Defending the Castle, Widening the Moat:

Management's Blueprint for Enduring Value

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CFA Society Rochester

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Todd Wenning, CFA

President & CIO, KNA Capital Management

Disclosures

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All information contained herein is provided “as is” and KNA Capital Management, LLC (“KNA”) expressly disclaims making any express or implied warranties with respect to the fitness of the information contained herein for any particular usage, application or purpose. Prior to making any investment decision you should consult with professional financial, legal and tax advisors to determine the appropriateness of the risks associated with such an investment. No assurance can be given that the objectives of a particular investment will be achieved or that an investor will receive a return of all or part of his or her investment. All investments involve the risk of loss, including the loss of principal. In no event shall KNA be responsible or liable for the correctness of any material used herein or for any damage or lost opportunities resulting from the use of such material.

Users of this content may not reproduce, modify, copy, alter in any way, distribute, sell, resell, transmit, transfer, license, assign or publish any information obtained through this website without permission. KNA and the terms, logos, and marks included herein that identify KNA products are proprietary materials. The use of such terms, logos, and marks without the express written consent of KNA is strictly prohibited.

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About KNA Capital

• Founded in 2024, KNA Capital Management, LLC is a boutique investment advisor based in Cincinnati, Ohio that manages a proprietary equity strategy (Core Equity) alongside offering investment management services to high-net worth individuals, families, trusts, foundations, and other client types.

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• The KNA investment philosophy is rooted in three core principles: owning companies with economic moats (durable competitive advantages) led by thoughtful stewards of shareholder capital and buying them at attractive prices. I value simplicity over complexity.

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• KNA Capital fee structure: 1.25% of average assets under management (AUM); 1% above $10 million.

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• Minimum account size: $250,000; household assets under management count toward the minimum.

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Investment Philosophy

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What is management’s primary responsibility?

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Shareholders vs. Stakeholders

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Assets

Equity

Liabilities

First principles

• Investors provide capital (debt + equity) to management to buy productive assets with an expectation of a return on investment consistent with the risk of the investment.
• Productive assets should generate a return sufficient to at least meet investor expectations and ideally surpass them.
• Management should therefore only invest in projects that generate returns more than the cost of funding the projects.
• Management should view themselves as “stewards” of this capital and think beyond their own tenures.

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Too many professional managers, not enough stewards of capital

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Source: Equilar, Joyce Chen

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“I want to make money on the stock 10 years after I retire.”

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- Former Honeywell CEO Dave Cote

Stewardship characteristics

Good signs

• Intrinsically motivated by the business’s purpose
• Leads a positive corporate culture
• Thinks beyond own tenure
• Allocates capital thoughtfully
• Tidy balance sheet
• Frank communication
• Understands “front lines”
• Stakeholder considerations

Bad signs

• Has a history of job-hopping
• Poor governance
• Loves bureaucracy
• Penchant for leverage
• Obsession with quarterly results or stock performance
• Pro-cyclical capital allocation priorities
• Personal enrichment beyond what seems reasonable

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“We believe shareholder value is created, primarily, by not destroying it.”

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– Kevin Rountree, CEO Games Workshop

Management’s Quest for High ROIC

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Why High ROIC should be the mission

ROIC > WACC generates distributable cash flow, which can be used to return value to shareholders or reinvested.

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Companies that can do this consistently are creating value and are therefore more valuable than companies that cannot do this.

*Conceptual

What makes high returns possible?

Investing in projects where return on capital > cost of capital is intuitive, so why do so many companies fail to do it consistently?

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• Poor project analysis
• Uneconomic reasons
• Misaligned incentives
• Behavioral flaws
• No durable competitive advantages

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What is an Economic Moat?

• In capitalism, money flows to high returns until those high returns are competed away
• Some companies generate sustainable high returns by resisting competition through durable advantages
• These durable advantages are colloquially known as “economic moats”

Why Moats matter

• Moats are not the engine of the business – that happens inside the castle.
• As would be the case in a medieval siege, moats provide the castle inhabitants (management) with time.
• Time to respond to new innovations
• Time to strategize against new competition
• Time to endure challenging macroeconomic environments
• Just because a management has this time doesn’t mean it will be used productively
• This is why stewardship matters when thinking about moats

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How to identify a moat

• Does the company have a history of generating above-average (>10%) returns on invested capital?
• A track record of high ROIC is helpful, but not necessary
• Does its business model clearly fit into one of the five moat “sources”?
• Network effects (e.g. eBay, Meta, Uber)
• Switching costs (e.g. Bloomberg, ADP, Jack Henry)
• Intangible assets (e.g. Coca-Cola, Medtronic, Waste Management)
• Low-cost production (e.g. Martin Marietta, Wal-Mart)
• Efficient scale (e.g. Union Pacific, Ball)
• Even with sufficient capital, what stops a company from competing effectively with this company over the next decade?

