We had the pleasure of speaking with Pat Dorsey on the topic of moats recently. Pat is President of Sanibel Captiva Investment Advisers, where he leads the investment team and helps guide capital allocation. Pat was previously Director of Equity Research at Morningstar for over ten years, where he was responsible for the direction of Morningstar’s equity research effort. He led the development of Morningstar’s economic moat ratings as well as the methodology behind Morningstar’s framework for competitive analysis. Pat is the author of The Five Rules for Successful Stock Investing and The Little Book That Builds Wealth.
The Manual of Ideas: Please tell us about your background and how you became interested in the topic of moats. Pat Dorsey: I was director of equity research at Morningstar for about 10 years. I basically built the equity research team and process there, starting with about 10 analysts and building it to about 100 analysts when I left. I formed the intellectual framework that we use to evaluate companies. A big part of that is a focus on a competitive advantage, or an economic moat. I became interested in the topic because some companies essentially defy economic gravity and manage to maintain high returns on capital despite competition.
It’s a fascinating topic because economic theory suggests that all companies should just revert to mean over time. Competition shows up, capital seeks excess profits, and you drive returns down. But, both empirically and intuitively, we all know that’s not the case. We can all name a dozen companies off the tops of our heads who have basically defied the odds and maintained high returns on capital for decades at a stretch. What frustrated me when I got into the topic is that most of the literature on competitive advantage is written from a strategy standpoint. Most of your readers are familiar with Michael Porter’s Five Forces model, which is very useful and a great starting point, but it’s always from the perspective of a manager of a business. In other words, I manage a company or a unit of a company, and what can I do to make that piece of that company better? So, it’s all about maximizing the assets that you have.