The dictionary defines the word ‘moat’ as a “deep, wide ditch surrounding a castle, fort, or town, typically filled with water and intended as a defense against attack “.
The Concept Of Economic Moat While Analysing a Company
Economic Moat 101
A Thread 👇
Inspiration -- @FI_InvestIndia
The dictionary defines the word ‘moat’ as a “deep, wide ditch surrounding a castle, fort, or town, typically filled with water and intended as a defense against attack “.
- It will have little or no competition
- it will be in an industry which would be difficult to penetrate into
-It will have a distinct cost advantage
- it has a proven track record of generating huge profits
It might take years for some companies to reach a certain scale like the traditional brick and mortar companies to the likes of Walmart, P & G, Asian Paints, Dabur.
There are certain businesses where customers find it difficult to switch over either due to cost or due to the hassle in doing so.
It becomes difficult for customers to switch over to a competitor.
It works on the premise that existing satisfied customers bring more customers and so on, which in turn creates a wide network of customers.
From the competition perspective, such a huge network benefit becomes tough to crack.
A company can either offer a lower price at the same level of service or at the same price as the competition but can still earn higher profits.
These companies are able to offer lower prices per unit as their costs et spread over a larger amount of goods.
Technology and legal licenses, patents, intellectual property rights, brand formulations in the pharmaceutical industry, government approvals, brand name, goodwill, etc – all these give a unique competitive advantage to the businesses.
These intangibles bring pricing power and provide the distinct advantage of ‘premium’ over others.
Now that we are clear with what moat is and how companies establish it,
The important question needs to be answered- how to identify these companies for investments ?
Such companies have huge pile of cash either to be invested back in the business or is maintained to carry out normal business if there is any sort of short term business disruption or an expectation of revenue loss etc.
Most businesses would not perform when the economy is slow.
However during such times a business with economic moat sustains well and even if it is impacted, its performance is far better than the overall market or competition.
Such companies come with formidable brand value and name recognition.
In fact, most of the times the industry is identified with the brand itself.
This is a material advantage for any business.
The product can define the advantage the company has over others and also against its own ‘not so great products’.
Companies with moat will always be way ahead of the competition.
Thus a look at their year on year profit and revenue numbers will prove beyond doubt that their size and market capitalization is way ahead of any fathomable competition.
A company with so many benefits or a wide moat is definitely a company that is worth investing in and will create a lot of value for the shareholder.
It would also act as a cushion and will be way ahead of the competition if any.
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