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Three moat dimensions

Moat width: How advantaged is the company’s business today?

• Are potential competitors intimidated to even try to compete?

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Moat depth: Will the company’s advantages be at least as strong over the next decade?

• Does the company have a track record of successfully defending its position?

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Moat trend: Will the company’s competitive advantages improve over the next 3-5 years?

• Will the company’s products and services be at least as relevant over the next 3-5 years?

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How Moats Crumble

• Most analysis of moat failures focuses on how external threats led to the company’s demise:
• Kodak vs. digital cameras
• Blockbuster vs. Netflix
• Research in Motion vs. Apple

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• Moat erosion starts, however, behind the castle walls and is caused by internal problems:
• Bureaucracy
• Inflexibility
• Risk aversion

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Moat trend drives stock returns…

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…as does moat persistence...

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…Especially moat persistence

Expected values derived from Counterpoint Global’s previous tables

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Value investors (rightfully) assume that a company’s ROIC will eventually “fade” toward the broader market average of around 9%.

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It’s unwise to assume that a company’s competitive advantage period lasts in perpetuity.

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Companies able to maintain and widen their moats extend their competitive advantage period essentially “beat the fade” and force investors to re-rate the stock higher.

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Fastenal is a great example.

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On the other hand, companies that fade quicker than the market expects have poor results.

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In the early 2010s, Core Labs had a wide moat based on a deep proprietary database of global reservoir rock and fluid samples, specialized analytical technology, and unique expertise in helping oil and gas companies optimize reservoir performance, especially in deep water environments.

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Shale revolution made Core Labs’ products/services less relevant, which led to deteriorating moat trend, declining ROIC, and poor stock performance.

Avoiding Quality Traps

• If you’re investing in high quality companies, your number one concern should be moat erosion.
• The double-whammy of contracting multiples and slowing (or declining) earnings growth is a recipe for capital impairment.

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Moat + management impacts value

• In a standard five-year discounted cash flow model that assumes a perpetuity + growth equation to determine “terminal value,” most of the resultant “fair value” (65%+) comes from the terminal value input.
• What happens in years 6 and beyond has a material impact on valuation.
• Understanding how a company might be able to defend - or ideally widen - its economic moat and productively allocate capital is a critical component to understanding the investment opportunity.

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Buffett on Moats & Stewardship

”If you have a castle in capitalism, people are going to try to capture it. You need two things – a moat around the castle, and you need a knight in the castle who is trying to widen the moat around the castle.” – 2013 speech

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“The difference between GEICO’s costs and those of its competitors is a kind of moat that protects a valuable and much-sought-after business castle.  No one understands this moat-around-the-castle concept better than Bill Snyder, Chairman of GEICO.  He continually widens the moat by driving down costs still more, thereby defending and strengthening the economic franchise.” – 1986 Shareholder Letter

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In summary

• Management’s job is to increase the long-term per share market value of the business.
• This is achieved by investing in projects where ROIC > WACC
• Attractive and sustainable ROIC is made possible by durable competitive advantages – i.e. economic moats
• Management teams able to defend and widen their economic moats have the opportunity and time to enlarge their castles
• The best-suited management teams to achieve this end think like stewards rather than professional managers.

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Thank you

Selected Writings by the CIO

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Flyover Stocks

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• The Inevitable Capital Cycle – February 2025

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• Position Sizing: Optimizing for Better Returns - August 2023

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• Mind the Gap: The Risks of Missing Moat, Management, or Valuation -October 2023

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About Todd Wenning, CFA

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Todd Wenning is the President and CIO of KNA Capital Management. Before founding

KNA Capital, Todd was a senior investment analyst at Ensemble Capital Management

where he helped manage a $1 billion concentrated equity portfolio.

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Before joining Ensemble in 2017, Todd was a senior equity analyst at Johnson

Investment Counsel, one of the largest independent RIAs in the U.S., where he worked

on the firm’s SMID cap equity strategy and supported the equity income portfolio.

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From 2011 to 2015, Todd was a sell-side analyst at Morningstar and served as the

Head of Morningstar’s equity stewardship methodology.

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Earlier in his career, Todd worked at The Motley Fool, SunTrust Asset Management,

and The Vanguard Group.

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Todd has written about investing since 2006, including his popular blog, Flyover Stocks, and his book, Keeping Your Dividend Edge (2016). He is a finance lecturer at The University of Dayton, where he is the advisor to the student-run sustainability fund.

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He has earned the right to use the CFA designation and has obtained the CFA Certificate in ESG investing.

Contact information

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Todd Wenning, CFA

President, CIO

+1.513.202.3679

Todd@kna-capital.com

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Legal counsel: Custodian & Prime Broker:

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Calfee, Halter & Griswold LLP Charles Schwab

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Bank:

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North Side Bank & Trust

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KNA Capital Management, LLC

P.O. Box 157081

Cincinnati, OH 45215

www.kna-capital.com