Controlled Greed must be a bit worried about this statement].
• GM’s got terrible obligations.
• Entered into contracts with UAW with market dominance .  Pay for 2.5 people who don’t work for each person who actually works. 
• GM is a huge annuity and health insurance company attached to the auto company.
• Buffett can’t come to a conclusion.  Can they exist with 25 percent of the market, huge tough competitor and so many obligations?
• Charlie Rose asked him what is the test.  Buffett responded:
1. I have to understand the business.
2. It has to have a company that has some enduring competitive advantage.
3. Management that I like and trust.
4. Reasonably attractive price.  Price is the least important.
• No candidates right now for Buffett.
• Buffett doesn’t get paid to hold money, fees for exit unlike hedge fund managers.  They have a different calculus.
• Buffett discussed Iscar now versus in 2004.  Buffett didn’t buy in 2004 because he didn’t know about it.  Iscar’s CEO emailed Buffett in October of 2005 and that’s what lead to the purchase.
• He waits until companies are ready for him to buy into them.  They come to him.
• Charlie Rose asks: How does he review management so quickly?  Experience?
• Seller must know the price of their business.
• [He never really answers this question directly.]
• Buffett acknowledges he made a mistake in not selling Coca Cola.
• Buffett doesn’t sell businesses he owns outright.
• [I think this gives him a competitive advantage when buying family companies.]
• There are three successors that are potentially available for Berkshire Hathaway.
• The board knows exactly who to assign immediately.
• Even if he found a big investment he would keep $10 billion as a minimum in cash for the insurance part of the business.
• Buffett is good at calculating odds.  You always need the right premium.
• Buffett is looking up international companies. 
• People internationally don’t look to Berkshire for selling their businesses.
• The economy today looks pretty good.
• Buffett worries some about inflation.  It is never gone, just in remission.  When governments are involved that is always a concern.
• The dollar over time will go down in up to a 10 year time frame. This is a result of the trade deficit. The U.S. is trading away a bit of the farm slowly and this has consequences.
• Fiscal deficit is not as much of a worry.  Buffett recommends to look at it as a percent of GDP.  Buffett thinks the trade deficit is more important.
• China can’t easily get rid of American assets.
• Social security – the problem revolves around policies.  We won’t get rid of social security.

Later this week I’ll post part three, my notes on the final segment of the Charlie Rose interview with Warren Buffett.
 

What is this Magic Formula?

The Magic Formula seeks to identify “good” businesses selling at “bargain” prices.  It uses two factors to rank stocks so that you can identify the best businesses selling at bargain prices. 

The first factor identifies a good business as one that produces a high return on capital (ROC).  Return on capital is calculated by dividing earnings before interest and taxes (EBIT) by the sum of net working capital and net fixed assets.

ROC = EBIT / (Net Working Capital + Net Fixed assets)

The second factor identifies businesses selling at bargain prices by examining earnings yield, which is basically the in inverse of the price earnings ratio (P/E).  More specifically, earnings yield is defined as earnings before interest and taxes divided by enterprise value.

EY = EBIT/EV

Shai Dardashti has done a great job discussing Joel Greenblatt and The Little Book that Beats the Market, and he has compiled all his work in a recent post to prepare for a meeting with Joel Greenblatt.  In fact, Shai will be publishing his transcript of that meeting shortly.

Looking under the hood

I’ve decided to take a closer look at how the Magic Formula works in the real world.  I just went over to the Magic Formula Investing site and registered for free.  With the login information in hand, I decided to run the Magic Formula screen. 

The first step required me to select the minimum market capitalization that I would allow.  I entered 50 for $50 million market cap minimum, since I heard that is what Joel Greenblatt used in when he developed the formula.  Step two requires you to select the number of top ranked stocks that you wish to choose from.  I selected 25, and then I did step three, which was to hit go.  Here’s the list of stocks that it returned today:

