Moat: What is it in Investing Terms? As you may know: A traditional moat refers to the water around a castle. A business moat is what makes a company predictable and allows us to put a value on the business. This approach has huge potential for brand building and Harley is brilliant at it. Another secrets company is Pfizer. They make Lipitor and a lot of other drugs that they patent and have exclusive rights to for many years.
A company like Dow Chemical, which creates a lot of products using their technology and secrets in the lab, that they then also patent. A secrets company is a big moat company. A great example of that is Pacific Gas and Electric.
Another toll bridge example is the Chicago Mercantile Exchange. Burlington Northern Santa Fe Railroad is another example of this type because pretty much all the railroads in America have some sort of a monopoly. This occurs when the cost of shifting from one supplier or product to another is too expensive for companies to consider.
For example: Costs like redoing all of your software that links your network together are often so high, CEOs would not consider making a change. Many people would have given up on the tree by this time. But not you. At least not in my story.
Overpriced When I was looking to acquire the first client for my writing business in , I had no idea how much to charge. I had no point of reference as far as content writing fee was concerned. For me, there were a few hours of work involved. Anyways, to my first prospective client, I dared to ask for a hefty sum of Rs 2, per article, simply going by the understanding that you charge not for how much work it is for you, but how much the service is worth for the client.
It took me several clients to figure this out. My next client, I tried charging Rs 3, per article. He went for it. The next client Rs 3, The next client Rs 4, I kept charging more and more until finally three clients all turned down my Rs 5, fee. So I lowered the price back to Rs 4, Acting as a majority they can hire and fire managements and bend them completely to their will. As a class they show neither intelligence nor alertness.
The only way to inspire the average American shareholder to take any independently intelligent action would be by exploding a firecracker under him. Most of us overlook the human aspect of operating a business. This is despite the fact that, in most cases, the future success of a business is directly tied to the quality of its people. Outside of the closed glass chambers in the corporate world, there is another very unusual place where grand scheming about workplace strategies read, office politics happens regularly.
Wondering what I am talking about? Let me give you another hint. You guessed it right. I am talking about the smoking areas. I was almost at the end of a beautiful evening drive. Refreshing cold breeze gently blowing on my face through the car windows coupled with minuscule traffic was like heaven on earth. Sporting an ear-to-ear smile I felt confident that nothing in the world had the power to take away my inner peace at that moment.
But, as usual, my faithful and ever reliable nemesis, the chaos-monkey, had different plans for me that evening. Just when I was about to take a smooth turn on a closing traffic signal, a taxi cut me off while overtaking my car. The surprising rash maneuver from the taxi called for sudden brakes and by that time signal had turned red.
As a result I missed my turn because of the insensitive driving by the taxi driver.
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Learn about our editorial policies What Is an Economic Moat? The term "economic moat," popularized by Warren Buffett , refers to a business's ability to maintain competitive advantages over its competitors in order to protect its long-term profits and market share.
Just like a medieval castle, the moat serves to protect those inside the fortress and their riches from outsiders. Key Takeaways "Economic moat" is a term that refers to a business's ability to maintain a competitive edge over its competitors. The analogy relates to the moats that would surround medieval castles and act as a barrier of protection. Ways in which a company can create an economic moat include creating advantages in size, intangibles, cost, and high switching costs.
The term economic moat was made popular by legendary investor Warren Buffett. A good example of a competitive advantage would be a low-cost advantage, such as cheap access to raw materials. Very successful investors such as Buffett have been adept at finding companies with solid economic moats but relatively low share prices. One of the basic tenets of modern economics , however, is that, given time, competition will erode any competitive advantages enjoyed by a firm. This effect occurs because once a firm establishes competitive advantages, its superior operations generate boosted profits for itself, thus providing a strong incentive for competing firms to duplicate the methods of the leading firm or find even better operating methods.
Example of an Economic Moat Let's return to the example of a low-cost advantage. Suppose you have decided to make your fortune by running a lemonade stand. Your low prices lead to an increase in the number of customers buying lemonade from you and not from your competitors. As a result, you see an increase in profits; however, it probably wouldn't take very long for your competitors to notice your method and employ it themselves.
Therefore, in a short period of time, your large profits would erode, and the local lemonade industry would return to normal conditions again. Other common financial analogies include referring to the stock market as a casino, bonds being the anchor of a portfolio, and having no financial plan is like skydiving without a parachute. This would have the same effect of reducing your average cost per glass of lemonade.
This time, your competitors will have no way of duplicating your methods, as your competitive advantage is protected by your patent. In this example, your economic moat is the patent that you hold on your proprietary technology. In this case, if your lemonade company was a public firm, your common stock would probably outperform that of your competition in the long run.
As you can see, a company's economic moat represents a qualitative measurement of its ability to keep competitors at bay for an extended period of time. This translates into prolonged profits in the future. Economic moats are difficult to express quantitatively because they have no obvious dollar value , but are a vital qualitative factor in a company's long-term success or failure and in the selection of stocks. Creating an Economic Moat There are several ways in which a company creates an economic moat that allows it to have a significant advantage over its competitors.
Below, we will explore some different ways in which moats are created. Cost Advantage As discussed in the lemonade stand example, a cost advantage that competitors cannot replicate can be a very effective economic moat. Companies with significant cost advantages can undercut the prices of any competitor that attempts to move into their industry, either forcing the competitor to leave the industry or at least impeding its growth.
Companies with sustainable cost advantages can maintain a very large market share of their industry by squeezing out any new competitors who try to move in. Another company that has a nice switching moat is Intel. The cost to switch services is just too much. Walmart of course is the king of price moats, as the company can create or sell products much, much lower than anybody else. Costco also competes on that basis, as does JetBlue, for example.
Conclusion You might notice that a lot of these companies have multiple moats. Certainly, businesses can have multiple durable advantages. In fact: The more the better. But you will find that every good company has at least one of these kinds of moats: brand, secret, toll bridge, switching, or price. Make sure that with any company that you are looking at buying, you can identify at least one.
Your job is to look into industries you understand so you can recognize companies with strong business moats. Your homework for this tutorial is to take the company that you found in the last tutorial, and figure out what type of moat that company has.
Is it a brand, secret, toll bridge, switching, or price moat? Related reading:.
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A secrets company is a big moat company. A great example of that is Pacific Gas and Electric. Another toll bridge example is the Chicago Mercantile Exchange. Burlington Northern Santa Fe Railroad is another example of this type because pretty much all the railroads in America have some sort of a monopoly. This occurs when the cost of shifting from one supplier or product to another is too expensive for companies to consider. For example: Costs like redoing all of your software that links your network together are often so high, CEOs would not consider making a change.
Another company that has a nice switching moat is Intel. The cost to switch services is just too much. Walmart of course is the king of price moats, as the company can create or sell products much, much lower than anybody else. Costco also competes on that basis, as does JetBlue, for example.
Conclusion You might notice that a lot of these companies have multiple moats. Certainly, businesses can have multiple durable advantages. In fact: The more the better. And having this patent, or trade secret is critical for the production of their product.
This is very common in the pharmaceutical and technology industry. Even Coca-Cola holds their recipe very near and dear to their heart. Price Moat A price moat promises to provide its products at a lower cost than its competitors.
Providing products at the lowest price will draw customers in. When a business has one of the 5 moats, it's wise for it to try to protect its moat.
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