- William James
One evening a Cherokee elder told his grandson about a battle that goes on inside people.
He said, “My son, the battle is between two “wolves” inside us all. One is Evil. It is anger, envy, jealousy, sorrow, regret, greed, arrogance, self-pity, guilt, resentment, inferiority, lies, false pride, superiority, and ego. The other is Good. It is joy, peace, love, hope, serenity, humility, kindness, benevolence, empathy, generosity, truth, compassion, and faith.” The grandson thought about it for a minute and then asked his grandfather, “Which wolf wins?” The old Cherokee simply replied, “The one you feed.”
- Ancient American Indian Parable
Over the years, I’ve been asked many times what is the one major question I ask when looking to invest in a stock. It’s pretty difficult to pick just one thing. For instance, in most cases it is critical that the company has a management team focused on costs and capital returns. In some industries where margins are tight, the ability to focus on costs, production methods, and distribution costs is vital. In some industries the ability to navigate research and development and meet regulatory requirements is vital.
It’s pretty hard to nail down one specific thing that would make Nintai Investments say “Aha! That’s the perfect investment. We MUST have it in the portfolio”. There are a lot of moving parts that make for a great company. So how do you rate each component? Which piece is the keystone block that holds it all together?
Invest In What Got You There: Your Competitive Moat
Of all the statistics and the ratios that drive my interest in a company, the cap or keystone is the company’s competitive moat. A great moat drives high return on capital, high return on equity, high free cash flow ratios, and other sustained high margins. Great management will focus on how to always widen and strengthen their moat. They realize they need to dance with the one who brought them there.
Morningstar has the view there are five sources of a competitive moat - the network effect, customer switching costs, intangible assets, efficiency scale, and cost advantage. Most companies with a wide competitive moat will have at least one of these competitive advantages - and likely - have more than one. Every company I own in a Nintai portfolio has a laser like focus on one of these advantages. Everyday when they head to the office they think of how to maximize their strategy and operations to widen any one of these advantages.
The Network Effect
Every day, leaders of Nintai holding Mastercard (MA) look for ways to strengthen their company’s network advantage. Whether it be against fellow duopoly member Visa (V) or a smaller up and comer like Discover Cards (DFS), Mastercard’s network - who uses their cards and who accepts their cards - constantly strives to find new tools, advantages, discounts, etc. as a tool to bring in new customers and maintain existing ones. This competitive strength will continue to drive Mastercard’s competitive advantage for decades to come. As a shareholder we look to see revenue growth and higher returns on equity as some the statistics showing the continued strength of the company’s moat.
Customer Switching Costs
SEI Investments (SEIC) provides investment processing, management, and operations services to financial institutions, asset managers, asset owners, and financial advisors in four material segments: private banks, investment advisors, institutional investors, and investment managers. It’s services are deeply embedded in all of their customers’ operations. The cost and time requirements to switch their systems to a new vendor is staggering. The potential for errors in the transfer of data, downtime in the course of switching vendors, and amount of time teaching a new internal system are all deeply complex and involve high risk. Combine this with the risk placed on the core functions of the customers’ systems – daily fund accounting, SEC filings, etc. and one can see how difficult it is to make the decision to pull the plug on SEI Investment’s product and suddenly move to a new vendor.
Novo Nordisk (NVO) has been a leader in the treatment of diabetes for almost a hundred years. Armed with intangible assets such as FDA (US-based) and EMA (European-based) regulatory approvals, patents for drug levers of action, and intensely deep organizational knowledge about diabetes (the disease) and diabetes (the treatment history), it’s hard to see a new competitor come along and suddenly start competing with Novo Nordisk’s competitive advantage in these intangible assets. Combined with a network effect of prescribing physicians who implicitly trust Novo Nordisk’s knowledge with the disease along with billions of dollars sitting on the balance sheet while producing billions more in free cash flow and what you’ve got is a company with a wonderfully deep moat.
Veeva Systems (VEEV) has the most in-depth customer relationship management (CRM) vertically focused on life sciences (pharmaceuticals). The efficiency that Veeva brings to their space has driven out nearly every home-grown model and small boutique player. There simply isn’t room for another player than Veeva within the space. The company is now taking that industrial dominance and looking to add new verticals to its expertise such as consumer goods, chemicals, and cosmetics (all industries with similar CRM and regulatory needs). Veeva’s extraordinary depth of knowledge drives out a need for other competitors. By constantly focusing on adding new functionality, new applications, and new knowledge, the company continues to widen its moat.
By far, this is Nintai’s smallest source of competitive advantage or moat. As Amazon (AMZN) has always said “your margin is my opportunity”. Even Walmart (WMT) - the king of margins - for decades found itself unprepared for Amazon’s pricing revolution. At Nintai, we believe this is the weakest of all moat characteristics. The closest we’ve come to owning a company that made price a key component of its competitive offering was Fastenal (FAST - we sold the position in 2015). Management for the longest time utilized cost structure as a means for driving business to Fastenal distribution centers. They focused this along with the ability to carry nearly every part (in a just-in-time model) and the company dominated the industry parts business. This has changed somewhat as they have focused more on a network effect with vending machines on site allowing customers to not even have to wait for delivery.
Nintai focuses on companies with high returns on capital, equity, and assets, high free cash flow margins, growing businesses, and management focused on maintaining - if not increasing - those previously mentioned measures. The ways to get there is to identify your core competitive advantage and focus on making it better every day. That’s why you don’t see Novo Nordisk suddenly purchasing an oncology immunotherapy firm. Or you don’t SEI Investments purchasing a publishing company on investment management. The Nintai portfolios are made up of companies that know what they do best and they stick with it. With a portfolio run by such management – with companies with such attributes – you really need to sit back and make sure management has its eye on the ball and generates numbers that demonstrate their excellence in making the company grow. After that, let time do its magic and you’ll be surprised how well your portfolio will do over time.
As always, I look forward to your thoughts and comments.
DISCLOSURE: Nintai maintains positions in MA, SEIC, NVO, and VEEV
 Of course past performance is no assurance of future returns.