Economic Moat is a term that is used in a corporate context to describe a firm’s ability to maintain profitability over long periods of time. The wider the moat of a company, the more protected it will be from competitors entering its market and stealing its customers. A company can have a wide moat by having a unique product that customers find hard to replace and are difficult to copy, or by having a large competitive advantage over its competitors.
For value investing, an economic moat is one of Warren Buffett’s most favored terms. It is the competitive advantage that allows companies to generate high returns on capital. In other words, an economic moat is a barrier to entry that makes it difficult for a company’s competitors to knock it off its perch.
Warren Buffett, the most successful investor of the 20th century, is famous for his buy-and-hold strategy. That is, as long as he believes the business has a “moat” (a competitive advantage that is difficult for competitors to replicate), he is willing to let the business compound its earnings for years.
What is an economic moat in economics? In the context of equity investing, the most common term for this is a competitive advantage. What is it? It is a term used to describe the advantage a company has over its competitors.
List of companies with an economic moat in India
If Warren Buffett was looking for stocks in India, which Indian companies would catch his eye? He will invest in stocks with a wide economic diversification. It’s simple: A company with a big moat acts like it has a monopoly on the market. What is the advantage of a monopolistic enterprise? They have considerable pricing power. As a result, they operate at higher margins than companies with lower benefits.
Updated: 25 May 2021
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Before we can understand what an economic moat is, we must first understand what a moat is.
What is a trench?
A moat is a hole dug around the castle, which is then filled with water. It was a security device built around locks in ancient times. The wider and deeper the moat, the more secure the castle. The moat serves as a barrier for attackers to enter the castle. How does the moat around the castle help us to invest in actions? If we treat a company like a castle, the competitors are the aggressors. If a firm has a moat (competitive advantage), it can prevent competitors from taking over its business (or profits).
|Water (ditch / protection)
What is an economic moat?
An economic moat is also referred to as the competitive advantage that a company enjoys over a given period of time. No company can enjoy this benefit forever. Some benefit for a shorter period, others for a longer period. The concept of the economic moat in a company (competitive advantage) is an extremely important one for equity investors. But we talk more about the share price, the price/earnings ratio, recent news, etc.
What’s the reason?
Because we no longer hear the experts talking about the economic moat. In this article, we will attempt to discuss the concept of a stock gap. We will also use this knowledge to select some RV companies in India. These are excellent companies among the many mid-cap companies whose shares we can buy and hold for the long term. RV companies should be admired by investors because they create long-term shareholder value. After all, mobile home companies work in large quantities and offer high profitability.
Why is an economic moat necessary for a business?
Companies need to build fortresses. It takes a big trench. In general, a company cannot transfer its commercial or product know-how to its competitor. It’s like leaving the moat. Britannia (biscuit manufacturer) is not allowed to give its secret recipe to its competitors like Nestlé, ITC, Parle, etc. The stronger their secret, the wider their moat. In a free market, any product or service will eventually be duplicated. In that sense, all companies are in business. So as important as it is to develop and deliver products and services, it is also important to build a moat within the company.
Whether a company is very large or profitable, if it does not have a moat, it will not be able to remain competitive. Competitors will eventually develop similar or identical products and profits will begin to flow in their direction. No company can prevent the doubling of its products and services forever. Even global corporations like Coca-Cola, Pepsi Co, Apple, Microsoft, Nestlé cannot ignore the threat of replication from their competitors. Patents, copyrights, and trademarks may provide temporary protection. But a long-term competitive advantage (economic gap) must be built up (gradually, over time).
Firms with narrow moats are better than those without (no competitive advantage). But to be profitable in the long run, a company must build a wide moat. These companies continue to be preferred by investors because of their ability to generate high returns over the long term.
Factors that create an economic moat
The element that gives a company the widest moat (competitive advantage) is the customers’ preference for its products. No matter what competitors do, if customers don’t look the other way, the company will continue to generate sales, profits and margins. Market restrictions may also confer an advantage on undertakings.
The auto industry in the 1980s is an example of these limitations. At that time, 90% of the Indian population drove cars made by Hindustan Motors (HM), Maruti, and Fiat. The Indian economy was closed and giants like Ford, VW, and Toyota could not enter India. The constraints of the Indian economy have allowed HM, Maruti, etc. to gain economic benefits.
But such a trench is often short-lived. Of these two factors, the economic moat, based on customer preference, has lasted longer. So what are the factors that drive people to a particular brand or product? We’ll find out more.
Change in activities and customer preferences
A company should do everything possible to create a preference for its products and services. In this way, it creates added value for its customers. The higher the value created, the more this will discourage customers from switching to other brands or products. This cycle of customer preference, value creation and pressure to change can create a
huge economic gap for a company.
But what should a company do to create customer preference (add value or discourage change)? The following four actions can create more value for the customer:
- Excellent product quality: It all starts with the quality of the goods and services offered by the company. No matter how small the business is, if customers appreciate the offer, sales/profit will increase. This is one of the reasons why good companies spend a lot of money on the research and development of their products.
- Low cost: A good company finds a balance between quality and cost. A buyer may reject even the highest quality product if he finds the price too high. Costs are an essential element of value creation. This is one of the reasons why a low-cost manufacturer outperforms its competitors in the market.
- Brand Value: This gives customers a sense of pride in their products. There are certain brands whose products are considered more reliable than others. Some brands become a status symbol for people. It takes time and effort to build a brand, but it’s worth it. This can give the company a huge competitive advantage by providing value to all stakeholders.
