Massive Moats: An introduction to the importance of a company's moat

A good business is like a strong castle with a deep moat around it. I want sharks in the moat to keep away those who would encroach on the castle. 
     - Warren Buffett. 

As Warren Buffett devotees, we like to do research on companies that have an economic moat. In this article series, we will explain the different kinds of moats that are present in our financial world. This week, we will start with an introduction to moats. What use do moats give to companies? And what kinds of moats are there?

According to the efficient market theorem, highly profitable companies in highly profitable sectors will attract rivals and hence face competition. In order to survive, the existing companies in a sector must ensure that they will stay relevant with their products or services. 

This is where moats come into play. Moats will prevent, or at least delay, the rise of competition in an industry. A moat should maintain a company’s durable competitive advantage, and with that its viability. Warren Buffett: “When you have a wonderful business, it's like having an economic castle. The nature of capitalism is that people want to come in and take your castle. You need a castle that has some durable competitive advantage. A castle that has a moat around it.” 

• Intangible Property (e.g. Intellectual Assets); 
• Switching Costs; 
• Network Effect (& Data Feedback Loop); 
• Cost Advantage (Low-cost production);  
• Efficient Scale (& Large Barriers to Entry). 

Analyzing companies their moats, in order to define a possible investment proposition, requires a long-term mindset. First, you need to define how strong a company’s moat is, followed by a determination how strong this moat will be in the future. Are there for example huge innovations in the industry happening at the moment that will bring substitutes to a company’s products/services? And will that make the current profitable business model obsolete in the future? 

Necessary questions you need to ask yourself in qualitative moat analyses.

Next article we will deep dive into the world of Intangible Property. 

Happy Investing, 
Massive Moats 

Your guide to select the best companies in the world. 

Disclaimer
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