Want to Be a Great Investor? Maybe You Should Have Been an English Major

I recently read Robert Hagstrom's "Investing: The Last Liberal Art", a tome that has some fascinating insights for any investor. The book is full of wisdom from Charlie Munger, longtime investing partner and confidant of Warren Buffett. Munger believes great investors are great thinkers, and great thinking involves the ability to recognize and apply metaphors.

For those readers who are not English majors, a metaphor is a linguistic concept used to compare seemingly unrelated objects or concepts. But more important than the definition is the thought process behind metaphors, the ability to make connections in the real world. It might seem strange to think that Shakespeare's "summer's day" has any relation to investment performance, but the rewards of metaphorical thinking become clear in the context of sustainable competitive advantages.

In a metaphorical sense, great businesses build "economic moats" that allow them to ward off competition year after year. An "economic moat" is a competitive advantage that serves as a protective barrier for a business; a business with a strong "moat" can maintain high profit margins and market share even in the face of competition. There are many types of competitive advantages and they often differ across sectors, but not all competitive advantages are sustainable.

Mark Sellers, hedge-fund manager and former Morningstar chief equities strategist, identifies only four sources of "economic moats" that truly withstand the test of time. Technology can be copied, great managers age, and fads go out of style, but there are four durable competitive advantages that have been repeated with great success by businesses the world over: economies of scale, network effects, intellectual-property rights, and high switching costs. (For a more detailed discussion of moats, click here.) Great businesses that consistently fend off competition demonstrate their ability to maintain one or more of these competitive advantages. The irony inherent in this is that most investors are constantly in search of the next big thing whereas great businesses focus on doing the simple things better than everybody else.

Now is the time to apply metaphorical thinking. If great businesses consistently demonstrate one or more of these competitive advantages, the logical thing to do would be to find other businesses with comparatively similar processes. Consider Disney (NYSE: DIS  )  and Pfizer (NYSE: PFE  ) , two companies that seem markedly different at first glance. Disney holds patents for thousands of beloved characters whereas Pfizer maintains a strong portfolio of drug patents. Because of these property rights, both companies boast "economic moats" in their respective industries. However, these two companies have already grown to considerable size. The largest gains to be had are in lesser-known businesses with similar advantages that will allow them to expand both themselves and your portfolio.

Kinder Morgan  (NYSE: KMI  ) , the third-largest energy company in America, owns an extensive network of approximately 80,000 miles of pipeline and 180 terminals. This represents a significant investment in capital and labor that would be very difficult for an upstart competitor to match. Furthermore, government approval for new pipelines is stringent and need-based, which further insulates the incumbent. The U.S. is expected to be the world's largest energy producer by 2020 – with the largest natural gas network in the U.S., Kinder Morgan is well-placed for the natural gas boom. As production rises, the ability to transport resources will become increasingly valuable. Applying the logic identified above, it can be argued that Kinder Morgan has built a strong "economic moat" through both property rights and a portfolio heavy with fixed-fee, long-term contracts that will generate cash regardless of pipeline use. Using metaphorical thinking to evaluate companies in terms of sustainable competitive advantages can help identify businesses like Kinder Morgan and add a qualitative assessment to growth estimates.

Like any skill, metaphorical thinking can be developed with practice. While it may be too late to switch your major, it is worth keeping in mind that investing is not just about calculations and charts. Learning how to think, make connections, and consistently apply logical thought have far-reaching benefits, and not just for your portfolio.

Kinder Morgan's competitive advantages give the company a significant market opportunity with an enormous potential for profits. In The Motley Fool's premium research report on Kinder Morgan, we break down the company's growing opportunity – as well as the risks to watch out for – in order to uncover whether it's a buy or a sell. To determine whether this dividend giant is right for your portfolio, simply click here now to claim your copy of this invaluable investor's resource.

 


Read/Post Comments (0) | Recommend This Article (7)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

Be the first one to comment on this article.

DocumentId: 2490783, ~/Articles/ArticleHandler.aspx, 4/23/2014 8:57:54 PM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...

TREND TRACKER: Get Rich When the Web Goes Dark

It's time to say "goodbye" to your Internet! One bleeding-edge technology is about to put the World Wide Web to bed. And if you act right away, it could make you wildly rich. Experts are calling it the single largest business opportunity in the history of capitalism… The Economist is calling it "transformative"... but you'll probably just call it "how I made my millions." Big money is already on the move. Don't be too late to the party – find out the 1 stock to own when the Web goes dark.


Advertisement