Contents
Every great business is built around a strong moat. - Warren Buffett
A company’s moat is an essential concept for investors and business professionals. It refers to a company’s ability to maintain competitive advantages to protect its long-term profits and market share from competing firms.
Think of a company's moat as the answer to What keeps competitors at bay?
Identify the Moat Types
There are several classic types of moats, and therefore, it is important to identify a company’s moat. In doing so, we can pinpoint what makes a company formidable.
Moat types can consist of one or more of the following:
- Brand Strength: Companies like Apple (AAPL) or Coca-Cola (KO) have strong brand recognition. People trust and prefer them.
- Cost Advantages: Walmart (WMT) and Costco (COST) have cost structures that competitors find hard to match.
- Network Effects: Companies such as Visa (V) and Mastercard (MA) become more valuable as more people use them.
- Intellectual Property: Patents and proprietary technology, like those held by pharmaceutical companies, create barriers to entry.
- High Switching Costs: Software companies like Microsoft (MSFT) have products that integrate deeply into business processes, making it costly for customers to switch providers.
Assess A Moat's Durability
Once we determine the moat(s) a company possesses, the next step is evaluating the extent to which they are sustainable since some moats last longer than others. Think about the following:
- Innovation: Is the company continuously improving? Or is it a one-trick pony?
- Customer Loyalty: Are customers coming back for more?
- Management Quality: Does leadership focus on long-term growth?
Monitor the Moat
A moat is not static, and therefore, a company must continually protect and enhance its moat. To do so, a company must pay particularly close attention to:
- Competitors: Are there new players trying to enter the market?
- Market Trends: To what extent are industry trends shifting, and how can the company adapt?
- Company Actions: How is a company investing to strengthen its moat?
Moat Threats
Even the strongest moats can face threats. The following can upend a company's wide moat:
Technological Advancements
New technologies can disrupt entire industries. Traditional taxi services, for example, were upended by ride-sharing platforms like Uber and Lyft.
Think about Kodak and how its business was decimated by technological advancements made by companies that did not even exist in the early 1980s.
Canada Post, a Canadian Crown Corporation, has also been upended because of technological advancements. Since 2018, it has reported over $3B in losses. This financial decline reflects both 'the Great Mail Decline' and an erosion of its parcel market share, which dropped from ~62% before the pandemic to a current ~29%.
Regulatory Changes
Government regulations can alter the competitive landscape. For instance, stricter environmental laws could impact companies reliant on fossil fuels.
The highly regulated telecommunications industry in Canada has led to BCE Inc. (BCE) – once a 'widows and orphans' stock – being forced to issue debt to service its dividend; BCE faces a very real risk of having to cut its dividend.
Market Competition
Intense competition from existing domestic and international industry participants or new entrants can erode a company's moat.
Customer Preferences
Shifts in consumer behavior can weaken a moat. If a company fails to adapt to changing tastes, it can lose its competitive edge. Blockbuster is a good example of a company that failed to keep up with the transition to digital streaming.
Economic Factors
Economic downturns can impact consumer spending and investment. Companies reliant on high discretionary spending may find their moat less effective during tough economic times.
The economic downturn in China has had a major impact on companies selling luxury consumer items. Not many consumers get too excited about purchasing high end handbags when they can’t maintain a roof over their head.
Management Missteps
Poor strategic decisions or leadership changes can weaken a company's moat. Mismanagement can lead to loss of market share and competitive advantage.
Think Starbucks and BlackBerry (formerly Research In Motion).
Innovation Lag
If a company falls behind in innovation, it risks being overtaken by more agile competitors. Continuous improvement and adaptation are crucial to maintaining a moat.
Supply Chain Issues
Disruptions in the supply chain can impact a company's ability to deliver products or services, eroding its competitive advantage.
Wide Moat Companies In The FFJ Portfolio
The following are a few examples of wide companies held in the FFJ Portfolio.
- Moody's (MCO): MCO has a wide moat primarily due to its intangible assets and network effects. Its credit ratings are deeply embedded in the financial markets, making it difficult for new entrants to compete.
- S&P Global (SPGI): Similar to MCO, SPGI benefits from intangible assets and network effects. Its credit ratings and indices are widely used, creating a strong competitive position.
- Visa (V): V has built what is often considered the ultimate moat. Its network effects and scale make it the largest payments network in the world. The cost and complexity of building a similar network act as significant barriers to entry.
- Mastercard (MA): Like V, MA enjoys a wide moat due to its network effects and scale. It operates in over 200 countries and is used by millions of merchants, making it difficult for competitors to challenge its position.
- Intuitive Surgical (ISRG): ISRG has a wide moat due to its proprietary technology and high switching costs. Its da Vinci surgical systems are highly specialized and require significant training, making it hard for competitors to enter the market.
- Cintas (CTAS): CTAS has a wide moat because of its economies of scale and strong brand. Its extensive infrastructure and long-standing relationships with customers create significant barriers to entry for new competitors.
- Copart (CPRT): CPRT’s wide moat is built on network effects, cost advantages, high switching costs, strong customer relationships, strategic land expansion, and minimal competition.
All of these companies have a market leadership position. They have built their wide moat on a combination of brand strength, network effects, intellectual property, high switching costs, recurring revenue, continuous innovation, economies of scale, and market leadership. These factors collectively protect their respective competitive advantage and help ensure long-term profitability.
Final Thoughts
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. – Warren Buffett
A company's moat is all about its ability to protect its market share and profitability from competitors.
Understanding a company’s moat can provide valuable insights into its competitive position and long-term prospects. By identifying moat types, assessing their durability, monitoring their status, and the potential threats, we can make more informed investment decisions.
I wish you much success on your journey to financial freedom!
Note: Please send any feedback, corrections, or questions to [email protected].
Disclaimer: I do not know your circumstances and do not provide individualized advice or recommendations. I encourage you to make investment decisions by conducting your research and due diligence. Consult your financial advisor about your specific situation.
