Michael Mauboussin and Dan Callahan came together sometime in 2013 under the aegis of Credit Suisse to bring out a research report named – “Measuring the Moat”. It is an excellent 70 pages report and I recommend any serious value investor (worth his salt) to read it.
Sustainable Value Creation contrary to what many people believe is not a managerial miracle. Its a near about 50-50 split between the industry dynamics and the managerial prowess. Industry dynamics, internal competition and the extent of fragmentation influence managerial decisions. The phase through which the industry is going (i.e is it consolidating or is it getting disrupted) influence a manager in favour of competition or cooperation.
Industry effects are the most important in the sustainability of high performance and a close second in the emergence of high performance.
Mauboussin highlights that Industry is not destiny, there are outliers of outperformance in every industry but the base rate of success differs. As a result it takes varying amounts of managerial skills to create value.
Interestingly out of this picture, two things jump out:
1. As one selects an industry closer to the origin i.e higher rates of internal return (CFROI-WACC), the number of companies which succeed in creating value is always higher. I.e in communication equipment industry, very few companies destroy value, while its the opposite in paper and forest products industry- very few companies create value.
2. As one selects industries with varying rates of internal return, the best company with the maximum IRR cannot be “far better” than its own peers/industry averages. i.e the best company in paper and forest products have an IRR of mere 10% whereas the best company in communication equipment industry has an IRR of 40%.
Industry might not be destiny, but surely deserves a scrutiny.
I carry with me after reading this report two major lessons- how important is an industry map and how fruitful is creating a profit pool of a sector across a time period.
Do give the report a read. Its worth its weight in gold.