• American Eagle Outfitters Inc (AEOS)
• Anika Therapeutics Inc (ANIK)
• Block H & R Inc (HRB)
• Callwave Inc (CALL)
• Catapult Communications Corp (CATT)
• Collectors Universe Inc (CLCT)
• Deluxe Corp (DLX)
• Forward Industries Inc (FORD)
• Ftd Group Inc (FTD)
• Grubb & Ellis Co (GBEL)
• Infospace Inc (INSP)
• Innovative Soltns & Supp Inc (ISSC)
• Intervideo Inc (IVII)
• Jakks Pacific Inc (JAKK)
• K-Swiss Inc -Cl A (KSWS)
• King Pharmaceuticals Inc (KG)
• Korn/Ferry International (KFY)
• Kos Pharmaceuticals Inc (KOSP)
• Magellan Health Services Inc (MGLN)
• Mannatech Inc (MTEX)
• Marvel Entertainment Inc (MVL)
• New Frontier Media Inc (NOOF)
• United Online Inc (UNTD)
• Vaalco Energy Inc (EGY)
• Vertrue Inc (VTRU)

The first thing I noticed was that this list wasn’t ranked by the two factors, but was just an alphabetical list of the top ranked stocks with market caps great than $25 million.  There are quite a few familiar names on that list, but there are several new companies on that list that I know nothing about.

I have decided that I’m going to research each of these companies.  But before I do that, I read a comment by Rick on Shai’s blog that got me thinking.  The comment by Rick notes:

“Screening by using a “magic formula” is merely the first step. I wouldn’t get caught up in the “formula” per se. It merely screens for businesses that have the highest ROIC and matches them with a valuation tool, earnings yield. This inherently is what all successful value investors of Buffett discipline would ascribe to. Not just a cheap price for a cigar butt investment! The real magic in my opinion comes from the determination of two things: (1) How sustainable is the competitive advantage, i.e. How long can we sustain these superior ROIC? and (2) When we utilize earnings yield, are we using normalized earnings or are we dealing with overstated or super-normal earnings? In this way, the discipline becomes far less formulaic and becomes more analytic and more of an art.”

I totally agree with Rick.  I think the Magic Formula provides a great starting point to identify investment candidates.  However, I think determining the sustainability of these companies’ competitive advantages is critical.  Right off hand I note a few fashion stocks on the list above that may have a very fleeting competitive advantage that could disappear very quickly if consumer tastes change suddenly.  In addition, accounting shenanigans could mask whether or not these companies are really selling at bargain prices.

Kicking the tires 

I’m going to kick the tires of these companies over the next few weeks.  I’ll figure out what they do and how they do it.  After a few kicks, I’ll figure out if the above stocks truly have a durable competitive advantage or whether they are going to potentially run out of gas, break down or require lots of maintenance.

I’m also going to be testing out the Magic Formula independently to see how it performed in the past.  I even have an idea of how to turbo charge this little engine.  This is all going to take some hard work, so expect a lot of activity here at Fat Pitch Financials over the next few weeks regarding the Magic Formula.

1. FPA Capital Fund managed by Robert L. Rodriguez - Top holdings
2. Fidelity Low-Priced Stock managed by Joel Tillinghast – Top holdings
3. Calamos Growth A managed by John and Nick Calamos – Top holdings
4. Heartland Value managed by William Nasgovitz – Top holdings
5. Columbia Acorn Z managed by Charles McQuaid and Robert Mohn – Top holdings
6. ICM Small Company managed by Robert McDorman – Top holdings
7. Hartford Capital Appreciation HLS managed by Saul Pannell – Top holdings
8. DFA U.S. Micro Cap team managed – Top holdings
9. Merrill Lynch Value Opportunities managed by R. Elise Baum – Top holdings
10. Muhlenkamp managed by Ron H. Muhlenkamp – Top holdings
11. Federated Kaufmann K managed by Lawrence Auriana and Hans Utsch – Top holdings
12. Hotchkis and Wiley Small Cap Value I managed by Jim Miles – Top holdings
13. Janus Small Cap Value Instl. managed by Tom and Tod Perkins – Top holdings
14. Neuberger Genesis managed by D’Alelio and Vale – Top holdings
15. Laudus Rosenberg U.S. Small Cap Instl. managed by William Rick – Top holdings
16. Wasatch Core Growth managed by J.B. Taylor – Top holdings
17. Mairs and Power Growth managed by William B Freis – Top holdings
18. Third Avenue Value managed by Martin J. Whitman – Top holdings
19. Skyline Sepecial Equities managed by William Fiedler – Top holdings
20. Legg Mason Value Trust managed by Bill Miller – Top holdings

In addition to beating Bill Miller’s performance over the past 15 years, I discovered that FPA Capital, Fidelity Low-Priced Stock, Calamos Growth A, Columbia Acorn Z, Muhlenkamp, Hotchkis and Wiley Small Cap Value I, Janus Small Cap Value, Neuberger Genesis, and Wasatch Core Growth also outperformed Miller’s Legg Mason Value Trust in the past five and ten year periods.  Looking at the ten and five year performance records in addition to the fifteen year performance period helps eliminate funds that outperformed Bill Miller due to just short periods of high performance.

