What is an Economic MOAT and why it’s Worth Investigating

What is an Economic MOAT and Why it’s Worth Investigating?

What is an Economic MOAT and why it’s Worth Investigating?

During the time of the Kings and Queens, the huge walls of the royal castles were protected by digging the earth around the castle and filling it with mud and water. This is called ‘moat’ and it helped the kingdom to survive in case any of their enemies attacked.

Due to the moat, these castles had an advantage (as a defense system) which their enemies were not able to break easily. And hence, many of the castles were able to survive for a long time.

The same concept of ‘MOAT’ is also applicable in the stocks.

Many companies have created an invisible protection around themselves, which give them an advantage over their competitors and help them to keep their business profitable for a long time.

In this post, we are going to discuss what is an economic moat and why is it worth investigating.

What is an economic MOAT?

An economic moat can be defined as a competitive advantage for a company against its competitors or the companies in the same industry. It helps to create a closed market with a profitable business which is difficult for the competitors to copy.

The moat can be because of multiple reasons like brand value, business monopoly, intangible assets (patents and regulations), low production cost, good networking, technology etc.

The economic moat helps the company to sustain success for long-term.

Warren Buffett’s thoughts on Moat.

The concept of economic moat is quite old. Benjamin Graham, the mentor of Warren Buffet and father of value investing, discussed the same in his book ‘The Intelligent Investor’.

Warren Buffett always looks for an economic moat in the company before making his investment decision.

Here’s a quote by Warren Buffett from his company Berkshire’s 2000 annual meeting:

“So we think in terms of that moat and the ability to keep its width and its impossibility of being crossed as the primary criterion of a great business. And we tell our managers we want the moat widened every year. That doesn’t necessarily mean the profit will be more this year than it was last year because it won’t be sometimes. However, if the moat is widened every year, the business will do very well. When we see a moat that’s tenuous in any way -it’s just too risky. We don’t know how to evaluate that. And, therefore, we leave it alone. We think that all of our businesses – or virtually all of our businesses — have pretty darned good moats.”

-Warren Buffett (Berkshire’s 2000 annual meeting)

“A truly great business must have an enduring ‘moat’ that protects excellent returns on invested capital. The dynamics of capitalism guarantee that competitors will repeatedly assault any business ‘castle’ that is earning high returns.”

-Warren Buffett (2007- letter to shareholders)

(Source: Investment Archive)

Also read: Top 10 Warren Buffett Quotes on Investing.

5 Characteristics of big ‘MOAT’ Companies:

Here are the 5 different characteristics of a company with a big moat :

1. Production advantage:

Many companies create an economic moat around themselves by developing a cheaper production cost compared to its competitors. As their production cost is low, they can make a good profit margin.

Low production cost can be created because of different reasons like cheap raw material, low labor cost, highly-efficient plants etc.

For example, ‘Maruti Alto’ has been the best-selling car in the ‘Hatch-back’ segment of the passenger vehicle for a very long time. This is because Maruti Suzuki has been able to build ‘Alto’ at a cheap price (with superior quality) for over 15 years according to the demand of the Indian audience.

2. Brand Value:

There are a number of companies whose consumers get ‘used to’ the products and creates a habit for it. They become a fanatically loyal customer and either do not need or do not want to look for any another company for that product or services. Few companies with big brand value in India are Asian Paints, HDFC Bank etc.

3. Business Monopoly:

If any company is the single supplier or single service provider in an industry, then it can be considered as a business monopoly. There are no direct competitors for these companies and hence, they cover the whole market segment. For example- Coal India.

Also read: Investment vs Speculation: What you need to know?

4. Switching Cost:

A company can also create an economic moat if the switching cost for the customers is too high. Few products and services are not easily abandoned by the customers as they involve switching cost. The best example of a company with switching cost as the economic moat is TCS. This information technology giant provides the best service in this field. Moreover, in order to switch to other company, it might require a lot of technology/service change which might be little difficult for the customers.

5. Entry Barrier:

There are few industries where the ‘entry-barrier’ acts an economic moat for the company. These barriers can be because of multiple reasons like patents, brand recognition, a high cost of set-up, government licenses etc.

For example, the telecommunication sector has an entry barrier because of the huge initial set-up cost. Similarly, a pharmaceutical company has an advantage over its competitors due to patented drugs, which will act a moat. No other pharmaceutical company can produce that patented drug.

Few other industries with entry barrier are Oil and Gas, Airlines, Cigarette industry etc.

Apart from the above 5, a few other characteristics of big ‘moat’ companies are a high network, technological advantages, unique products etc.

Few Examples of Indian Companies with big MOAT.

Here are few Indian companies with a big moat, which give them a competitive advantage over their competitors:

  • Hindustan Unilever (HUL): Consumer goods giant with brands like Surf Excel, Lux, Lifebuoy, Sun silk, ponds, Vaseline, Axe, Wheel etc.
  • Britannia Industries: Indian food corporation company with products like biscuits, bread, dairy, cakes etc.
  • ITC: Cigarettes (ITC Ltd sells 81 % of the cigarettes in India)
  • Nestle: It is famous for “Maggi”, chocolates etc
  • United Spirits: USL has more than 140 liquor brands including McDowell’s, Antiquity,  Vladivar etc.
  • Castrol India: Largest manufacturer of automotive and industrial lubricants in the Indian lubricant market and owns around 48% market share in the overall Indian lubricant market.
  • Asian Paints: As of 2015, it has the largest market share with 54.1% in the Indian paint industry.
  • Page Industries: Also known as Jockey India, one of the biggest manufacturer of inner and underwears in India.
  • Pidilite Industries: Adhesives manufacturing company with brands like Fevicol, Fevikwik, Dr. Fixit etc.

hul products

Bottom Line:

While investing for long-term, always look for an economic ‘moat’ in the company. Not just it helps in longevity but also increases the profitability of the company.

However, even companies with big ‘moat’ can lose their charm and market segment. For example, after coming of Baba Raamdeo’s ‘PATANJALI’ in the market, many of these big players like HUL, Colgate, Godrej etc have lost their market share.

Nevertheless, having an economic ‘moat’ gives these companies a lot of advantage. And that’s why it’s really difficult for the ‘Yog-guru’ to capture the market despite having a great product and an amazing marketing strategy.

That’s all. I hope this post on “What is an Economic MOAT and why it’s Worth Investigating?” is useful to you.

Please comment ‘below’ the names of other companies having big ‘moat’ which are not mentioned in this post.

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