Does the company enjoy an Economic Moat?
An advantage that the company enjoys in comparison with the competition.
What is an Economic Moat?
A term given by Warren Buffett means that there is some competitive advantage that a company enjoys. Traditionally a castle would be surrounded by water with deadly animals including crocodiles, piranhas, etc. so that enemies could not enter the castle. The same concept is applied to businesses. An advantage that the company enjoys in comparison with the competition. An Economic Moat keeps the competition at bay.
One of the ways to understand whether a company enjoys a competitive advantage is to look at the return on invested capital. If a company generates ROIC substantially higher than its cost or on a sustainable basis ROIC > 15% per annum, there is some competitive advantage.
What can be the source of competitive advantage?
Strong brand leading to customer loyalty – Nestle India
Patents – Google
Wide distribution network or service network – ITC
Switching costs – Microsoft Excel
Proximity to key raw materials and markets – UltraTech Cement
Cost advantages due to scale – Dmart
How can an economic advantage fade away?
Disruptive competition – Jio vs Airtel
Drastic regulatory change – Price cap during the pandemic on certain pharma companies
Capital misallocation by the management – Airtel buying Zain Telecom’s Africa assets