I also quickly examined the investment philosophy of these funds. Calamos Growth, Federated Kaufmann, Hartford Capital Appreciation, and Mairs and Power Growth are primarily large-cap growth funds. Columbia Acorn and Wasatch Core Growth are invested in mid- and small- cap growth stocks. DFA U.S. Micro and Laudus Rosenberg U.S. Small Cap are both quant funds focusing on small companies. Muhlenkamp and Legg Mason Value Trust are large-cap value funds. Third Avenue Value is a blended value fund, while Merrill Lynch Value Opportunities is a mid-cap value fund. Fidelity Low-Priced Stock, FPA Capital, Hearthland Value, ICM Small Company, Hotchkis and Wiley Small Cap Value I, Janus Small Cap Value, Neurberger Genesis, Laudus Rosenberg U.S. Small, and Skyline Special Equities invest in small-cap value stocks. Not surprisingly, most of the top funds are value oriented funds.

I took a look at what some of the top value funds have been doing.  FPA appears to be adding cash into Treasury Notes.  I noticed that William Nasgovitz of Heartland added to his position in Stewart and Stevenson Services (SVC).  Robert McDorman of ICM Small Company added to his position in Scottish Re Group (SCT). Muhlenkamp seems to be adding a strong concentration in financial stocks including Capital One Financial, Allstate, American International Group, and Citigroup. H & W added a new position, Mercury Interactive (MERQ).  However, it looks like they added this stock after its recent scandal which sent it to the pink sheets. Janus Small Cap Value upped their position in Kaydon (KDN). Bill Miller recently added Sprint Nextel (S) and Expedia (EXPE) to his portfolio.  I’ll be visiting this list later in the year to see what other new purchases these top fund managers make.

That suggests to me that there are market inefficiencies that can be exploited to earn above normal returns. The key to beating the stock market indexes may indeed lie in the writings and action of Warren Buffett. Just take a look at what Martin and Puthenpurackal report as Warren Buffett’s Berkshire Hathaway stock investment performance:

The stock portfolio of Berkshire Hathaway, comprising primarily of stocks of large-cap companies, has beaten the S&P 500 index in 20 out of 24 years for the time period 1980-2003. In addition, the average annual return of Berkshire Hathaway’s stock portfolio exceeds the average annual return of the S&P 500 by 12.24% over this time period.

Those are some pretty amazing numbers. Let’s take a little closer look at the transactions that make up that record. Martin and Puthenpurackal analyzed a total of 261 investments during their study period from 1980 to 2003. The average annualized returns for the stock investments in Berkshire’s portfolio from 1980 to 2003 are an amazing 39.38%. I was somewhat surprised to find out that 59 of those 261 investments could be labeled as arbitrage investments. The average annualized return for the arbitrage stocks was 81.28%! Given that statistic, I now know that I’m not wasting my time pursuing going private transactions and other arbitrage opportunities.

“When long-term investment possibilities are limited, Berkshire Hathaway has used risk arbitrage as an alternative to holding short-term cash equivalents. These are arbitrage opportunities that present themselves after an announced corporate event such as sale of the company, merger, recapitalization, reorganization, liquidation, self-tender, etc. The major risk incurred is the risk of the event not happening. Berkshire prefers to engage in only a few large transactions each year because of the effort required to monitor the progress of transactions and the market movements of related stocks .”

I originally started researching arbitrage and special situation opportunities when I was having trouble finding long-term opportunities two years ago. My focus on going private transactions falls into the same category of risk arbitrage opportunities as those described above. However, I engage in lots of small transactions versus the few large transactions Buffett pursues each year. It is difficult for a small investor like myself to compete with the all the large hedge funds that use significant leverage seeking these arbitrage opportunities, so I have to focused on my competitive advantage with the small transactions provided by the reverse splits associated with going private transactions. My competitive advantage here being the relatively small amount of funds that I need to invest.

