Every year Warren Buffett releases his shareholder letter. It is publicly available for free online and contains a lot of investing wisdom. Buffett’s long-term investment record is one of the best in history, but his advice is helpful even to novice investors.
I have been looking back over some of Buffett’s old shareholder letters to help inform my own investment strategy. Since his last letter, reflecting on Buffett’s wisdom, I sold a holding in a large FTSE 100 company.
Warren Buffett emphasizes competitive ‘moats’
Warren Buffett talks a lot about moats. In medieval times, moats around castles made it harder for attackers to breach the castle ramparts. In investment terms, a competitive advantage can fulfil a similar function. Auto Trader is a good example. With its brand recognition and the network effect of large numbers of buyers and sellers congregating in one place, Auto Trader enjoys a business advantage which it is hard to undermine.
Moats matter because they help companies have pricing power and a captive audience.
But not all industries have moats. Natural resources is an industry where it can be hard to build a moat. Maybe a certain oil block gives economic advantages – but it’s hard to see a commodity like oil as having unique qualities competitors can’t replicate. Nonetheless, a well-run oil company can still establish some sort of competitive advantage, for example, by running a proprietary network of petrol stations as distribution outlets downstream.
When I bought Shell (LSE: RDSA, RDSB), it hadn’t cut its dividend since the Second World War. I was more attracted by that record than I ought to have been. After all, what matters to me as an investor is the likelihood of future dividends, not the certainty of past ones. When it did cut the dividend steeply last year, that hurt me as a dividend lover. I started to assess whether I ought to keep Shell or sell it.
I felt management messaging about the dividend was weak. However, Warren Buffett doesn’t always sell shares just because he is unimpressed by management. It’s the business he is more interested in.
But I also started to question whether Shell really had a moat going into the future.
Renewable energy focus
Shell, like some other oil companies, has been pushing hard to move from oil and gas to renewable energy sources such as wind. Indeed, the chief executive recently said that Shell would never again reach its previous levels of oil production.
But I don’t see where its moat is in green energy. Shell has a lot of expertise in oil, which it has gained over a century. It also has local expertise in areas like the North Sea and Nigeria. By contrast, alternative energy strikes me as a crowded field. Shell’s expertise in energy distribution could offer it a competitive advantage – but that is uncertain. Similarly, the company’s ability to deal with government and regulators in oil may be transferable to alternative energy. On the other hand, it may not work as well there.
In short, Shell is reshaping itself in a way which to me looks like it has less of a moat every year. That doesn’t agree with a Warren Buffett-style investment strategy. Like Shell itself, I decided to look elsewhere for new opportunities.