You may have heard some tales from the Middle Ages that featured castles surrounded by large moats. These moats were designed to keep out intruders. The wider and deeper the moat, the more protected the castle would be.
Did you know that companies also have moats? They aren't literal moats, they're metaphorical ones. Learning about these moats can help you as an investor. In investing terms, the word "moat" mainly refers to a competitive advantage. To say that a company has a "wide moat" is to say that it has a unique edge over other companies in its industry. In a broader sense, it can be used to describe something in the company's business that can protect it for the long term.
You can look closely at these moats to find out whether a company can withstand tough times. The stronger the moat, the better.
Key Takeaways
- A wide-moat company can withstand tough times without a huge effect on its success.
- Amazon, Apple, and Walmart are all examples of wide-moat stocks that have stood the test of time.
- Find wide-moat stocks by looking at a firm's earnings performance during lean times, especially compared to other firms.
- Cash on hand, name recognition, and a focus on one superior product are the key signals that a stock might have a wide moat and be worth investing in.
Examples of Wide-Moat Stocks
For the average investor, an ideal stock is one that offers steady growth over time. It should also have the power to withstand market downturns and tough times. If you invest for the long term, you should look for companies that are tough in the face of competition and changing conditions.
The famous investor Warren Buffett often gets the credit for using the term "moat" to describe such an advantage. In an article in Fortune magazine, he said:
"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. The products or services that have wide, sustainable moats around them are the ones that deliver rewards to investors."
So, what are some high-profile stocks that are known to have a wide moat? Amazon could be one. The company dominates e-commerce, with some projecting that the firm may seize nearly 50% of all online sales in the U.S. Amazon also has unique built-in efficiencies, as well as warehouses and supply chain systems that make it very tough for both online and traditional stores to compete.
Walmart is another firm that is often praised for its wide moat. It's the largest brick-and-mortar retailer, with a vast e-commerce side as well. Plus, it has a big edge in that it is able to offer a large number of products at prices that undercut the competition. Also, it is a discount retailer, which helps it see strong sales both when the economy is doing well and when people have less money in their pockets.
Finding Wide-Moat Stocks
There are some companies, such as Walmart and Amazon, that clearly have wide moats. But moats are not always so easy to see. This is quite true with firms you may not know as well.
If you are looking to find stocks with wide moats, looking at past stock performance and financial statements can help. While you are taking a closer look, keep an eye out for certain signals that can show a firm's strength.
Earnings Performance During Bad Economic Times
See whether the company still seems to be doing well, even when the broad economy is not. That may show that there is something about its business plan that allows it to keep going in tough times.
Cash on Hand
Many companies make a choice to keep a lot of cash rather than reinvest it or pay dividends. Some may argue that a company should spend its cash or give it back to investors. Keep in mind, though, that having lots of cash on hand will provide a strong cushion if revenues don't meet expectations.
Revenues and Profits as Compared to Competitors
First, seek out the company's key competitors, and then compare their revenues and profits to the company you're looking at. If there's a big gap between your company's earnings and those of firms it competes against, you can say that the more profitable one probably has a wide moat.
Dominance of a Single Product
Apple is said to have a wide moat, because sales of its iPhone far outpace those of any other smartphone business. Intel has led the semiconductor industry for years, because its chips are commonly used by most computer makers. The popularity of these products gives their makers a wide moat, protecting them against the competition. They may even protect them against potential failure of their other products.
Powerful Intellectual Property
Often, one company may have a unique patent on a product or technology that other firms have little choice but to use. This advantage can be a powerful driver of revenues that competitors can't match.
Name Recognition
Is the company practically synonymous with the industry? Do people use its product or services simply because they are recognizable and have been around for a long time? Sometimes, simply having a long, reliable presence in the marketplace can give a company a strong advantage.
The Bottom Line
A company with a wide moat is likely worth investing in. It is often profitable in both good times and bad, and it can bounce back after bad news. It's likely also dominant in its field.
Knowing where to find firms with wide moats and how to invest in their stocks can be a key part of building a strong portfolio.
Frequently Asked Questions (FAQs)
What is an economic moat?
This term refers to a company's competitive advantage and how sustainable that advantage is. A company with a wide economic moat has competitive advantages that could be expected to last more than 20 years, while a narrow economic moat might only give a company advantages for 10 years. Other companies don't have any moat and thus are vulnerable to competitors.
How do you identify the economic moat of a company?
Some companies specialize in rating the economic moats of publicly traded companies. There are even indexes that track this information, including the Morningstar Wide Moat Focus Index, which includes companies like Merck, Philip Morris, and Campbell Soup Company. You can also do fundamental analysis to reach your own conclusions about which companies have wide economic moats.
