Look up the definition of moat and you’ll find descriptions of the water and trenches that make up the line of defense around castles.
But search it again in relation to value investing, and you’ll find that a moat is that special something that keeps a company safe from competitors. Think of it as the unique advantage that allows an organization to stand strong against attack. It’s one of the four main principles we’ve been discussing, and in Episode 4 of Stocks4Docs we work through examples of each type of economic moat.
Why you need to look for moats in your investments
As Warren Buffet says, if you have an economic castle, people are going to try and take it from you. So you better have a strong moat and a knight in that castle that knows what they’re doing.
The moats we’re talking about today are really characteristics that give a company a durable, competitive advantage. It’s an intrinsic value that’s so embedded in the company that if you got rid of that characteristic, that special something, you’d probably destroy the company. It’s the thing that marks the company as being predictable and it helps keep its value high.
Here’s a quick overview of six types of moat we cover in Episode 4:
- Brand… the culture, unique value, and personality a company delivers. Entire lifestyles can be built around it. Great examples of this are Rolex, Coca Cola, and Starbucks. Harley Davidson is a great example of this.
- Secrets… includes patents, intellectual property, or items that come with legal protection. These are things that can’t be quickly replicated by competitors. Think of things like Lipitor by Pfizer, and the Walt Disney characters.
- Switching… comes into play when the cost of changing services or products between companies is high. This moat helps keep customers from leaving one company and going to a competitor. Examples include Apple products and Google.
- Toll… think Monopoly here. Companies that provide services like electricity where you pretty much have no choice but to go through them to get the product or service you need. PG&E is the electricity provider in Northern and Central California, so if you want electricity in their regions, you have to pay them.
- Network… when the value of the product or service increases as the number of people using it increases. You see this concept a lot with digital products, like Facebook and Twitter.
- Price… also known as a cost moat, this is when a company can successfully compete by selling products at a lower price than its competitors. Well-known examples are Wal-Mart and Costco.
So when you research companies and create your list of potential investments, moat is one of the characteristics to check for. You want to make sure each company has a very strong moat and that it provides a durable, sustainable advantage. And because there are always going to be competitors, you want to be sure the company is actively working to strengthen their moat for the long-term.
If you missed our overview on the four principles of value investing, click here to check it out.
You can catch Episode 4 of the Stocks4Docs podcast here and a full list of episodes here.