The Five Rules for Successful Stock Investing — Pat Dorsey: COMPLETE

The five rules, in the book's own order and in a free translation. One: do your homework — a stock is a share of a business, not a lottery ticket, and you must understand the operations, their economics and their competitive strength before you buy. Two: find companies with economic moats — structural advantages that protect profitability against competitors for a long time.

Three: demand a margin of safety — pay clearly less than the company is worth, because your valuation is always uncertain. Four: hold for the long term — time is the moat holder's friend and the enemy of costs. Five: trade rarely — every buy and sell costs brokerage, spread and tax, and the more often you trade, the more you pay for activity instead of value.

The book's structure is pedagogically straight. First the moat doctrine: four chapters that define what a moat is, which four sources it can spring from, which ones only look like moats (Mistaken Moats), how moats erode and where they are found. Then economics-101: one chapter each for the income statement, the balance sheet and the cash flow statement — how to read them and where to dig. After that the five-year analysis of the company and the valuation with Morningstar's discounted cash flow model, with uncertainty and margin of safety.

Finally a long section of industry walkthroughs — banks, asset managers and insurance, pharmaceuticals, consumer services, software, hardware, media and more — where Dorsey shows what moat logic looks like in each industry's own financial ratio language.

For AK1A this book is quite simply the source document of V13–V15. When AKM1 scores Patents and intellectual property rights (V13), Brand and customer loyalty (V14) and Network effects (V15), it is Dorsey's four moat sources that lie at the bottom — with an AK1A addition the course returns to several times: the points must be set on measurable indicators, not on stories.

And already here, in the course's first chapter, honesty belongs on the table: the moat concept is contested. Academics question whether moats can be identified in advance, and Morningstar's own moat funds have at times performed mediocrely. Chapter 7 is devoted to the whole controversy — the book deserves a course that also dares to examine it.

The definition, in a free translation from the book's chapter Economic Moats: an economic moat is a structural characteristic of the business that lets the company generate excess returns on capital — that is, more than the capital costs — for a long time. The word structural is the whole difference. A good quarterly figure, a hot product or a capable CEO is not structure; that is weather.

The moat is what in the company's architecture stops well-financed competitors from taking its profitability away, even when they try. Buffett's image: the castle is the business, the moat is what protects it — and the best investment is a castle with a wide, water-filled and crocodile-filled moat.

So how do you measure whether a moat exists? Dorsey's answer is brutally practical: look at the return on capital — ROE, and preferably ROIC — over time. A company that year after year sits clearly above its cost-of-capital level has something structural; a company with wildly good years and loss years most likely just has luck, leverage or cycles.

Free cash flow relative to revenue is the sister metric: moat companies convert revenue into cash at margins that persist. In AKM1 this is V09 ROE as a persistence metric and V07–V08 the margins as level metrics — the moat shows itself in both remaining high when the business cycle turns.

Morningstar's four moat sources — on which the whole rest of the book's first part and the whole of AKM1's Moat category are built — are: intangible assets (brands, patents and regulatory licences), switching costs (it costs the customer more to switch than to stay), network effects (the product's value grows with the number of users) and cost advantages (durably lower cost per unit — through process, location or scale).

Note that Dorsey in later writings came to summarise three of them as intangible assets, but the book works with the four sources and so does the course. The chapters 3 up to 6 go through each source in depth with V mapping.