Dear Reader,
Lululemon crashed big last Friday.
The stock has gone from $500 a share a few years ago to around $100 today.
And I've been watching Michael Burry defend his position in it — buying more under $100.
I understand the instinct.
On a valuation basis, under $100 might look cheap.
But I've been here before.
And I want to tell you what I learned.
The GAP Trade I Never Forgot
Twenty-five years ago, I did the same thing with GAP that Burry is doing with Lululemon right now.
In the '80s and '90s, GAP was just extraordinary.
Opening stores everywhere.
Launching Old Navy, Banana Republic, the whole thing.
I waited ten, fifteen years to buy it.
Finally got it really, really cheap.
And it stayed really, really cheap.
Dead money.
And watching Lululemon collapse the same way, I recognize every symptom.
What Actually Happened
Lululemon built something genuinely great.
Stylish, fitted athletic wear — specifically leggings that became a cultural phenomenon.
They had a real competitive advantage.
For a while.
But here's the thing about fashion and apparel.
The moment something works, Target is watching.
Walmart is watching.
Every retailer in America is watching.
They walk into your store, figure out what you're selling, and tell their manufacturers to copy it.
Two years later they have a cheaper version.
Five years later they have a competitive one.
Seven years later they're recruiting your executives.
That's exactly what happened to GAP.
That's exactly what's happening to Lululemon.
Management keeps trying to fix it.
New strategies. New CEOs. New product lines.
Nothing works.
Because the root problem isn't management.
It's that the competitive advantage was never durable.
And when you can't fix the business, you start taking on debt.
Earnings get bad. You borrow. You say you'll turn it around next quarter.
The board brings in a new CEO who may or may not understand the real problem.
Wealth transfers from the equity to the creditors.
You've seen this with Toys R Us. With GAP. You're seeing it with Lululemon.
I'm not judging Burry.
I made the same mistake.
I just recognize the symptoms now.
The Three Durable Moats
What I learned from that GAP experience — and from reading Michael Porter's Competitive Strategy — is that there are really only three types of competitive advantages worth owning.
The first is network effects.
The more people on the network, the more valuable it becomes, and the harder it is to leave.
Visa. Mastercard. Facebook.
Once everyone you know is on Facebook, you're not leaving.
The second is switching costs.
Microsoft Office. Oracle. SAP. Banking systems. Transaction infrastructure.
Even if a cheaper alternative exists, switching is so painful and expensive that companies just don't do it.
That's a moat you can sleep on.
The third is cost advantages from scale or unique assets.
Republic Services — Bill Gates' largest non-tech position.
You own the landfill, you get paid for life.
Railroads and their right of ways.
Taiwan Semiconductor's manufacturing scale.
These take decades to replicate.
Now here's the important caveat.
None of these are indefensible forever.
Nike had cost advantages from scale for twenty-five years, and now China has studied them in business school and is chipping away at it.
The same will eventually happen to Taiwan Semiconductor.
But the key word is eventually.
A moat that lasts twenty-five years is very different from a moat that lasts seven.
The Test I Run on Every Stock
Whenever you're thinking about buying a stock — especially putting a significant portion of your wealth into it — ask yourself one question.
If a well-funded competitor decided to copy this business tomorrow, how long would it take them to chip away at the lead?
For Lululemon, the answer was seven or eight years.
For Visa, the answer is decades — maybe never.
For Republic Services, you'd need to permit and build a new landfill, which is nearly impossible.
If you just focused your investing on companies in those three categories — network effects, switching costs, unique assets or scale — ninety percent of bad investment ideas would never make it past your first question.
You'd own a much stronger portfolio.
And you'd sleep a lot better at night.
The One Moat You Can Still Get Into Early
The companies I just described don't just hold their value.
They generate reliable cash, quarter after quarter, year after year.
But I want to be honest with you about something.
Two of those three moats are already spoken for.
Nobody is building the next Visa. That network was finished being built before most of us started investing.
And nobody is dislodging Oracle. Those switching costs were locked in decades ago.
You can own those businesses — you should — but you're buying them at the price everybody already agrees they're worth.
The third category is different.
Unique assets still get created.
Somebody had to permit that first landfill. Somebody had to lay that first right of way.
And go back and read the test I just gave you, because it cuts both ways.
The reason Republic Services is nearly impossible to compete with is the permitting.
Not the trucks. Not the technology. The years of paperwork.
So the question I've been asking myself is simple.
What is the economy desperately short of right now, that also takes years of paperwork to build?
The answer is electricity.
Every data center behind the AI companies runs on it.
Every model Taiwan Semiconductor's chips are being bought to train runs on it.
And you cannot conjure new power in this country quickly. You permit it, you license it, and you wait.
Which is precisely the moat we've spent this whole letter talking about — except it's being dug right now, in public, by companies most investors have never looked at.
There's one in particular I've been following.
I put the whole story together for you here >>
If the three-moat test made sense to you today, this is what it looks like applied to a business that's still being built.
Have a wonderful day.
I'll see you tomorrow.
"The Buck Stops Here,"
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Written by Dylan Jovine