Returning to Buffett’s performance record, the average annualized return for the other 202 long-term stock investments made in Berkshire’s portfolio are an impressive 26.96% according to the paper. This is a very impressive performance, but I’m a bit surprised that it is so much lower than the performance of the arbitrage investments. I guess the key difference is that the arbitrage investments were only held for an average of 5.56 months, and thus were subject to much higher tax. Many of Buffett’s long-term holdings are virtually tax free since he has not sold stock in many of his large positions. When those positions are finally sold, they will be taxed at much lower long term rates than the short term arbitrage trades. The nice thing for me is that I can avoid tax in my Roth IRA and Coverdell ESA accounts, so the short holding periods associated with risk arbitrage opportunities doesn’t cause me much of a tax liability.

I also found it interesting that the authors found that Warren Buffett’s strategy was more of a large-cap growth style versus the mainstream view of him being a traditional “value” or “contrarian” investor. However, I do not really think the term “large-cap growth style” really portrays what is unique about Warren Buffett’s investment style.

I also found the fact that Berkshire’s top 5 holdings often comprise over 70% of the total portfolio to be a bit surprising. I knew Warren Buffett was a focused investor, but I did not realize how high the degree of concentration was. This is something for me to keep in mind when managing my own portfolio.

I often look for a strong brand when determining if a company has a wide moat. The discussion I just read lead me to a question. When do strong brands not lead to a franchise?

Strong brands can often give companies strong sustainable competitive advantages. A business with a strong brand is often also a franchise, but there are many examples when this is not the case.

Here are a few of my observations of when a strong brand does not lead to a franchise/wide moat:

1. Brand names are not important with commodity items. No one really cares what brand of electricity, coal, airlines, or sugar they are buying. You just buy the cheapest one.
2. Industries with too many brands and too much capacity often don’t lead to strong franchises. Here you can probably think of automobile brands, bicycles, and appliances.
3. Brands of frequently purchased items are more likely to lead to franchises than those of long lasting capital goods. I think the key here is that you are more likely to be brand loyal with low cost items, since it takes too much effort to research alternatives each time you buy them. Long lasting goods are purchased less frequently, often cost a lot, and you are therefore more likely to take the time to carefully consider your options before purchasing.

This is a rather interesting topic that I’ll have to think about a little more. I’d like to build a list of criteria by which to determine whether a brand will lead to profitable business or not. The three items above are just a start.

1. Index funds at times they can be horrendously risky.
2. The entire value of the market can become overvalued.
3. The stocks in the index are not selected based on merit, but often for industry diversity to reflect the general economy.
4. Capitalization-weighted indexes will result in the index to overweight overvalued stocks

Morningstar has developed a ten stock portfolio of the current best value stocks in their database to track whether stock picking can indeed outperform an index fund over the next ten year. This will definitely be worth following.

Batchelor boils the “fat pitch” investment philosophy into 5 key parts, which I describe as follows:

1. Seek companies with wide economic moats.
2. Always maintain a margin of safety when investing.
3. Cash is king. Holding cash is not a bad thing.
4. Focused investing in a few stocks is not something to fear.
5. Limit your trading costs and maintain a long term perspective.

Overall, I agree with Batchelor’s description of fat pitch investing. The only thing I was surprised about was that this article didn’t mention that the use of the phrase “fat pitch” to discuss investments came from a Warren Buffett quote

It is extremely difficult to generate incredibly consistent earnings over a long period of time. Miller lists several reasons why this is. Since I’m often looking for companies with smooth and predictable earnings, this article was a bit of a wake up call to me. I need to remember that earnings that seem too perfect to be believable maybe should not be believed.

Random Gleanings: The Beautiful Line

In the past, I struggled to take advantage of unexpected downturns in the stock market. In the emotional chaos that often hits after a market plunge, I often was unable to research enough companies fast enough to make a quality purchase decision while prices remained low.

My goal is to identify the highest quality companies now, so that I can swing hard and sure at the next fat pitch that comes over my plate. I am particularly looking for companies with sustainable competitive advantages and will keep them ahead of their competition for years to come. Warren Buffett refers to these companies as having wide moats.

What gives a company a wide moat that keeps the competition at bay? Some companies are very low cost producers, others have key patents on their products, and still others provide services that have high switching costs.

I’ll go into these characteristics in further detail in the examples I discuss in upcoming articles. Feel free to suggest your favorite wide moat companies and I’ll take a close look at them here.