Note: This article first appeared on CFA Institute’s Enterprising Investor blog. “The key to investing is not assessing how much an industry is going to affect society, or how much it will grow, but rather determining the competitive advantage of any given company and, above all, the durability of that advantage. The products or services that have wide, sustainable moats around them are the ones that deliver rewards to investors.”
I think the term moat may not be fully appreciated for what it actually means. "Moat" and "Market power" are not mutually exclusive. Market power is derived from a wide and deep moat, and market power can in some cases beget a wider and deeper moat.
A moat is in essence a competitive advantage or barrier to entry - anything that allows a business to earn outsized returns on its invested capital, and which allows it to keep the competition at bay so that these profits don't get competed away. Market power is a result of this. A moat can be a strong brand, advanced technology, regulatory (i.e. patent protection, or a monopolistic license to operate in a specific market) or even geographical (e.g. specific metals). Moats help businesses achieve market (or pricing) power if used well by management, and the supernormal economic profits from this moat can be reinvested into widening the moat to entrench the firm's market power.
Market power without a strong moat to maintain that power is likely to be transient - free markets foster competition, and where there are profits to be made there will be new businesses trying to enter the fray, competing away the fat juicy profits enjoyed by the first mover.
I am currently reading competition de-mystified by Bruce Greenwald. He highlights the importance of market share in determining the competitive advantages a firm enjoys.
I always considered a moat as whatever allows for sustaining market share at the minimum. I do see how it might be easier with companies in industries with fewer competition, hence I heard Warren Buffet say there are very few good businesses. The durability of a company's advantages sustains its' market share (I do not consider this to be an easy task to accomplish in a lot of industries).
Greenwald makes the case that these competitive advantages start local (Walmart enjoyed it's best years smaller than bigger) and Buffet mentioned in his letter this year the importance of local businesses.
So yes, it seems the wrong metric has been focused on all along but I would like to think that it maybe was quite simple to understand.
When I read the statement highlighted in your article by Buffet, I see the same conclusion Stefan Jaspersen reached.
Thanks again Joachim. Your daily emails have become a highlight of my education (I will admit I do not read the emails on Friday yet).
I think the term moat may not be fully appreciated for what it actually means. "Moat" and "Market power" are not mutually exclusive. Market power is derived from a wide and deep moat, and market power can in some cases beget a wider and deeper moat.
A moat is in essence a competitive advantage or barrier to entry - anything that allows a business to earn outsized returns on its invested capital, and which allows it to keep the competition at bay so that these profits don't get competed away. Market power is a result of this. A moat can be a strong brand, advanced technology, regulatory (i.e. patent protection, or a monopolistic license to operate in a specific market) or even geographical (e.g. specific metals). Moats help businesses achieve market (or pricing) power if used well by management, and the supernormal economic profits from this moat can be reinvested into widening the moat to entrench the firm's market power.
Market power without a strong moat to maintain that power is likely to be transient - free markets foster competition, and where there are profits to be made there will be new businesses trying to enter the fray, competing away the fat juicy profits enjoyed by the first mover.
Thank you for educating individuals constantly.
I am currently reading competition de-mystified by Bruce Greenwald. He highlights the importance of market share in determining the competitive advantages a firm enjoys.
I always considered a moat as whatever allows for sustaining market share at the minimum. I do see how it might be easier with companies in industries with fewer competition, hence I heard Warren Buffet say there are very few good businesses. The durability of a company's advantages sustains its' market share (I do not consider this to be an easy task to accomplish in a lot of industries).
Greenwald makes the case that these competitive advantages start local (Walmart enjoyed it's best years smaller than bigger) and Buffet mentioned in his letter this year the importance of local businesses.
So yes, it seems the wrong metric has been focused on all along but I would like to think that it maybe was quite simple to understand.
When I read the statement highlighted in your article by Buffet, I see the same conclusion Stefan Jaspersen reached.
Thanks again Joachim. Your daily emails have become a highlight of my education (I will admit I do not read the emails on Friday yet).