- After-sales service: In recent decades, it has become increasingly common to create added value for existing customers. There will always be customers who have problems with the company’s products or services. How a company treats these customers is very important. Making a dissatisfied customer happy is good. These customers spread goodwill through word of mouth. This in turn can bring new customers to the company.
Why these four actions are important?
Customers who buy a good quality branded product at a low price and enjoy good customer service. These customers are less likely to switch to other competitors. They also attract new customers. That way, you can see what the company is trying to accomplish by creating value for its customers. All these measures ultimately discourage people from switching to other brands. A company with a lot of economic leeway is a company whose customers simply will not or cannot switch to other products. As an investor, you should always look for such companies.
However, it is also true that few companies have a large economic gap. That’s why these companies always haggle with inflated prices. So what can we do? The first step is to identify these companies. Make a list of RV companies in India. Second: Wait patiently for the price correction. Whenever the price of these companies drops 4-5% or more, grab them and hold them for the long term. Read: The effect of bonus shares and stock splits on long-term returns.
How do economic moats mean more profit?
Economic dominance gives companies pricing power. What is pricing power? Whether a company raises the price of its products or services, there will be no drop in demand. Examples: BMW, Bose, Rolex, Gucci, Harley Davidson, etc. These few companies (brands) have the most leeway. They have gained cult status with their customers. People will buy them anyway. Owning such branded products gives the buyer a sense of price. The desire to buy the products of these brands is so great that people often spare no expense to buy them. This gives the company pricing power, which ultimately translates into higher profits (EBIT, PAT and EPS growth).
How can fisheries enterprises be identified?
That’s a separate issue. The people doing these searches spend months identifying these companies. But we don’t have to go that far. Our selection criteria are sustainable profitability and company size. What is the logic behind this? RV companies are necessarily companies that operate at high profitability (margins). But it is also important to check the stability of the edge. Therefore, single year margin figures are not sufficient. The consistency of the figures over the last 5 to 10 years and the high averages should be kept in mind. We can use ROE and Return on capital employed (ROCE) is a financial ratio that ... More as financial measures of profitability. After we obtain the list of high-performing companies, we apply a size filter. This amount can be expressed in terms of turnover or market capitalisation. Personally, I prefer market capitalization as a second filter. Companies selected on the basis of these two criteria are what might be called Warren Buffett stocks. Read more: How to identify companies with strong competitive advantages.
For value investors, there is nothing better than investing in a company with wide margins. But a big moat is not a financial measure or a ratio that can be easily measured. The researcher must draw a conclusion based on the self-study (the four actions listed above). In addition to the company’s finances, it is also advisable to keep an eye on the general market situation. We can try to find brands that are known for their high quality products and services. Thank you for reading and good luck with your investments. Next >> Industry analysis (competitive advantage)The concept of the economic moat was developed by Warren Buffett to determine how to differentiate between a good business and one that is excellent. Buffett has said that a good business has a durable competitive advantage that allows it to increase intrinsic value over time. In a nutshell, an economic moat is the competitive advantage that a business has over its competitors. A company with a wide economic moat has a better chance of increasing intrinsic value for shareholders.
Frequently Asked Questions
How do I find a company’s economic moat?
A company with a moat has some kind of economic barrier that keeps the competition away. For example, there might be a company that maintains a high price-to-earnings ratio, which means that the company is relatively more expensive than its competitors. If a company has a moat, then it can maintain a high price-to-earnings ratio because the market will pay a higher price for a safe investment. In this case, the company’s profits are relatively safe and it has a moat.
What is moat investing?
Moat investing is one of Warren Buffett’s favorite ways to generate excess returns. In fact, he has said, “The single best protection against inflation is owning productive assets.” A moat is a sustainable competitive advantage or barrier that prevents rivals from easily entering the market, allowing the company to keep prices high. The term “moat” was first coined by Warren Buffett in his 1996 letter to shareholders for his company, Berkshire Hathaway. He uses it to describe the competitive advantages his company has against external competition.
How do I know if I have economic moat?
We can only answer this question by identifying what economic moats are. In “The Warren Buffett Way” and “The Essays of Warren Buffett, Lessons for Corporate America”, Buffett has made a definition: An economic moat is a sustainable competitive advantage or an intangible asset that is difficult for new entrants to mimic and that gives a business a long-term competitive advantage over its rivals.
In “The Warren Buffett Way”, Buffett says that the economic moat of Coca-Cola is its brand recognition. In “The Essays of Warren Buffett, Lessons for Corporate America”, Buffett says that an economic moat of Well Fargo is its automated teller machines (ATMs).
In this book, there are few things better for long-term investors than a business with a wide moat. The moat protects the business from the competition, enabling the company to earn high profits over an extended period of time. In order to understand whether a specific company has a moat or not, a good first step is to examine the company’s economic moat.
An economic moat is a sustainable competitive advantage that a business possesses over its competitors. If a business has this advantage, it will enable the company to earn higher profits or even in some cases guarantee the company will be profitable.
What is a good economic moat?
An economic moat is one of the most successful investment strategies of all time. Warren Buffett, one of the greatest investors, has used this strategy to build an $85 billion empire. (And he might be worth $125 billion soon!) Warren Buffett believes that the key to success in the stock market is to find companies that are able to earn more money each year than they spend.
A moat is a business’s economic protection from competitors. It can be hard to find an economic moat when you are searching for the best stocks to buy for long-term returns.
The best moat stocks are likely to continue to generate high returns, even when the overall economy isn’t performing well.
The best economic moat stocks will have sustainable high returns on capital, pricing power, strong balance sheets, and hard-to-replicate competitive advantages.
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