Every growth investor or investor thinking about reaping massive gains are all on the hunt for one thing – finding the next company that is so innovative and ahead of the curve that it will be the pioneer of the next industry. Most investors in their mid-forties have also seen the rise (and fall) of so many companies. Companies like IBM, Google, Amazon, Ebay and so many others were selling their shares for pennies in the late 90’s and now have provide gains upwards of 1000’s of percents. Most people remember these times and now when they invest they are always on the look for companies that are ready to explode – so they don’t miss the train like they did before.
The concept of the economic moat –coined by Warren Buffett is a classic tool that is used when analyzing what companies fit the above description. The concept of the moat is simple – it seeks to identify future powerhouses on the premise of their competitive advantages – and specifically what are these companies doing now that their competitors are not. In essence, a business’ ability to maintain competitive advantages over the market in the long term will be in a better position to secure its long term profits and retain the highest possible market share.
There was a great saying by Philip Fisher who wrote Common Stocks and Uncommon Profits in which he used to ask companies “What are you doing now that your competitors are not doing yet”.
So what constitutes a moat?
There are several key elements that can constitute a moat. One of which is a low-cost advantage. For example, a company can make a lot more money if it is able to produce an identical product or service for a cheaper cost then a competitor. This will allow the company to have a higher gross profit margin meaning that per item sold the company bottom-line grows much faster then any of its competitors.
Another key element of the moat is proprietary technology – something that is highly prevalent in pharmaceutical companies. For example, if a drug or product is only sold by Company X – then that company is able to hold the market share for a longer period of time meaning more profits for the shareholders.
It is a known fact that over time competition and new companies entering the industry will erode the competitive advantages. But it is up to the company to find another advantage that can grow its moat. The way a company maintains its moat over time is equally important. This is where analysis looking into the company’s innovation, organic growth and past (and future acquisitions) come into play.
The longer a company is able to keep its moat wide - the longer it will be able to provide shareholders with immense returns.
Disclaimer: All of the above information is my own personal opinion. It should not be used as financial advice. I have provided a few examples of moats – they are others as well. Please consult with a licensed representative when making any investment decision.
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