Identifying the ‘economic’ moat
Updated: Aug 9, 2021
In 2007, Warren Buffet wrote in Berkshire Hathaway's letter about the ‘economic moat.’ Just like a castle has a moat that surrounds the castle with muddy water, crocodiles, etc. This moat prevents the enemy from entering the castle. So likewise, an economic moat provides some sort of protection of business cash flows.
There is an excellent distinction between the competitive advantage and a wide economic moat. A competitive advantage is an edge that allows a business to earn better margins over its competition. In comparison, an economic moat is an advantage that lasts for a long-time.
Here are few “indicators” to help us identify economic moat:
1. Intangible assets: Fanatically loyal customers. Profit margins or cash returns on invested capital consistently exceed the industry average or those of their competitors—successful companies with high priced, quality products or services for decades, supported by their brand strength. Example, Asian Paints, Colgate.
2. Customer Switching Costs: If a customer of the product or services is required to spend more money or time for the closest substitute. Example, Bloomberg.
3. Networks Effect: Networks that become more useful as more people join. Example, Facebook.
“All intelligent investing is value investing, acquiring more than you are paying for. You must value the business to value the stock.” – Charlie Munger
You may be willing to pay a premium for these high equal high-quality, but you still can’t pay any price and incorrectly assume it’s a fair price.
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