A 'moat' means a wide ditch filled with water (maybe has crocodiles too!) around a castle to protect it. The investing legend, Warren Buffet loves moat, not this one but the economic moat that companies have. What does moat mean in a company's context? It is a competitive advantage that may also act as a barrier that helps the company to maintain its market position and not allow others to beat it.
Now, it is easier said than done. Identifying a moat takes experience and patience. Still, as an amateur, how can you know whether a company has a moat? Here are some pointers:
- Strong brand: This is obvious. When a company has strong brand recognition, it becomes very difficult for others to beat it or even come close. A great example is Nestle's Maggi which continued to have significant brand recognition despite all the allegations back in 2015. Another great example is Nike in the sports shoe segment.
- Great distribution: Companies require many years to spread their distribution. Hence, companies with widespread distribution are in a prime position. Kurkure, Parle-G, and Britannia biscuits are some of the best examples as these seem to be omnipresent. No matter where you are in India, you can easily find these.
- Costly to imitate: Let's say that a company has a feature/technique. How easily can a competitor copy this? That's the question. It is costly to imitate and copy features, methods, and techniques in industries where high and efficient R&D is required. Intel is a great example here. With the help of high and consistent R&D, the company has been able to retain its position as the market leader for years despite a recent nudge from AMD and its low-cost processors.
- High switching cost: If it's difficult to switch from something to another, the former can be said to have a moat. Microsoft Windows in the case of the operating system is a great example. If one becomes used to it, it is difficult to switch to another operating system. The same goes for the Apple ecosystem. When one starts using multiple Apple products, it becomes extremely difficult for them to leave that ecosystem.
- Low cost: A low-cost producer can drive its competitors out of business. It can sell its product at wafer-thin margins, which its competitors can't emulate. A great example is McDonald's. There are several fast food outlets in the US but why is McDonald's still the leader? This is because of the price at which it offers its products and services. The company literally has something called a 'Dollar menu' where you can buy food at just $1, $2, and $3.
Suggested read:
Six parameters to look for in a company before investing
Five factors to analyse a business
